Joined Nov 11, 2007
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Spanish Banks: Worth The Risk?

I can understand if you don’t own Banco Santander (STD +1.33%) or Banco Bilbao Vizcaya (BBVA +1.60%).

The euro debt crisis just seems to drag on and on, getting scarier with each day. And Spain is the current center of that crisis and Spanish banks are the focus of the Spanish crisis. So owning these two stocks, even if they’re the best banks is Spain, feels very risky on most days recently.

So why do I own them in my portfolios? Let me explain my reasoning on these two stocks right now. (I own Banco Bilbao Vizcaya in my Jubak’s Picks portfolio and Banco Santander in my Dividend Income portfolio.)

At current prices I think both stocks have pretty much discounted all the risk of a meltdown in their portfolios — short of the very unlikely event Greek-style de facto default by Spain on its sovereign debt. For example, Credit Suisse has run a scenario that looks at a full write-off of the property portfolios of Spain’s banks. For Banco Santander that would result in a loss of 16 billion euros — no mean sum — and although the bank would take a big hit to earnings from a need to add about 8 billion euros to its provisions against losses, it would not need to raise additional capital. Neither would Banco Bilbao where the loss would be $10.9 billion euros and the bank would need to add $6.5 billion euros to its provisions for losses.

How could these two banks take a 100% loss on their property portfolios and still come out so well? Because while each of these banks is headquartered in Spain, most of their assets aren’t in Spain. For example, only 25% of Banco Santander’s loan book is in Spain. About 50% of Banco Santander’s profits come from Latin America and Spain accounts for just 33% of Banco Bilbao’s income.

That geographical exposure has let these two banks build up comfortable capital cushions — Banco Santander showed a 9.1% core capital ratio at the end of 2011, for example, by the strict European Banking Authority standards — and to show relatively low ratios of non-performing assets (4% at Santander.)

That doesn’t mean these two bank stocks aren’t without risk — it’s just that at this point in the trashing of their stocks — shares of Banco Santander are down 49% in 2012 through May 29 and shares of Banco Bilbao Vizcaya are down 46% — I think the big risks are political. It’s the uncertainty of what the Spanish government might do — and especially the possibility that the government might force these two relatively healthy banks to acquire some of Spain’s worst banks — that links these banks to the Spanish banking crisis and sends their share prices tumbling whenever there’s bad news about another Spanish bank such as Bankia.

My read is that the odds of this kind of move by the Spanish government are very low. I don’t think the government of Prime Minister Mariano Rajoy is looking in that direction and I think these two big banks have the political muscle to head off that alternative.

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