This is one of the very few European banks which met our Cashflow Solution investment criteria during the recently-concluded annual review of companies’ report and accounts, marking the first time we have added a retail bank to our funds for a number of years. The UK banks sector is either loss-making or, for those banks that are not, there is not yet enough evidence of significant restructuring, in our view.
A selection of UK and European banks were flagged up during this year’s review, primarily due to the level of balance sheet restructuring seen in the sector – this is one of the quantitative elements which forms part of our cash flow screen†. The banks that appeared on our screen as undergoing significant restructuring included Barclays, Deutsche Bank, Credit Agricole, Banco Santander and UBS.
Whilst Deutsche Bank and Barclays both ranked within the top quintile of our quantitative screen, it was clear on further analysis that the impact of changes in the fair value of derivatives was distorting financial ratios. An important part of our annual review process involves ruling out companies that may appear superficially attractive on our screen but on further analysis of the accounts, notes and annual commentary are being flattered by distortions or anomalies.
In contrast, UBS, Credit Agricole and Banco Santander ranked in the top quintile of our screen and also rated well in our subsequent qualitative research process. UBS has been added to the European Growth Fund, Credit Agricole has been bought in institutional mandates confined to the eurozone, while Banco Santander has been added to both the European Growth Fund and the Global Income Fund and bought across pan-European and eurozone mandates.
We found during the course of our analysis that, broadly speaking, continental European banks have been shrinking their activities in an all-together more meaningful way than their UK counterparts, which are not yet showing sufficient signs of restructuring. If we take Banco Santander as a case study, the company is currently engaged in a programme targeting €1.5bn of cost savings by 2016. Over two thirds of these savings are expected to come from an efficiency plan with the remainder from merger-related synergies (for example in Spain it has merged Banesto and Banif into Santander, and in Poland merged Bank Zachodni WBK and Kredyt Bank).
Having endured five years of a tough business environment characterised by rising non-performing loans and falling revenues, there are indications that the current environment is becoming significantly more favourable for Santander: non-performing loans are falling which is driving provisions lower, cost savings are being delivered and revenues are beginning to show signs of recovery.
The balance sheet is now stronger – the loan to deposit ratio declined a further four percentage points in 2013 to 109% which is a significant improvement on 150% in 2008. Its core capital ratio also improved, by 1.1 percentage points to 11.7% – again a notable improvement since the 7.6% recorded in 2008. Our view is that companies in the banking sector that stand to benefit the most from the improved economic environment are likely to be those that have focused on significant internal cost and balance sheet restructuring.
Encouragingly, during those tough years, Santander’s management showed commitment to strong capital management and shareholder returns by maintaining the dividend payout throughout the crisis period. As Chairman Emilio Botin commented in the 2013 annual report, “shareholder remuneration continues to be a priority for Banco Santander.” The stock is currently generating a dividend yield of 8.4%.
This commitment to the dividend and to the improved financial strength of the company is reflective of the significant shareholdings of the chairman and other members of senior management, a potential benefit which I highlighted in the ‘Family Fortunes’ blog last year.
