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Banco Santander: One Man's Fear is Another Man's Opportunity

NEW YORK (TheStreet) -- Spanish banks have been in the headlines for months now, as investors (and the Spanish government) ponder their solvency and fate. One bank that is attractive to investors is arguably one of the most misunderstood banks trading: Banco Santander (SAN).

Banco Santander provides a range of banking and financial products. It offers various deposit products, such as demand and time deposits; savings and current accounts; repurchase agreements; mortgages and personal loans; consumer finance; and telephone, mobile and online banking services. The company operates primarily in Spain, the United Kingdom, other European countries, Brazil and other Latin American countries and the United States. As of Dec. 31 it had 6,608 branch offices in continental Europe; 1,379 branches in the United Kingdom; 6,046 branches in Latin America; and 723 branches in the United States.

From the description of the company, we can see that the bank is involved in more markets than just Spain and the surrounding countries. This is the primary driver of the opportunity. Many investors mistakenly believe the bank derives the majority of its profits from Spain, but upon closer investigation, this is not the truth.

As the below chart details, Spain and Portugal (and, heck, the rest of Europe ex-Germany) account for less than 20% of net attributable profit. This is less a Spanish bank than it is a Latin American bank based in Spain. This fact is too often overlooked.

Once an investor can get past the mischaracterization of the bank, Santander looks extremely compelling; it trades at approximately 64% of book value, has a dividend yield of 14%, a forward P/E of 7.6x, a PEG ratio of 0.55 and strong core capital ratios. As with any investment, further investigation is warranted.

Real estate
One of the largest concerns noted with Spanish banks (or just about any bank) is real estate exposure after the popping of the bubble in Spain. Santander is in an enviable position within Spain, as its exposure is not as heavy as other banks' and it is well provisioned for the sector.

Dividends
With a dividend yield of approximately 14%, one question that comes to mind is: "Is the dividend sustainable at these levels?" During the Q4 earnings call, the CEO said:

"Our payout or shareholder return policy is already set, and I will confirm that there will be no changes. We will continue with the same percentage of scrip dividend we've had until now. If change were to be proposed, it would have to be approved by the AGM. But for now, this will continue to be our payout policy. As the chairman also reported during our investor day, it will continue to be EUR0.60 per share and there's not really very much else I can add to that."

Now, many will say "the best-laid plans of mice and men" -- and they might be right. If Banco Santander increases scrip dividend, it dilutes shares; if it cuts the dividend, the yield will fall. If the dividend yield was cut in half, it would still be above the large U.S.-based banks, and if they dilute the shares with scrip, it will not be significant enough to constrain future growth.

Capital
Profit, dividends and real estate exposure don't mean anything if the bank is undercapitalized and will have to raise capital in the near to intermediate term.

As the above table shows, the bank is more than adequately capitalized and can handle further provisioning if required.

Liquidity
One of the primary concerns with banks is liquidity or, better put, the source of funds. An over-reliance on short-term funding can bring the house down. So what about Santander?

While a loan-to-deposit ratio above 100% is not optimal, at 115%, the loan-to-deposit ratio is manageable.

Risks
While the case for Banco Santander is very compelling, one must be aware of the risks:

1. Spain's reliance on its banks to buy debt at the sovereign auction could increase the risk profile of the investment portfolio of the bank (the "Greek" risk). Approximately 39.3 billion euros, or 27.3%, of our investment securities at Dec. 31 consisted of Spanish government and government agency securities. This is manageable, but I am looking forward to an updated exposure.

2. "Emerging market" risk has to be understood. The reason the bank is not focused on its home country is that it has expanded into Latin American countries. The bank is well positioned within these countries (typically has a local listing of the subsidiaries shares) and has been managed extremely well.

3. Spanish bank audit and potential recapitalization. The audit results were finally released June 22 and said Spain's three biggest banks -- Banco Santander, BBVA (BBVA) and Caixabank (CABK) -- would not need extra capital even in a stressed scenario. It said the problems were limited to a small group of Spanish banks on which the state has already started to act.

Bottom line:
Santander is well positioned to grow within Spain when the economy recovers (yes, this is longer term) and will continue to grow in the rest of its higher-growth markets in the interim. I believe the bank is in a better position than most of its peers and is not confronted with the same issues its U.S. counterparts were -- and are -- since the financial crisis. The bank has a better risk/return profile than its U.S. "value" peers such as Citigroup (C) and Bank of America (BAC) as well as the "safe" U.S. banks such as JPMorgan Chase (JPM) and Wells Fargo (WFC). The bank has solid capital levels and decent return figures, although its equity is trading at approximately 50% of book value. Ultimately, I believe this bank's stock presents value in the near- to long-term given its exposure to high-growth markets and what I believe is manageable exposure to Europe. The bank also has a very attractive preferred stock (SAN-E) with a 10.5% rate with a yield of 9.97% and a yield to call of 7.92%.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Research conducted by Rubicon Associates. Michael M. Terry, CFA, is the founder and principal of Rubicon Associates and has nearly 20 years of experience in the investment management industry focused on the analysis, investment and management of fixed-income and preferred-stock portfolios.

At the time to publication, the author was long Banco Santander equity.

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