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Ana is a very determined and straightforward person who sees things rather in black and white,” says a close adviser to Santander’s executive chairman. “When she decides to do something, she doesn’t hang around.” She certainly hasn’t. On January 8, Ana Botín gave the green light to Santander’s issuance of €7.5 billion of new share capital in a ballsy accelerated bookbuild, even as nervous equity investors struggled to absorb the implications of the still falling oil price for global growth and European deflation. Volatile stock markets were trending down at the start of 2015 and nerves in Europe were stretched further by the impending Greek election, renewed talk off possible euro break-up and fears that the ECB has got behind the curve on quantitative easing.
The first full business week of January is traditionally the preserve of highly-rated sovereign and supranational bond issuers launching low-risk debt capital markets deals, not issuers from an out-of-favour sector launching equity in record size.
Santander’s €7.5 billion deal, equating to $8.9 billion, was the largest accelerated offering on record in the European equity capital markets. It was the largest accelerated offering globally since the US government’s $20.7 billion sell-down of AIG stock in September 2012. It was the third largest Spanish ECM deal ever done in any format. And while Deutsche Bank had done a bigger capital raising, for $9.2 billion equivalent, in June last year, that was a rights issue, allowing for prolonged marketing to existing shareholders at a 21% discount to the theoretical ex rights price.
Other European banks, such as Barclays and Commerzbank, did rights issues last year with discounts above 30%.
Santander’s deal was a risk trade, done quickly – in under four hours – in just about the largest size possible without doing a rights issue, at 9.6% of capitalization and taking the market by surprise. It priced at a 9.5% discount to the previous close.
The rights issue completed a whirlwind first four months in the role in which Botín succeeded her father. First she overhauled her senior management team and the bank’s board. Next, she changed the dividend-first policy that had long been a core part of Emilio Botín’s strategy for 30 years. And now, the new share issue reversed the previous regime’s insistence that its capital base was more than adequate.
Markets expected Botín to stamp her authority quickly on the bank — but perhaps not at this speed. The whirlwind start took many outsiders by surprise, though it shocked no one who knew her well. “It’s Ana — what else did you expect?” says one executive who has worked closely with her for a number of years.
José García Cantera, who became group CFO as part of Botín’s management overhaul, tells Euromoney that once the decision was taken to raise capital, there was little appetite to get caught up in a cumbersome and time-consuming rights issue. The bank quickly decided to do an accelerated deal, which companies can do up to a maximum of just under 10% of capitalization.
It may also have wanted to jump ahead of any other banks preparing to raise capital as the industry now converges on a new paradigm of 10%-11% fully-loaded Basle III common equity tier 1. Attention was turning to other large eurozone banks with ratios below this, such as Bank of Ireland, Banca Popolare in Italy, Commerzbank in Germany, Natixis in France.
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Work started in earnest only in the last two weeks of December. Given minimal trading volume in the final days of the year and at the start of January, the deal proceeded at a stunning pace.
First came the choice of lead managers in a sensitive deal that could not be signalled in advance to the market. With an accelerated deal, secrecy is vital lest the market get wind of a coming transaction and the issuer’s stock price tank as the shorts take advantage of uncertainty around the size and price of new supply. Informal discussions on a new capital plan were kept very tight. A look through Dealogic league tables doesn’t see Goldman Sachs leap out as a house bank for Santander. But the US firm was Santander’s first choice.
“Immediately we took the decision that it would be a much more efficient way to achieve our goal by doing an accelerated deal rather than a rights issue, we appointed Goldman Sachs,” Cantera tells Euromoney. “The relationship with Goldman Sachs goes back many years and is very close. While many of the things that pass between us have never become apparent to the market as transactions, Goldman has advised on some of the transformational deals for Santander. Soon after that, we also brought in UBS.”
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The relationship with Goldman Sachs goes back many years and is very close. While many of the things that pass between us have never become apparent to the market as transactions, Goldman has advised on some of the transformational deals for Santander José García Cantera |
In the past two years, UBS has been a regular adviser to Santander. But the relationship between its bankers goes back further. Andrea Orcel, CEO of UBS’s investment bank, was Emilio Botín’s most trusted adviser through a decade or more of dealmaking, when Orcel was a senior investor banker at Merrill Lynch. Sources close to the deal said that previous relationship found no favours with the new regime: “If anything, we had to work even harder than other firms to get on the deal,” says a senior banker at UBS.
Goldman and UBS shared €75 million in fees. But they had to earn it.
They gave Santander a different read on the market to that of their rivals. “Most banks told us there was a limit to what we could do as an accelerated deal and that limit was around €5 billion and that we couldn’t do over that,” says Cantera.
Santander wanted to do much more than €5 billion of course and Goldman and UBS gave comfort that it was achievable. “With the benefit of hindsight, a number of banks have subsequently said they would have loved the chance to join a very doable trade,” says Michael Sherwood, vice chairman of Goldman and co-chief executive of Goldman Sachs International. He raises an eyebrow. “They weren’t quite so keen when they asked to get in on the deal only to discover they had not realized that it was hard underwritten.”
For that €75 million, Santander invited its lead banks to put their money where their mouths were.
On most bought deals in the equity capital markets, banks will gauge the volatility of the specific stock, the size of the block as a multiple of its typical daily trading turnover, as well as overall market tone and risk appetite and then bid for the block at a discount to the prevailing price. So typically, if a bank intends to reoffer a stock to investors at a 13% discount to the close, it will bid to buy it at a 15% discount. The hard underwriting price is typically below the visible price at which the deal comes to market.
What was it on this transaction, Euromoney wonders innocently? “The underwriting commitment was at the bookbuild price of the deal. It was at €6.18,” Sherwood says.
As news of the deal broke, talk was of informal price guidance in a range from €6.18-€6.50, with analysts testing earnings per share implications of a deal struck in the middle of that range at a roughly 8% discount. It finally priced at the bottom of that range.
The two bookrunners, Goldman and UBS, were on the hook for the entire transaction. Goldman underwrote 62.5% of the trade and UBS 37.5%.
Javier Oficialdegui, head of EMEA FIG at UBS, says of the hard underwriting commitment: “We had enough time to put it through our committees. It was not an issue. This is exactly the kind of capital commitment that the investment bank of UBS stands for these days. It was large but it was short-term and it enabled a key transaction for a close client. If anything, it’s probably easier to get approval for these kinds of principal commitments now than it may have been in the past.”
Both lead managers took a positive view on Santander’s story at the deal price of €6.18 a share – a near 10% discount to the previous day’s close and a 13% discount to its intraday high at the start of the year. Enough outside investors ultimately shared that view to cover the deal, which succeeded thanks to large orders mainly from US and UK-based hedge funds.
The deal was between 1.4 and 1.5 times subscribed. That might sound healthy, but not to experienced ECM bankers who understand order inflation. It didn’t leave much cushion, if any.
“I would say that for a deal of $8.9 billion, you need an order book of $14 billion or $15 billion for it to work at all,” says Sherwood. “Santander wanted to go as soon as possible at the start of the year but we could not have anticipated how volatile equity markets were going to be in that first week. There were times during those first trading days of the year when it wasn’t clear to me that this transaction would be fully subscribed.”
Goldman and UBS couldn’t even use the traditional pitch to investors for European banks stocks: buy them because they’re cheap. While many of its European banking peers trade at one times book value or less, Santander was trading at around 1.6 times book value on the eve of the deal. It wasn’t cheap. It was expensive. This was very different from the Sabadell equity raising through a combined accelerated bookbuild and rights issue for €1.4 billion back in October 2013. That was anchored by two new strategic investors placing a big macro bet on the Spanish recovery story through the stock of a bank trading at 0.8 times book. Other US investors bought into the rump of the accelerated portion of Sabadell’s capital raising on the same basis.
By contrast, investors were now being asked to buy into Santander, one of the few banks trading at a multiple to book value, at a time when doubts about European growth prospects were gathering once again and also when a key underpinning for Santander’s high stock valuation was being pulled away.
Santander had come to be regarded as an income stock with that unusually high dividend payout ratio, maintained since 2008 even when most European national banking regulators were preventing or limiting dividend distributions and instead forcing banks to retain earnings to build their capital. Along with the big capital raise, Santander announced that it would cut dividends per share from €0.6 – mostly in scrip – in 2014 to just €0.2 this year, albeit maintaining the previous rate of €0.15 of that in cash. That fits just under the Bank of Spain’s cap on cash dividend payouts. Raoul Leonard, analyst at Deutsche Bank, warned clients: “Now that future dividend yield expectations have been lowered, we expect a rotation of the shareholder base, as income investors exit.”
And how did this all play to the equity capital markets amid all the nerves and volatility at the start of the year?
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There was a brief debate over whether to move the price up and our strong advice was not to. This was a rare example of a very large deal – something like two and a half times bigger than the last large accelerated bookbuild in the eurozone – that only just got covered Michael Sherwood, Goldman Sachs |
As trading began on Monday January 5, 2015 markets sank and they fell again on the Tuesday. On Wednesday they steadied. By now, the deal was cranking up. “We wall-crossed about a dozen large investors two days prior to the deal,” recalls Sherwood. “At that point there was really no going back.” He adds: “The price decline for the Bank and EuroStoxx actually helped us to attract momentum, macro investors, who wanted to take positions in size at a discount and to warehouse them.”
Thursday of the first week in January was the first positive trading day of the year. Timing may not be quite everything in capital markets but it counts for a lot. Told of the impending deal, the capital markets authorities in Spain required that trading in Santander’s shares be suspended, and then the banks and Santander could announce it and start marketing officially. Previously wall-crossing those big hedge funds – and then a second group – now allowed the bookrunners to send a strong signal. “We announced when we launched that we were already 55% subscribed by accounts that numbered 20-odd,” says Sherwood.
Investment bankers at other firms must have smiled. Saying a deal is 55% covered by a small handful of key accounts is perfect. It builds the impression of scarcity in the minds of other potential investors but at the same time holds out the chance of still getting a big ticket for those buying into the issuer’s story. It says this deal will work with you or without you. You still have a chance to get a big piece of it, but you had better be quick, or the likes of Soros and Och Ziff will have it all.
Goldman is really smart at equity capital markets stuff like this.
Sherwood says: “Santander is a very well-known and well-covered stock with a diffuse share register. We approached very large accounts, roughly half being existing shareholders and half not. In the end, we had 250 accounts in the book. The single largest order was for €1 billion, but we saw that as clearly inflated. There was a brief debate over whether to move the price up and our strong advice was not to. This was a rare example of a very large deal – something like two and a half times bigger than the last large accelerated bookbuild in the eurozone – that only just got covered.”
What was Goldman’s back-up plan if it had found itself long the stock in an undersubscribed deal? “While $8.9 billion is a huge deal, we figured that it was only 18 days’ worth of trading volume. We’ve done blocks that represented over 100 days’ of trading volume. If we’d had to, we would have worked it out into the market,” says Sherwood.
For investors, time will tell if this was a good buy. The first target they will be watching is for the stock price to creep back to the €6.18 at which they bought in January. The hope is then that within a few months, it may head back to the €6.84 prevailing before the shares were suspended for the transaction to take place. Citi analysts quickly reset their target price to €6.70, Credit Suisse to €6.60.
Time will tell. All now depends on the new management team capturing the growth it claims to see while maintaining efficiency and controlling risk.
Previous chairman, Emilio Botín, had deliberately run Santander on a capital-light model, claiming that the diversified earnings and contained risk exposures of a retail bank with large market shares in 10 countries spanning developed and emerging economies justified this. With the best cost/income ratio in the business, Santander always managed to eke out results during the tough times.
For so long, Santander had argued it didn’t need to raise capital. Now, suddenly, it was raising bucket loads: the most it could, as fast as it could. “It’s a major strategic decision,” says one long-term adviser to the bank. “Santander needed capital and clearly its dividend policy was unsustainable. But there’s a big risk to it – it’s not yet clear how retail investors, which are such a large part of its investor base, will react to the new policy.”
Even when the capital light model fell far out of favour for large banks after the financial crisis, Emilio Botín had stuck to his guns. When the group needed capital to support expansion or satisfy regulators in particular countries, it floated minority stakes in local operating subsidiaries. It kept the group equity valuation high, which the king dealmaker Botín regarded as his acquisition currency, with a generous dividend payout ratio. And even while Santander, arguably the biggest and most successful bank in the eurozone, fell far behind its peers in common equity tier 1 ratios, it somehow seemed to get away with it.
The ECB’s stress test last September found that in the adverse scenario, Santander would have the lowest capital decrease among its international peers, with its transitional common equity tier-1 ratio dropping just 1.4 percentage points, to 9%, easily exceeding the 5.5% minimum and the required capital amount by close to €20 billion.
Maybe the bank had been right all along to insist that its low capital relative to peers was appropriate to its low risks? The market wasn’t sure.
Oficialdegui at UBS says: “Santander was at that moment trading at higher multiples than those of its main European peers, leaving the Nordics aside, and investors were not demanding a capital increase. However, even if the AQR/stress test exercises confirmed Santander’s relative capital position was very strong once its earnings generation and low risk model were taken into consideration, Santander was at the bottom on a fully-loaded CET1 ratio basis (2014).”
Now, at the start of 2015, just when it appeared that Santander might have faced down the critics of its low capitalization ratio, the new group executive chairman Ana Botín, took a bold departure from her father’s way of running the bank.
CFO Cantera flatly refutes any suggestion that the bank caved in to behind-the-scenes demands from its new regulator, the ECB, to increase its capitalization. “Two things happened,” he says. “First, the new chairman and new chief executive have taken a different view of how best to construct group capital. Second, as we budgeted for 2015, it became clear that across the group we were seeing potential for a substantial pick up of lending at close to double digit rates. The dividend policy had been to issue scrip dividends, which enjoyed an 87%, take up, mainly among Spanish retail investors. That equated to us raising around €1 billion per quarter in equity. We took the decision instead to raise capital straight away in one go equivalent to two years’ worth of scrip dividends.”
The scrip dividend policy as a means of steady capital growth already looked far too slow to many analysts. It put Santander at around 8.3% on a fully-loaded Basle III basis at the end of 2014 with the prospect of getting to 9% this year but little likelihood of moving up to 10% until the start of 2017. Many of Santander’s European peers are already converging on 10%-11% fully loaded. And what analysts could not see was the budgeted loan growth, which would have consumed much of the capital slowly built through scrip dividends in 2015 and so further delayed any improvement of that laggard ratio.
Raising €7.5 billion brings Santander closer in line with peers at a stroke at around 10% with a chance to get to 10.5% next year and 11% in 2017. Analysts, at last, approve. “We see this as a material improvement in Santander’s capital position which brings it closer to peers – we estimate that the European Bank sector as a whole will be at an 11% CET1 ratio in 2014, rising to 11.7% in 2015,” say Rohith Chandra-Rajan and Marta Bastoni at Barclays.
In any case, time had already been called on the bank’s scrip dividend policy, with tax changes due in 2017 to remove the advantages that had attracted Spanish retail investors to it.
Cantera says: “The ECB has been our lead regulator since November 4 last year and we have had a couple of high level meetings but there was absolutely no pressure from regulators to raise more capital. This was an entirely internal decision.” He adds: “The fact is that we always appeared to be on the back foot on capital ratios. The question was always on the table: what were we going to do about that? Ana decided to take that question off the table in one go.”
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Following her father’s death last September, Botín’s first acts were to overhaul governance of the bank and revamp senior management. In November Santander unveiled Bruce Carnegie-Brown as first vice chairman and lead independent director on a 15-person board that will, from the shareholders’ meeting this March, have a majority of nine independent directors.
Botín has picked the former chief financial officer José Antonio Álvarez to work with her as the new chief executive, a role he took up from the start of January this year. His old CFO job goes to Cantera, who had previously been chief executive of Banesto, the Spanish banking group fully integrated into Santander in 2013, and who had most recently run Santander Global Banking and Markets (SGBM). Jacque Ripoli takes over as global head of SGBM, having previously run that division in the UK.
“We may have all been in the group for a number of years but we really are a new management team,” says Ana Botín.
But perhaps her most radical shift has been to offer equity investors something so rare and precious, something so little spoken of by bank management teams in recent years: growth. Not just marginal growth, but balance sheet growth in the mid-to-upper single-digit percentage points. That growth is to be delivered organically by a bank operating on an industry leading cost/income ratio of around 45% and not through risky and time-consuming acquisitions. So even after the dilution of the new supply, Santander might quickly provide a return even on these now much higher tangible equity levels of 12%-14% at a time when few other large European banks are returning more than half that to equity investors.
Her father had grown Santander as an acquisition machine. So Ana Botín must have known that the first question from analysts about the new capital raise would be whether she was raising a war chest. Her answer was unequivocal: “There are no plans for acquisitions. We are exclusively looking for organic growth. We are not anticipating any deals in the near term or even the medium term. We now see most of our core markets to be in a different growth cycle.”
Cantera offers a small qualifier: “The government of Portugal will at some point privatize Novo Banco [the good bank recovered from the collapse of Banco Espírito Santo]. There will be a group of banks shortlisted to look at that and Santander will be on that list. We have to be. We are a big bank in Portugal and we have to take a close look at anything so significant in that market. But acquisitions are absolutely not a priority. Organic growth is the priority and capturing the huge opportunity for growth we now see in our ten core markets.”
Does this amount to a new growth strategy from a new management team, or is it more a happy accident of location and timing?
For a period of time through the financial crisis and the eurozone crisis, Santander looked to have big positions in countries where it was not so good to be and it was negatively impacted.
Oficialdegui at UBS points out: “Today it has very relevant positions in the developed economies outside the eurozone that are growing most strongly – the US and UK; in the eurozone markets that are recovering fastest, especially Spain; and also in countries that were never affected by the crisis in the first place and that are growing nicely, such as Mexico, Poland and Chile. The only engine that is not firing completely now is Brazil, which is going through a temporary macro slowdown. Furthermore, Santander has a strategy of increasing market share in an organic way in the most profitable areas of its core markets, which will be accelerated with the funds coming from the capital increase. In this regard Santander can definitely capture organic growth opportunities now that the cycle is turning.”
Oficialdegui adds: “And Santander has positioned itself as a big player in each of these key countries, a top three retail bank with at least 10% market share, except in the huge US market. That allows Santander to benefit from both higher growth and lower earnings volatility than its peers due to its earnings diversification. This is a bank expected to report €5.8 billion of net income for 2014 and that by 2017 could be reporting in excess of €9 billion according to current analysts’ consensus.”
Ana Botín has learned valuable lessons running parts of the Santander, notably the UK business that has accounted for 25% of the balance sheet and 20% of profits.
She now intends to apply her key metric of “customer loyalty” across the whole group’s retail network. Cantera says: “A loyal retail customer can be 10 times more profitable for the bank than a non-loyal customer and a loyal corporate customer can be four or five times more profitable than a non-loyal one.”
Santander will also be making a bigger play for business from small and medium size enterprises. “In this new environment of low rates we have to look at the clear growth opportunity in serving SMEs where our market share lags behind our positions in retail and commercial banking,” says Cantera.
