And for his next trick… Botín weaves his magic at Santander
Alliance & Leicester is the latest rabbit that Emilio Botín has pulled out of his hat as Santander continues its inexorable rise. Botín has now cemented his reputation for being a dealmaker as well as one of the most talented retail bankers in history. What else does he have up his sleeve? Clive Horwood reports.
While HBOS, the largest mortgage lender in the UK, was waiting for the results of a disastrous rights issue, Santander’s Abbey had quickly bought 2.5% of the UK banking market for a little over £1 billion ($2 billion).
The speed with which the deal was concluded took everybody by surprise. Less than 24 hours after picking up a trophy for being the best bank in the UK at Euromoney’s Awards for Excellence dinner in London on July 10, Abbey’s chief executive, António Horta Osório, was ready to make his move for A&L.
At 4.35pm on Friday afternoon, just after the UK markets had closed for the weekend, Horta Osório made a call to A&L’s chief executive, David Bennett. Rumours about A&L’s difficulties had been rife but overstated. The lender had funding in place for the next 18 months but, like HBOS, it would need to raise capital and also shrink its business to the point where its growth opportunities were severely restricted.
Bennett opened his books for the second time in eight months to Santander/Abbey. The due diligence process ran from Friday night through to Sunday morning. At lunchtime on Sunday, Santander called a board meeting to discuss and then make the offer. By 2am on Monday, Bennett and his board had approved it.
|Santander is the clear leader among eurozone banks|
|World’s largest banks by market cap (at July 29 2008)|
|2||China Construction Bank||China||197,683.40|
|4||Bank of China||China||138,544.59|
|6||Bank of America||US||124,949.69|
|18||Bank of Communications||China||59,551.14|
A deal worth a little over $2 billion might not seem of huge importance to a bank that is now the seventh largest in the world by market capitalization (see table right).
But during the course of this decade, Botín and the Santander group that he chairs have entered new territory for the banking industry: an attempt to build a global retail and commercial bank that is worth more than the sum of its parts.
As chief executive Alfredo Sáenz said in his letter to shareholders this year: "We know that leveraging our global scope and creating market value is not just an option. It is an obligation. The market will demand a break-up of any bank that is not able to create value as a group, thus being only a collection of businesses."
The business now stretches across Latin America, including Brazil, where Santander’s operations make it the only international bank to have a 10%-plus market share in one of the Bric (Brazil, Russia, India, China) economies. Its European business not only includes Spain and the UK but also a thriving consumer finance business in western Europe and parts of central Europe.
And the numbers, by Sáenz’s benchmark, appear to add up: although Santander is only the 10th-biggest bank by assets in Europe, it is the second most valuable by market capitalization, behind only HSBC Holdings.
Perhaps the most telling statistic of all: Royal Bank of Scotland, for so long the senior partner in a close working relationship, most recently in the consortium that bid for ABN Amro, now has a market cap almost half that of Santander.
The latest addition to the Santander collection, on a value basis, could be the best deal Botín has done to date – subject to possible counter-bids from banks that see that the Spanish have got a steal of a deal for A&L at £1.26 billion.
The price looks even better when you consider that Santander entered negotiations to bring A&L into the Abbey fold in December 2007, and was prepared to pay about £2.7 billion at the time. Euromoney understands that eight months ago the initial approach had actually come from A&L’s board to Abbey but that the deal came to nothing more on structural than price issues. (The due diligence done at this time helped Santander to complete the July negotiations over the course of just one weekend.)
The cost to Santander is higher than the headline price. It will need to inject about £1 billion of capital into the business; if A&L had remained independent, and undertaken the same impairments and adjustments to its book that Abbey’s executives plan, such as winding down the lender’s large treasury portfolio, A&L’s core capital would have fallen below 4%, requiring it to raise capital in a market where even leading lender HBOS had struggled and/or shrinking its business to the point where growth becomes difficult to achieve.
But the deal gets Santander much closer to its target of 10% market share in the UK for a relatively small amount. In effect, A&L adds close to 50% to Abbey’s business. Branch numbers rise from 700 to 950, with most branches in the areas of the England where Abbey had planned to build its network over the next three to four years. Abbey’s deposit base grows 45%. It gains a mortgage book that is 97% prime and with a similar average loan to value to its own. And it gives Abbey/A&L a UK market share of more than 8.5%.
When Santander bought Abbey four years ago, there was much debate about whether smaller shareholders would accept Santander stock in return for their old Abbey shares. Today, more than a million Abbey customers remain Santander shareholders.
Even though, at around €1.5 billion equivalent, Santander could easily have paid cash for A&L, it chose not to; as its executives say, giving A&L shareholders the chance to switch to one of the world’s largest banking groups, which is targeting 15% earnings per share growth, gives them more upside than a cash offer at the lender’s current, depressed value.
Capitalizing on the crunch
"We said at the start of 2007 that we thought the global financial situation might become quite difficult. And we also thought that if it did so, we would be in a great position to capitalize on it," says Botín.
That’s something of an understatement. Santander’s profit for the first quarter of 2008 was up 22% on the same period in 2007, just before the credit crunch hit. The trend continued in Q2: profit was up 21.7% on the same period last year, and earnings per share were rising at a healthy 14.2% – albeit just below Santander’s target 15%.
Success came across the full range of Santander’s businesses. For the first half of 2008, profit in continental Europe was up 13%; in the UK up 20%; and Latin America rose 20% as well, not including a near €500 million contribution from the old ABN Real business.
Santander makes great play of the fact that it has not been exposed to the credit-related hits that have affected many global banks. That is because its business is predominantly retail: retail banking now accounts for 85% of its revenues.
The avoidance of sub-prime, SIVs and the like is not all attributable to the management of Santander, as Botín readily concedes. "We have not invested in anything toxic. We have very good regulators in Spain who would not allow us to do so, even if we wanted to."
"In the Santander group we only make loans to clients that we know. We haven’t repackaged the loans. We still have contact with the client directly. And we are careful with risk"
At Euromoney’s awards dinner in London in July, Botín, in a recorded acceptance speech, gave some good-humoured advice to a room of 500 bankers on how Santander had been largely untouched by the credit crunch. Borrowing from UK poet Rudyard Kipling, his guide to success in banking went as follows: "If you don’t fully understand an instrument, don’t buy it. If you would not buy for yourself a specific product, don’t try to sell it. If you don’t know very well your customers, don’t lend them any money. If you do all these things, you will be a better banker, my son." But the advice has a serious edge. Botín explains: "In the US, banks were lending at high risk levels without really knowing their clients. In the Santander group we only make loans to clients that we know. We haven’t repackaged the loans. We still have contact with the client directly. And we are careful with risk."
Botín is as intimately involved with the business as he has ever been. "To be a good leader of a bank you have to have a proper grasp of the issues. Too many chairmen are up in the air; Emilio is very much on the ground," says a banker who knows Santander well.
Insiders and outsiders also point to the important role played by Sáenz in the Santander success story. As one banker says: "Sáenz is the first CEO that Botín has 100% trusted. His attention to detail is incredible." Or, as another puts it: "You need someone to build the engine, but you also need someone to keep it fine-tuned. Sáenz is constantly tweaking the carburettor."
After becoming chairman of Santander in succession to his father in 1986, Botín spent most of the next 15 years building a dominant banking franchise in Spain. Allied to organic growth, and an aggressive approach to gaining market share, were the key acquisitions of Banesto and Central Hispano – both deals shrouded in difficulty and controversy.
This decade, Botín has concentrated on international expansion. Two key deals stand out: the acquisition of Abbey in 2004, and of Banco Real in the past 12 months.
Botín swells with pride when his first acquisition in the UK is brought up. "Abbey is going splendidly," he says.
Growth across all key markets
Santander group profits by sector H1 2008
Santander’s acquisition of Abbey is seen as the moment when cross-border banking acquisitions in Europe came of age. The markets had been waiting for such a deal ever since the introduction of the euro. The fact that it took four years for the first big deal to happen showed how sceptical most bankers were that such transactions could succeed.
But Santander had already achieved notable success with its takeover of Totta in Portugal. And after the untimely death of Santander’s first chief executive for Abbey, Francesco Gómez-Roldan, the new choice already had deep experience of making cross-border acquisitions work.
Horta Osório had previously been chief executive of Totta. A man with a winning mix of charm, intensity and intelligence, Horta Osório was working for Goldman Sachs 15 years ago when he was approached by Ana Patricia Botín, who was then running Santander de Negócios, to build an investment bank in his native Portugal.
A success in its own right, Totta was also a test case that showed what could be done. When Santander bought the bank in 1999, Totta, like Abbey, was underperforming. Its market share was 9% and falling, and its share of banking profits in Portugal was just 7%. Over the next six years Horta Osório and his successors reduced the cost-income ratio of Totta to 42% from 52%; grew market share to 11%; and doubled its share of banking profits to 14%, giving Santander the crucial 10% market share that the board demands.
"We saw at Totta that you could lower costs and increase revenues by moving technology and ideas across borders," says Horta Osório. "We were aggressive commercially but prudent with risk. We learnt a lot in the group and were able to apply this to Abbey."
Now Santander will seek to apply what Horta Osório calls the same "pattern of know-how" to its Banco Real acquisition in Brazil.
The strategy is simple, and cost reduction is based on three fronts. The first is to adopt an austere attitude – take away the fat from the business. The next is to apply global scale to local needs; for example, making insurance, technological infrastructure and telecoms deals on a group-wide basis; and finally the implementation of a centralized IT system.
Once the superfluous costs have been taken away, the money saved can be applied in two directions: it can be returned to shareholders, and used to attract customers.
The next aim is to improve quality of service to clients. And the ultimate goal is to be both the most efficient and highest-quality service provider, in every market, thereby creating a virtuous circle of more business at better margins. As Horta Osório puts it: "The accepted wisdom was that you either had to be a leader on costs or a leader on service. We are showing that you can be both."
The rewards are substantial: in full-year 2007, Abbey’s profits before tax rose 32% on an increase in revenue of 7%.
"The accepted wisdom was that you either had to be a leader on costs or a leader on service. We are showing that you can be both"
And Abbey has been well positioned to benefit from the woes befalling other UK banks. In the summer of 2006, Horta Osório and his colleagues looked at the potential for a downturn in the UK market and decided that the weak link in any portfolio would be unsecured lending and credit cards but that increasing the mortgage book would be OK as long as it was done prudently. It aggressively cut its unsecured personal loans book by 22%; by contrast, HBOS’s UPL book rose 40% over the same period.
Abbey also took a leaf out of the old Santander playbook by offering high interest rates to boost its deposit base. From a position of relative strength, it was able to increase its share of new mortgage business from 6% to its target 10% in the second half of 2007. In the first half of 2008, as its rivals suffered, Abbey accelerated further, printing about 25% of all new mortgages in the UK. This has been achieved without compromising the quality of the mortgage book: 97% of its total book is prime, with an average LTV of just 45%.
As many UK lenders face funding gaps that mean they cannot offer new mortgages, the most liquid – such as Abbey, HSBC and Lloyds – have been in a strong position to cherry-pick the best customers. Best pricing is offered to customers with an LTV of less than 50%; those needing a mortgage worth between 50% and 75% of the property are in a different pricing tier; and if you want a mortgage above that LTV threshold, you are going to have to pay for it. Of Abbey’s loan book in 2008 to date, less than 0.5% of new mortgages has an LTV of more than 90%. It would take a catastrophic fall in the UK housing market for Abbey to suffer large write-downs. Other lenders will wish they could say the same.
The implementation of IT system Partenon also means Abbey can properly target the holy grail of UK retail banking: the sale of more products to each customer. Whereas in France the big banks might sell six or seven different product to each customer, the average in the UK is fewer than two. Although Abbey won’t reveal its exact numbers, it makes no secret of its desire to break down some old British barriers.
"Abbey has 18 million customers in the UK," says Horta Osório. "So we don’t necessarily need more customers, but we do need to sell more products to each one."
Prize deal in Brazil
The break-up of ABN Amro will go down as one of the great banking stories of all time (see box). But no one, least of all Botín, doubts that Santander ended up with first prize in the race for ABN’s assets.
"Brazil is a fantastic opportunity," says Botín. "The country has enormous potential to grow its wealth. It already has two very good, large banks in Itaú and Bradesco. But I am confident that when we put our Brazilian operations together there, within two or three years we will be at least as profitable as those two banks."
The purchase of Banco Real is an admission that Santander’s previous investments in Brazil could only take the group so far. "We paid $5.5 billion for Banespa in 2000, which is about $1.5 billion more than I would like to have paid," says Botín.
Botín estimates that, before the Real purchase, Santander had invested a total of $8 billion in the country. Although those investments were generating profits of $1.4 billion, Santander had only 6% of the market. With the $18 billion equivalent that was paid for Real, the total investment has now reached $26 billion. Combining the two operations should generate profit of about $3 billion for 2008. "Our investment will be profitable in the first year," says Botín. "Banespa gave us a strong foothold in the most important and profitable area – São Paulo. But Real gives us much more of a nationwide operation."
The two banks’ operations will be put together from October, including using the group’s Latin American IT platform, Partenida, and Botín expects to generate cost savings of about €1 billion by 2010. Santander is still pondering whether to merge the two brands – Real has strong brand awareness in Brazil that it might be loth to jettison.
"We are now able to attract to Banesto the best customers. Where they may have had offers from many different banks last year, now we are competing with only a handful" Ana Patricia Botín
With market-leading operations in Argentina and Chile, plus its top-three position entrenched in Brazil, the other important Latin American market where Santander might seek acquisitions is Mexico. The similarities to Brazil, with two strong incumbents dominating and Santander looking to catch up through its Santander Serfín franchise, are striking. "There is great potential in Mexico, where we are growing our business step by step," says Botín. "Banamex and Bancomer are very good banks, but we would consider buying something in Mexico if the price was right." Serfín is 75% owned by Santander and 25% by Bank of America. In 2007, Serfín’s contribution to group profits was €654 million. Year-on-year growth in profits for the first half of 2008 was 28.5%.
Sovereign: mis-step or first step?
Botín’s success rate on the acquisition trail over the past few years has been extraordinary. He’s not prepared to divulge which targets he regrets missing out on, but the one blot on his record to date is Sovereign Bancorp, a Philadelphia-based US bank.
Some Santander insiders say that buying a stake in Sovereign in 2005 was a mistake. Botín admits it has hardly lived up to expectations but won’t go that far. "In Sovereign, we have done a lot of work with the other members of the board of directors to clean it up. We made one very bad mistake related to internet banking, which cost us $800 million."
The latest step in the clean-up was for Santander to inject an additional €347 million into Sovereign, as part of a $1.39 billion capital increase, on top of the $2.5 billion already invested. That maintained Santander’s stake at 24.9% and did not give Botín the control of Sovereign that he would like to have. "But if you ask would I prefer to have the Sovereign we have today or no Sovereign at all, I will take what we have," Botín says. "It is not easy, but it is very important, to have a foothold in the US."
One benefit is that it gives Santander access to the US Federal Reserve’s liquidity facility. Indeed, as owner of banks in the eurozone, the US and the UK, Santander is in the enviable position of having access to all the three main liquidity facilities on offer post the credit crunch, even though it is one of the big banks least affected by it.
Botín is quick, and proud, to point out the differentiation of Santander’s approach to risk that he says has become evident since the credit crunch. He did it in the first five minutes of his presentation of annual results for 2007 in Madrid in February, when he said with a touch of irony that "we don’t even know what a SIV is".
He does so again when he meets Euromoney, quickly dropping into the conversation that: "We have not charged a single euro of toxic products to our balance sheet. And we have 66 million clients worldwide. So you see, we have a very different risk policy to some of the other major global banks."
He then pulls out a copy of the bank’s annual report, and without prompting turns directly to page 146. "You see, here, we give a full explanation of our position on toxic debt. We don’t think anyone else is this transparent."
For Botín, such transparency has a deeper meaning. "If you are prepared to tell everything to the outside world, then it means you must have confidence that comes from doing everything right every single day internally."
Botín’s colleagues say he is obsessed about the share price performance of Santander against his leading competitors. Every Monday they analyse the company’s value against a benchmark of 25 of the world’s largest banks.
Of course, as he still remains a substantial shareholder in Santander, Botín’s attention to this detail has a large element of self-interest. But, according to close adviser and board member Juan Rodríguez Inciarte, it goes deeper. "We must never forget that we are working in the interests of all of our shareholders."
It is that desire to outperform its peer group that has led Santander to target earning per share growth of 15% for at least the next two years. It is a tough goal for a predominantly retail bank in any conditions, let alone as the world faces increasingly difficult economic conditions.
Dealing with a Spanish downturn
The biggest risk to Santander in the current market would appear to be the increasingly parlous state of the Spanish economy. Rumours of the impending collapse of both the residential and commercial property sector will not go away. The bankruptcy in mid-July of big Spanish property developer Martinsa-Fadesa could, some analysts say, be the first of many.
Botín is not complacent but says the risks to Santander are not as great as many fear. "First, I do not believe that the situation in Spain is as bad as many people are making out. Secondly, while Spain of course remains core to our business we are much more diversified than we were at the turn of the millennium. Spain now represents one-third of our business; some time ago we reduced our lending to the construction sector by one-third; and the regulator in Spain is very careful not to allow publicly quoted banks to carry too much risk on their books."
But Santander remains cautious: loan-loss provisions rose from €1.5 billion to €2.5 billion from the first half of 2007 to the first half of 2008, with Spain accounting for more than 40% of the rise. But these provisions were offset by the increasing efficiency of the group as a whole: the gap, or jaws, between growth in revenue and growth in expenses has increased from 9.7% in 2006 to 11.6% for the first half of 2008.
And Santander group’s success in Spain extends to Banesto, its smaller local franchise, which has about 4% of the Spanish banking market.
Banesto competes with domestic peers such as Banco Popular, Banco Sabadell and Bankinter. Through 2007 it outperformed its peer group; posting revenue growth of 10.8% compared with next best Popular’s 7.5%. Gross operating income continued to grow at 10% in the first half of 2008, and profits were up 14% on the same period last year.
Ana Patricia Botín, president of Banesto, attributes a lot of the recent success to a strategy of building its SME business as it became clear that the growth of the mortgage market in Spain was beginning to slow.
Ana Patricia has a steel that comes from having to prove yourself every day. In conversation she refers to her father simply as "the chairman". At the moment, she is channelling any frustration into trying to grow Banesto’s market share.
"We have only 4% market share. That means we have the opportunity to gain market share from the 96% who do not bank with us," she says. And the impending malaise in the Spanish economy means that Banesto, from a position of relative strength, can pick up business from weaker competitors. "We are now able to attract to Banesto the best customers. Where they may have had offers from many different banks last year, now we are competing with only a handful."
At a crossroads
Santander now stands at something of a crossroads. It has invested heavily in the UK, a market it understood through its cross-shareholdings with RBS, and with the A&L purchase should quickly achieve its goal of having a 10% share of the UK market.
"We know that leveraging our global scope and creating market value is not just an option. It is an obligation. The market will demand a break-up of any bank that is not able to create value as a group"
It has rounded out its franchise in Latin America with the purchase of Banco Real, which makes it a clear top-three player in the region’s core market.
Another market that it has long coveted, Italy, appears to be off the agenda following the sale of Antonveneta to Monte dei Paschi di Siena.
The decision to offload Antonveneta looked a masterstroke – recouping overnight almost half the amount Santander had paid for its share of ABN’s business while maintaining the key asset in Real. Botín and his advisers had reassessed the bank’s potential in Italy in light of other recent M&A activity and also the global credit crisis.
"We spent a long time looking at our options for Antonveneta," he says. "There had been a lot of consolidation in Italy, and both UniCredit and Intesa had increased their market share to over 20%. We believe that to have critical mass in any market you need a share of around 10%. To get that in Italy, even with Antonveneta, would have required an investment of around €15 billion over the next seven or eight years. At the same time, we looked at the global financial situation. Where before we might have been happy with a core tier 1 ratio of 5.5%, in this environment it makes sense to have a ratio of 6.5% or higher. Then we had a fantastic offer from Monte dei Paschi. They wanted to be the number-three player in Italy, and buying Antonveneta allowed them to make that jump."
Creating future options
The pool of countries that Santander both understands and can gain critical mass in is diminishing. It is no surprise therefore that one senior Santander banker says the group’s main task is not so much to take new opportunities, but to create them.
That brings us back to the US. Sovereign, for all of its faults, has taught Santander a lot about the US market. Some bankers who know Botín well insist that he will want one final, transformational deal before he hands on the baton to a new generation of leaders.
With US bank stocks depressed, would this not be a great time to buy in the US? Wachovia, the fourth-largest bank in the US, is valued at well under $30 billion. By the time Santander had sold off non-core parts of the business to leave just the retail banking franchise, the cost would be a lot less than that. And did you know that Juan Rodriguez Inciarte was once a non-executive director of Wachovia?
Santander was rumoured to be looking at potential acquisitions in Germany. Until Crédit Mutuel bought Citigroup’s German retail banking operations for €4.9 billion, Santander was considered a possible buyer. It has also been linked with buying Dresdner Bank from Allianz, although a tie-up with local rival Commerzbank looks most likely.
But Germany is a good fit for Santander’s strategy of buying in countries it knows: it has had a long history in Germany, dating back to the mid-1980s when it bought Bank of America’s consumer finance business there.
Botín’s status as a now legendary dealmaker means he will be connected with most retail banking operations that are in play. But he’ll continue to play his cards close to his chest.
"Our policy has always been and will remain that when the time is right, when there is a strategic fit and when we can make a real, positive impact for shareholders within three years, then we will make acquisitions," he says. "Don’t forget we have also sold things as well; most recently Antonveneta, but also our pension fund business in Latin America and our property portfolio. Our aim is to make our capital as efficient as possible and maximize returns to shareholders. But we do not need anything to maintain our 15% EPS growth target."
At the age of 73, and after 22 years as chairman, Botín shows no signs of slowing down. "Of course I still enjoy this business. We have just had the best year in our history. What is not to enjoy?"