I have been recommending one European Bank as an equity and fixed income investment since the year started. This bank is Spanish based Banco Santander (NYSE: SAN) and I think the bank still is a good long. I believe its huge cash dividend ($0.80 per share or +10%) has great chances of being sustainable and hence the shares constitute a fair income source. That said, when I recommended Santander, I also warned that I expected price volatility to be very high. Unfortunately, recent news in Cyprus tell me that price volatility in European related assets could be still higher than expected (even much higher). What should you do with your Santander Shares if you own any? I think you should stay put for now. Let’s take a look at what is happening in Europe and what might be the consequences that you could face as an investor in the banking sector.
Non-Sense Policy in a Mediterranean Island.
Again, European authorities have shown that they are unable to offer real solutions to the Euro area problems. Brussels came up with the worst possible idea to help solve Cyprus’s crisis: in exchange for a 10 billion Euro bail out from the European Union, Cyprus will have to impose a one-off tax over all deposits in the local banking system. At the same time, the banks where deposits are placed, would have to offer depositors a “free out of the money” call on the bank’s capital. Total non-sense.
The one-off tax will be 9.9% for all deposits over 100,000 Euros and 6.75% for all smaller deposits. According to Paul Krugman, who is against this one-off tax policy altogether, the tax has been imposed because Cyprus has an over-sized banking system given its condition as a money haven, especially for the assets of Russian wealthy investors. Krugman argues that a straight-forward bail out would have been seen as a rescue to Russian wealthy investors who have been avoiding taxes everywhere else. Then why is a tax collected on “small” deposits? The reasons I have read from smart people such as El-Erian (Pimco’s CEO) do not convince me at all. I simply believe this is another non-sense policy with dangerous implications. The tax, even if it was reformed to affect in a lesser way small depositors, is setting a very dangerous precedent. Italian, Portuguese or Spanish depositors could start retrieving their deposits from local banks triggering bank runs and putting pressure on the European Central Bank (ECB) to intervene. Its very tough to understand what European authorities are exactly aiming to achieve. The idea of waking up one day and have my savings reduced by 9.9% but with a “free out of the money” call on my bank’s capital was insane until last weekend. I guess authorities will come back to reason and, at the very least, forget about taxing small deposits. Time will say and I think all will develop within a few days.
Implications For Investors.
The word in English to define Europe’s crisis is “protracted” which means: extended, long, prolonged, lengthy, time-consuming, never-ending, drawn-out, interminable, spun out, dragged out, long-drawn-out, overlong. That said, I don’t think the ECB would let a bank run happen in any of the big troubled European economies: mainly Italy and Spain. Cyprus is unique in its own way: bank deposits run as high as 800% of the country’s GDP making the country tough to rescue. I think that, at the end, a higher one-off tax will be imposed on big deposits (above 100,000 Euros or even above 500,000 Euros) while no taxes are to be imposed on smaller deposits. The precedent would still be dangerous but the impact should be less socially unacceptable. Besides, I don’t see any of this happening in Italy or Spain. To begin with, banks in both those economies are not as big (relatively to GDP) as banks in Cyprus are. Moreover, after many painful write downs, Italian and Spanish banks are in much better shape than they were two years ago.
As a matter of fact, I think that if a big sell off on high quality banks were to happen, it might be time to buy. I am long Santander equities and I also own Senior bonds from Banco Bilbao Viscaya Argentaria (NYSE: BBVA) which is also a great bank to own but is not as diversified out from Spain as Santander is (besides, its cash dividend yield is “just” 5.4%). I am also considering to go long on the Italian banking champion Unicredit (NASDAQOTH: UNCFF). The Italian economy is in terrible condition but there is huge value in the country and Unicredit is trading at 2013 50% of tangible book value (against 130% for Santander and 120% for BBVA). Buffett always recommends to be greedy when others are fearful. Maybe its time to follow his piece of advice and start looking at Europe’s leading banks.