Enjoy an income fiesta with this bank

Investors who stuck with the unlikely combination of 'tanks and banks' which, prior to the Russia-Ukraine war and the rise in interest rates, would not have won any popularity contests, are enjoying a champagne year so far. While defence stocks show no sign of waning, however, the great bank recovery is being met with growing scepticism. Arguably, though, there is still enough momentum left in banking shares, helped by the 'higher-for-longer' interest rate environment, hedging against rate cuts and share buybacks, for investors to shop around for a strong candidate with which to finish 2024.

On this occasion, finding a decent value banking share that has strong margins and a stable balance sheet means sailing across the channel on a Brittany ferry to the pretty fishing port of Santander and the eponymous Banco Santander (ES:SAN).

A Spanish opportunity 

Started by royal decree in 1857, Santander has grown by acquisition to become the largest bank in Spain measured by total assets, with an almost 40 per cent share of the Spanish market.

The most compelling reason to look closely at European banks is that the sector, after enduring dividend payout bans during the pandemic, is rushing to shovel as much profit into the hands of investors as possible this year, facilitated by rate rises, which have widened net interest margins – the difference between what a bank offers depositors and what it charges for loans. 

The extent of the industry's largesse seems to have taken the market by surprise. European banks will dole out an estimated €119bn (£101bn) this year, and the MSCI Europe Banks index has climbed by over a quarter since January, despite fears that interest rate cuts  – which have already started in the Eurozone  – will trim margins eventually.

For the moment, Europe’s banks do not seem to be too worried about the actions of the European Central Bank. One of the most eye-catching announcements of 2024 came from Italian bank UniCredit (IT:UCG), which has pledged to pay out its entire 2023 profit pool – over €8.5bn – in dividends and buybacks. There is a definite sense that banks must make hay while the sun shines, given the past fickle behaviour of regulators,.

Santander itself began a share buyback programme of €1.46bn in February, while its total payout and dividend programme puts it second behind UniCredit as the most generous income banking share in Europe right now. Santander is not far behind its Italian rival. It is poised to pay out half of its 2023 profits, which totalled over €11bn. This means that €5.53bn, split evenly between buybacks and dividends, will be coming back to shareholders. 

In addition, what investors are being charged for this income is very reasonable. According to estimates from broker Jefferies, Santander trades on a forward price/earnings ratio of 5.7 times for 2025, making it the cheapest bank on the Spanish market, and also putting it at a significant discount to the European banking sector, which trades on around seven times. 

This valuation implies that, because of its market weight in Spain, Santander will struggle to grow quickly and that the bank has essentially become a bellwether for the Spanish economy – the mirror image, perhaps, of Lloyds (LLOY) in the United Kingdom.

The European Union estimates that Spain will achieve GDP growth of 2.1 per cent this year and 1.9 per cent in 2025 – which broadly mirrors the earnings per share (EPS) upgrades that analysts have assigned to Santander and other Spanish banks. In other words, the market believes that if Santander is, as reported, moving away from a growth-led strategy to one of cost control and consolidation, then earnings will only grow as fast as it can write profitable loans.

However, one area in which it has a real competitive advantage over its biggest rivals, and which could generate significant growth, is its exposure to Latin America. Santander is now the leading bond issuer and syndicator in Latin America, where sentiment has been recovering after radical economic policies enacted by Argentina. Activity in commodities and electricity trading have been particularly buoyant, and it also has a big wealth management presence in emerging economies such as Brazil and Chile.

Different ways to buy 

Some influential commentators have been arguing that European banks now represent better value than their traditionally more expensive US peers. According to JP Morgan analysts, US banks are currently priced 34 per cent higher than European banks, against a long-term average premium of 25 per cent. Not only is the price running hot, but the US banks are arguably also more exposed to regulatory action – the sector has been in an interminable debate with the Federal Reserve over asset quality after the failure of Silicon Valley Bank. As a result, JP Morgan argues that European banks carry less inherent regulatory risk and, should they reach their average long-term price/earnings (PE) ratio of 8.2 times, this implies an upside of roughly 10 per cent to the current share prices.

Investors can tap into this trend in two ways. They can either own Santander directly or seek exposure to the benign conditions for European banks via a dedicated exchange traded fund. Owning the shares directly can be achieved by buying a Crest Depositary Interest (CDI) in London under the listing BNC, or purchasing the home-listed shares directly on the Madrid stock exchange if you are happy incurring more exchange rate risk.

However, the administration of foreign dividend income must be carefully considered. The taxation treaty between the UK and Spain allows for dividend taxes for UK residents at an agreed rate of 10 per cent. This is effectively a discounted rebate on the 19 per cent Spanish withholding tax that such income normally incurs. The difference can be claimed directly from the Spanish tax authorities using a Spanish 210 form.

Undoubtedly, this will provoke groans from UK investors who could do without the administration hassle. Luckily, there is an alternative. We have previously recommended Amundi Euro Stoxx Banks UCITS ETF (BNKE) with some success, with the advantage that this avoids almost all the administration issues of holding individual foreign shares, although without the asset concentration that might generate higher returns than the sector average. It does have the advantage that Banco Santander is one of its largest single holdings because this is based on the share’s weighting in the home index.

Whichever method you choose, Santander represents a good value play on the Eurozone’s banking market, which looks a little more stable now that the key election in France has not spooked investors. Spain tends to get forgotten among the great economies of Europe, but so far as banks like Santander are concerned, it seems a model of efficient management and steady returns.