With the acquisition of Banco Popular by Santander, the circle that was opened by the Novo Banco affair more than a year ago closes.
The bail in of T1 and T2 bonds and the total write-off of Banco Popular were easily absorbed by the market. Santander, despite a capital increase of 7 billion, closed with a loss of less than 1% on the day; other Spanish banks significantly outperformed the market.
We are not surprised by this reaction essentially for 3 reasons:
1) The banking sector comes in the last month from an underperformance relative to the market due to an expectation of a slowdown in European macroeconomic data after the recent acceleration. Consequently, expectations on interest rates, the main driver of profits, have become more contained. This dynamic was accompanied by an upward revision of sector estimates (about 5%) thus making banks less expensive from a valuation point of view.
2) With the Spanish economy accelerating (2,8% expected for the year) and the absence of other banks with too low capital levels, the elimination of systemic risk is now credible.
3) The capital issued by Santander is amply sufficient to cover Popular's non-performing loans and at the same time to guarantee levels of coverage well above the national average as already happened in the case of Unicredit in Italy.
More generally, while on the one hand we are not surprised to see a retracement of the sector, we continue to believe that in the medium-long term the operating and balance sheet leverage of the sector at higher rates is such as to guarantee very advantageous optionality. Unicredit is an illustrative example.
In 2015, with short-term rates already at zero and a cost base of 15 billion, the NII as a percentage of assets was 1,38%. Assuming the same percentage of NII on assets as in 2015 with a cost base of 11 bn Unicredit would reach an operating profit of 8,4 billion compared to the company's own guidance of 6,8 in 2019.
Although this is a positive scenario both in terms of rates and asset quality, it serves to illustrate how significant operating and balance sheet leverage is for banks after years of continuous cost reductions in the perspective of a seamless fall in rates.
