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Santander under capital spotlight, needs comfortable cushion, analysts say

Banco Santander SA may have to boost its capital levels to fend off any unexpected shocks and to have a more comfortable buffer against regulatory headwinds, according to analysts.

The Spanish lender, Europe's fourth-largest by assets, has one of the lowest capital ratios among its peers, something that has contributed to its weak share performance, analysts say. It ranked at the bottom of the list of Spanish banks for its common equity Tier 1 ratio — a key measure of financial strength — in the European Banking Authority's latest transparency exercise.

Year to date, the bank's shares have fallen 10.36%, against a 3.87% gain on the STOXX Europe 600 Banks index.

At September-end, Santander's CET1 ratio stood at 11.30%, unchanged from 2018-end, as regulatory impacts knocked 53 basis points off capital generation so far in 2019.

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CFO José Antonio García Cantera told analysts at a third-quarter earnings presentation that the bank was expecting a regulatory impact of 80 to 90 basis points in 2019 and 2020 due to the ECB's targeted review of internal models, or TRIM, which is designed to reduce inconsistencies in calculating risk-weighted assets, changes in accounting rules and the application of Santander models to the portfolio of Banco Popular Español SA, which it acquired in 2017 for a symbolic €1.

Concerns compounded

The bank has come under scrutiny for weak capital levels, and the third-quarter figure somewhat compounded those concerns. UBS analysts said in a note they continued to see the bank's capital ratio 50 to 100 basis points below "what investors could consider comfortable levels, and with limited scope to absorb unexpected impacts."

That translates into a capital shortfall of roughly €4.5 billion, or around 5% of current market capitalization, the UBS analysts added, noting that "accelerated capital strengthening" would be "the most effective tool to rerate the stock."

Berenberg analysts expects the bank's CET1 ratio to be 11.2% for the year, lower than the 11.4% to 11.5% CEO José Antonio Álvarez told analysts in October.

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With "regulatory headwinds" of 20 to 30 basis points in 2020, the bank would need to build 80 to 90 basis points of capital, above the 60-basis-point run rate over the past three years, Berenberg analysts said in a note.

Morgan Stanley analysts, meanwhile, said they were lowering their estimates of Santander's CET1 ratio by 20 basis points given a higher-than-expected impact from regulation. They now expect the ratio to be 11.3% in 2019 and 11.7% in 2020 on organic growth and a capital gain from the sale of Banco Santander Puerto Rico.

Álvarez told analysts in October that the lender is generating more than its guidance of 10 basis points in capital a quarter, reaching 19 basis points in the third quarter.

Capital increase

However, the bank may have to do more to convince investors that its perceived low capital levels will not end up having an impact on profits nor that it will have to raise capital, which would dilute investors.

"There is a question mark about whether the lower capital position of Santander actually impacts on their ability to grow the business forward and whether there is a knock on effect on profit growth because of that," Jefferies analyst Benjie Creelan-Sandford said in an interview, noting that some investors are nervous about whether the bank would again raise capital in the future.

Creelan-Sandford added that the bank's weaker capital position relative to peers has an impact on sentiment and an implied cost of equity for the lender.

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Santander's capital ratio, however, remains above the ECB minimum of 9.687%, and the bank is targeting a ratio of between 11% to 12% over the medium term.

Marco Troiano, an analyst at Scope Ratings, said in an email that he did not see it "necessarily as a credit weakness, as capital is above the requirements and also within the target range," and that it may be simply reflecting lower intrinsic risk in Santander's business model.

"The bank has a 40%-50% [dividend] payout strategy, which shows management's confidence in their capital levels and that they can stay within their midterm capital target range of 11%-12%," he said.

Santander's operations in Latin America and its consumer finance business should also help shield it, Troiano added.

Basel impact

Cantera previously said the bank is expecting an impact of 100 basis points from new post-crisis rules from the Basel Committee on Banking Supervision, known as Basel IV, which will require the bank to hold more capital. The rules are due to be fully implemented from 2027.

Berenberg analysts said the potential impact was higher than they had expected and could imply a Basel IV CET1 ratio of 10.50% by 2020-end. The bank's total capital shortfall, including Basel IV, is €8 billion, they said.

UBS analysts also warned of increased capital risk from Basel, saying "current ratios do not offer much scope to accommodate an increased regulatory drag."