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Spanish Banks’ Quest for Capital Piles Risk on Their Customers

Maria Pilar Izquierdo put 5,000 euros ($7,186) into bonds that will convert into shares of Banco Santander SA (SAN) next year, leaving her facing potential losses on an investment that helped Spain’s biggest bank bolster its capital.

“Let’s just say that relations with my bank branch have become very strained,” said Izquierdo, 38, a local government worker from Zaragoza province who invested money she’d set aside for her son’s First Communion ceremony in bonds that Santander sold to 129,000 retail clients in 2007. The 7 billion euros of bonds are set to convert into shares in October 2012 at 14.13 euros a share, above the current price of 7.94 euros.

Santander and CaixaBank SA were among Spanish banks that used funds raised with sales of such bonds through their branch networks to boost their capital. Bankia SA and Banca Civica SA, lenders formed from groups of Spanish savings banks, raised a combined 2.1 billion euros by selling shares in their initial public offerings to consumer-banking clients this week.

“Over-reliance on its own depositors to sell loss absorbing products brings a conflict of interest for the lender because it has the obligation of providing fair advice to its clients and a big interest in placing the securities,” said Juan Fernandez-Armesto, a former chairman of Spain’s financial markets regulator, known as CNMV. “If those securities produce losses for its clients after a period of time, the lender faces rupturing its commercial relations with the clients and a considerable legal risk because of the conflict of interest,” he said, without referring to any particular deal.

Photographer: Denis Doyle/Bloomberg

Balloons advertise Banca Civica SA on their opening day of trading at the Madrid Stock Exchange in Madrid, Spain, on Thursday, July 21, 2011. Close

Balloons advertise Banca Civica SA on their opening day of trading at the Madrid Stock... Read More

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Photographer: Denis Doyle/Bloomberg

Balloons advertise Banca Civica SA on their opening day of trading at the Madrid Stock Exchange in Madrid, Spain, on Thursday, July 21, 2011.

Bank of Spain

The results of stress tests published on July 15 showed that Spanish banks, including Santander and Madrid-based Banco Popular Espanol SA (POP), had a combined 12 billion euros of mandatory convertible bonds outstanding.

The Bank of Spain considers the reserves generated through the sales as equivalent to the highest quality capital, and cited them as a reason why Spanish lenders wouldn’t need to raise more funds, even after five of the country’s banks failed the stress tests with a capital shortfall of 1.56 billion euros. The failures were Banco Pastor SA, Caja de Ahorros del Mediterraneo, Banco Grupo Caja3, CatalunyaCaixa and Unnim.

The Santander securities paid annual interest of 7.3 percent until October 2008, before switching to a rate of 2.75 percentage points above Euribor, a yield that’s currently about 4.3 percent. The bank set out the risks for investors in the bonds’ prospectus, including the final conversion date and the possibility of share price declines.

Photographer: Denis Doyle/Bloomberg

Santander and CaixaBank SA were among Spanish banks that used funds raised with sales of such bonds through their branch networks to boost their capital. Close

Santander and CaixaBank SA were among Spanish banks that used funds raised with sales... Read More

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Photographer: Denis Doyle/Bloomberg

Santander and CaixaBank SA were among Spanish banks that used funds raised with sales of such bonds through their branch networks to boost their capital.

‘Paper Losses’

At the conversion price, 5,000 euros would buy about 354 shares, which are worth about 2,808 euros at the current market price.

A spokesman for Santander, who asked not to be identified in line with company policy, declined to comment, as did spokesmen for CaixaBank and Popular.

“There are thousands of Santander branch customers that were sold these investments that probably don’t know yet that they’re sitting on huge paper losses,” said Fernando Zunzunegui, a Madrid-based lawyer who is helping set up a group to press Santander to compensate clients for potential losses. “These are very dangerous products to sell through your retail network.”

Not all convertible bonds sold by Spanish banks have been aimed at retail customers. Bankinter SA sold 405 million euros of convertible bonds in April to existing shareholders or holders of preference shares.

Bankia, Civica

CaixaBank sold 1.5 billion euros of mandatory convertible bonds through its branch network in June to help boost its core capital ratio to more than 8 percent under Basel III rules by the end of 2012. The conversion price for the bonds, which have 18-month and 30-month maturities, will be 5.253 euros, compared with CaixaBank’s current share price of 4.217 euros.

Banco Bilbao Vizcaya Argentaria SA (BBVA), Spain’s second-biggest bank, raised 2 billion euros from the sale of mandatory convertible bonds with a five-year maturity marketed to branch customers in 2009. Bilbao-based BBVA, which had the right to convert the bonds into shares on quarterly coupon dates after the first year, announced on June 22 that it would do so. A spokeswoman for BBVA declined to comment.

Banks seeking to raise funds from share sales to meet capital requirements set by the government are also relying on their consumer-banking clients.

Madrid-based Bankia, led by former International Monetary Fund Director Rodrigo Rato, raised 3 billion euros with an initial share sale this week. It sold half of the stock to its own customers and through branches of other banks after cutting the price by as much as 26 percent. Banca Civica, also based in Madrid, raised about 600 million euros in its IPO, allocating 58 percent of the shares to individual investors.

Investor Appetite

A spokeswoman for Bankia declined to comment in a phone interview. The fact that 60,000 retail investors bought shares was a sign of their confidence in the bank, Enrique Goni, Civica’s co-chairman, said at a Madrid news conference.

Bankia declined 3 cents, or 0.8 percent, to 3.72 euros since it began trading in Madrid on July 20. Civica was unchanged at 2.70 euros in its trading debut yesterday.

Banks may be straining the willingness of their customers to sign up for the largest deals after an index of Spanish financial shares declined 16 percent in the past year and unemployment rose above 21 percent. CaixaBank received orders worth 1.74 billion euros for its 1.5 billion euros of convertible bonds and Bankia said demand for the retail investors’ portion of the IPO was 1.04 times the amount offered.

‘Disgruntled Clients’

Banks such as Santander sell bonds convertible into stock to “dodge the bullet” of immediately diluting existing investors, said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. Asking clients to buy stock-linked investments risks alienating them if they’re burdened with losses, he said.

“The last thing you want is 130,000 disgruntled clients,” Maughan said, referring to the mandatory convertible bonds sold by Santander. “If worse comes to worst they may have to compensate the customers and obviously that’s going to be unpleasant.”

One of those customers is Izquierdo, who bought the bonds after paying a visit to a Santander branch in Carineno, a town of about 3,500 in Zaragoza’s wine-making country. “It has become difficult for me to remain a Santander client,” she said.

To contact the reporter on this story: Charles Penty in Madrid at cpenty@bloomberg.net Esteban Duarte at eduarterubia@bloomberg.net

To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

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