Santander and my Spanish investment dilemma

As dilemmas go, it’s rather pleasant. I bought the UK Santander 10 3/8% Preference Share at the beginning of 2012. At the time this security was yielding 10% and was clearly a risky investment, given the level of turmoil in Euroland.

Read Income Investor's guide to preference shares

Fast forward to today and I am looking at an increase of nearly 40% in the capital value, still with a ‘tasty’ current yield of around 7.7%: my earlier gamble on Spain has turned out well.

However, my home-grown ‘sell’ indicator is approaching 5, signifying that I have earned capital gains equivalent to nearly 5 years of income. That’s when I allow myself to think about selling - with the proviso that the yield is no longer attractive. But it still is - and that is my dilemma. Are there any other mitigating factors?

Essentially my purchase was a bit of a gamble on the stability of the Spanish and Eurozone financial system. Of course, Santander UK is a separate UK bank but if the Spanish parent - Banco Santander - were to get into trouble, I didn’t expect the UK branch to remain unscathed. And in that scenario, preference shareholders suffer first.

Banco Santander is Spain’s biggest bank and I believe its destiny will be made in Spain, even though it has large (and apparently successful) banking activities in South America. So how is Spain doing? Not at all well: in the last three months of 2012 Spanish GDP contracted by 4% and is expected to slump again in 2013 as government cuts and a combination of high unemployment and declining wages undermine consumer and business spending. Total unemployment of 26% and in particular youth unemployment of over 50% is just not sustainable. What is more, a financial scandal implicating the government is brewing noisily: corruption at the top implies corruption further down the political food-chain.

And how is Banco Santander weathering this storm in Spain? The picture is pretty bleak: in 2012 it made debt provisions of more than €18bn as the property downturn intensified and the number of toxic loans increased. As a result, the bank saw its profits collapse by almost 60% on the previous year to €2.1 billion – not an insignificant amount of money (revenues from divisions in Latin America, Brazil and the UK have shored up profits) but when set against the provisions, it looks like they are in a hole and still digging.

And the news in the UK is not much better: Santander UK looks like being hit by the interest-rate-swap mis-selling scandal as well as payment insurance mis-selling.

Putting all that into my risk-assessment mix, I am less confident about Santander than when I bought a year ago. So, I’m watching the price of my preference shares and when the current upward trend turns, I’m taking my chips off the table.

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