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Banco Santander, S.A. (ADR) (SAN), Banco Bilbao Vizcaya Argentaria SA (ADR) (BBVA): Cyprus and Your Banking Shares

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I have been recommending one European bank as an equity and fixed income investment since the year started. This bank is Spanish based Banco Santander, S.A. (ADR) (NYSE:SAN), and I still think the bank is a good long. I believe its huge cash dividend ($0.80 per share or +10%) has great chances of being sustainable, and hence the shares constitute a fair income source. That said, when I recommended Banco Santander, S.A. (ADR) (NYSE:SAN), I also warned that I expected price volatility to be very high. Unfortunately, recent news in Cyprus tells me that price volatility in European related assets could be still higher than expected (even much higher). What should you do with your Banco Santander, S.A. (ADR) (NYSE:SAN) shares if you own any? I think you should stay put for now. Let’s take a look at what is happening in Europe and what might be the consequences that you could face as an investor in the banking sector.

Nonsense Policy on a Mediterranean Island.

Again, European authorities have shown that they are unable to offer real solutions to the Euro area problems. Brussels came up with the worst possible idea to help solve Cyprus’s crisis: In exchange for a 10 billion euro bail out from the European Union, Cyprus will have to impose a one-off tax over all deposits in the local banking system. At the same time, the banks where deposits are placed would have to offer depositors a “free out of the money” call on the bank’s capital. Total nonsense.

The one-off tax will be 9.9% for all deposits over 100,000 euros and 6.75% for all smaller deposits. According to Paul Krugman, who is against this one-off tax policy altogether, the tax has been imposed because Cyprus has an over-sized banking system given its condition as a money haven, especially for the assets of wealthy Russian investors. Krugman argues that a straightforward bailout would have been seen as a rescue for Russian investors who have been avoiding taxes everywhere else. Then why is a tax collected on “small” deposits? The reasons I have read from smart people such as El-Erian (Pimco’s CEO) do not convince me at all. I simply believe this is another nonsense policy with dangerous implications.

The tax, even if it was reformed to affect in a lesser way small depositors, is setting a very dangerous precedent. Italian, Portuguese or Spanish depositors could start retrieving their deposits from local banks, triggering bank runs and putting pressure on the European Central Bank (ECB) to intervene. Its very tough to understand what European authorities are exactly aiming to achieve. The idea of waking up one day and having my savings reduced by 9.9% but with a “free out of the money” call on my bank’s capital was insane until last weekend. I guess authorities will come back to reason and, at the very least, forget about taxing small deposits. Time will tell, and I think all will develop within a few days.

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