SANTANDER'S ACQUISITION OF ABBEY: BANKING ACROSS BORDERS

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1 December 7, 2011 SANTANDER'S ACQUISITION OF ABBEY: BANKING ACROSS BORDERS Caterina Buja Luca Gerotto

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3 INTRODUCTION Monday, July "We are convinced Santander is able to deliver the turnaround [of Abbey] faster than we can" Luqman Arnold

4 Banco Santander is 10 th largest Bank in the World in terms of Market Capilization 4 th largest bank in Europe Retail bank with 85% of total revenue coming from retail activities Agent of the 1 st major cross-border transaction in European retail banking in years

5 SANTANDER KEY FACTS Has provided its customers with security and service for more than 150 years Named the "Best Bank in the World"* Named one of the safest banks in the world by Global Finance magazine Over 14,000 branches, more than any other international bank in the world, and more than 35,000 ATMs More than 80 million customers in 40 countries $1.2 trillion in deposits and customer funds under management** More than 180,000 employees 3 million shareholders

6 15 bil bought 13 banks - 11 in Latin America - Portugal Banco Totta & Açores - - consumers finance companies in GER, IT, NL, NOR, PL

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8 BANKING INDUSTRIES WORLD WIDE Last 20 years of the XX century, deregulation of banking industry led to a considerable increase in M&A activities both internationally and domestically 3 main branches of banking: INVESTMENT BANKING securitization, intermediation in financial markets, advisory services in equity and debt restructuring, corporate M&A transactions, also issuance of other complex securities, (providing liquidity for some of those financial instruments not traded in organized exchange) Concentration: 90% covered worldwide by 5 large American banks.

9 WHOLESALE BUSINESS BANKING corporate financial advising, equity and debt raising and underwriting, day-to-day services related to financing od medium-size and large corporations around the world. This sector is highly dependent on bank's nationality and its traditional corporate relationship. RETAIL BANKING provision of saving products and loans to individuals, massive distribution of financial products, supplying financial need to small and medium size enterprises. Citibank (NY), and HSBC (London) 2 major retail banks with worldwide presence Evolution of this industry in Europe followed the worldwide path, with a major integration of investments and wholesale banking segments with few players, mainly U.S.-based. In contrast, retail banking varied greatly across European countries.

10 CONCENTRATION In Europe important increase in concentration was observed in the 90s within national borders and led to the appearance of a few large banks within selected national markets. In South America and Eastern European concentration started primarily through foreign ownership and entering of foreign investors as the domestic financial sector liberalized. South America from 13% to 45% between Eastern Europe from 8% to 53% over same period In Asia was perceived as the next target area of intervention but the crisis in the late1990s coupled with the high degree of government protectionist behavior on financial insdustries.

11 THE VALUE DRIVERS The value-drivers of this increasing concentration are many: economies of scale (saving in the costs of fixed inputs) even if this isn't so significant; economies of scope (ability of the bank to produce and sell complementary products on better terms) -> what Santander will do with Abbey? Risk reduction International Integration Geographical Integration (reduce risk of bank's asset portfolio and might allow to lower its funding risk by diversifying its provision of funds)

12 2 main regulatory changes that helped this move toward "global banking thinking": BASEL II keep minimum amount of capital on their book to face unexpected events; it let banks use their own internal risk-based models to evaluate their risk profile and their corresponding capital requirements and was therefore perceived in the industry as giving larger, better-managed institutions a regulatory break in their capital requirements. new Basel III IAS (International Accounting Systems)

13 Founded in 1857, specialized in Spanish-American trade 377% total shareholder return ( ) Concentrated in Spanish and Portouguese-speaking countries (Spain, Brazil, Chile, Mexico, Portugal) Spain: increase in market share Spain thanks to aggressive strategies and acquisitions (1989) Latin America: expansion through acquisitions and strategic alliances (Bank of America) Anglo-saxon markets: alliance with Royal Bank of Scotland (cross-ownership), participation in First Fidelity (U.S, )

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15 Largest Spanish financial group 14 th European financial group Among european leaders in consumer finance business (finance help in purchase of cars and other durable goods) This business does require a large branch network

16 Born as building society (1944), listed in 1989 Personal Financial Services Division: Main business is mortgages (92% of lending activity) Portfolio Business Unit (corporate loans, debt securities etc.) : objective is to shrink or dismiss Large branch system More mortgages-per-branch but lower revenues-perbranch than competitors

17 Among highest cost-to-income ratio (61.1% vs 46.6% avg value) lowest ROE (8.1% vs 17.2% avg value) BUT highest PER (11.8) in the UK retail banking industry Lloyds takeover bid blocked by UK Competition Commission in 2001 (antitrust concerns)

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20 FINANCIAL BENEFITS OF THE ACQUISITION Santander's last acquisition of Abbey was expected to benefit Abbey's consumers and to add value for both Banco Santander and Abbey shareholders through improvements in Abbey's customer offering and implementation of technology-based efficiency programs. Starting from 2007 would be 10 th largest bank in the world and 4 th in Europe retail banking services as major activity creating 85% of the tot revenues tot earnings: 47% from euro-zone (21% UK only) 31% from Latin America

21 Over 90% of the combined loan portfolio would be in countries rated "AA" or better by S&P Santander's management was convinced that this retail focus, with geographic diversity, would produce attractive growth and enhance returns.

22 COST SAVINGS Abbey's expenses were too high respect to what they should have spent. 450 mil of cost savings on 3 years Target for cost savings IT Customer operations Sales Other areas Medium -long run initiatives 128 mil 83 mil 45 mil 45 mil 150 mil 300 mil 150 mil Santander believed that significant scale benefits could be achieved in IT in particular through the application of common management principles in: client management branch IT tech risk management appraisal platform

23 Other areas where it was possible to initiates cost savings procedures were: Purchasing saving from more favorable contractual terms; Sales cost reductions from increasing the productivity of Abbey's branches, concentrating and eliminating administrative workload from branch offices, increasing efficiency in electronic distribution, and increasing the productivity of outbound call-centers resources; Reductions in general and administrative expenses from central-function optimization, business unit integration, and the realignment of business unit resources, including a reduction in corporate functions.

24 In order to achieve all these things Santader expected to incur in: Investment and restructuring charges Short-term tactical initiatives Delivery of long-term cost saving 560 mil (becoming 670 by the end) 110 mil (becoming 220 by the end) 450 mil

25 REVENUES INCREASES From cross selling of financial products to Abbey's existing customers. Abbey had a strong franchise in the retail mortgages business, and Santander through that it could generate significant incremental revenue by cross-selling life insurance and general banking products to customers who acquired their mortgages through Abbey, and by developing Abbey's lending to consumers to small-to-medium enterprises. Expected numbers for 2007 Area Amount in million Protection insurance 29 General insurance 45 Consumer loan 83 Small-to medium enterprises lending 63

26 TERMS OF TRANSACTION Under the terms of the acquisition: holders of Abbey security would receive new Banco Santander securities in a 1:1 ratio to Abbey shareholders, special cash dividend of 31 pence for each share they held. Banco Santander was to finance the acquisition via a capital increase. Issue of 1.5 mil of new shares representing approximately 23,6% of issued capital of Banco Santander as engaged by acquisition. While expecting the end of the procedures there were 2 major pending concerns : approval by competition authorities (UK Merger Authority and the European Commission) potential bids of competitors (other UK banks HBOS and also foreign)

27 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? Industry attractiveness Cost effects Differentiation effects Dual effects Risk considerations

28 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? INDUSTRY ATTRACTIVENESS UK has the highest ROE in Europe (after Ireland)

29 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? COST EFFECT Empirical evidence of economies of scale connected with bank size (Santander cited IT, for example) Also important cost savings would be obtained by restructuring Abbey according to Santender s more costefficient measures.

30 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? DUAL EFFECTS Banesto was one of the most important Spanish acquisitions for Santander Partenon was initially developed at Banesto and then, after strong evidence of efficiency, used as standard for all Santander Spanish subsidiaries Sharing the target expertise and procedures could lead to exporting efficient procedures to the other banks of the group

31 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? RISK DIVERSIFICATION 1 Santander has no other subsidiary in UK country risk diversification UK is also outside of the Euro area currency risk diversification Abbey has a different range of products product risk diversification

32 BETTER-OFF TEST: IS THE WHOLE WORTH MORE THAN THE SUM OF THE PARTS? RISK DIVERSIFICATION 2

33 THE WHOLE SEEMS TO BE WORTH MORE THAN THE SUM OF THE PARTS BUT THE MARKETS DID NOT SEEM TO REACT VERY WELL: WHY?

34 POSSIBLE EXPLANATIONS Concerns about Santander ability to implement its own procedures in an enviroment that is different from a cultural and administrative point of view no cost savings Abbey was overpriced (high PER + premium paid to Abbey s shareholders) cost savings would not be enough the recover the investment Concerns about rejections from anti-trust institutions ROE from Abbey would anyway be lower than the ROE of Santander itself profit dilution Uncompatibility between Abbey s strenghts (branches) and Santander s strategy (consumer finance)

35 THANK YOU FOR YOUR ATTENTION