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Friday, May 11, 2012

Spanish banks...Mañana, Mañana...?

The Spanish government held a press conference this afternoon finally laying out its plans for dealing with its significantly troubled banking sector. As usual Spanish Prime Minister Mariano Rajoy dodged the limelight and left the unenviable task of presenting the proposals to his Deputy, Soraya Sáenz de Santamaría, and Finance Minister Luis de Guindos – despite this being par for the course with the new government we still can’t help but feel that it fails to inspire confidence.

That fact aside, the plan did include a few concrete details on how Spain plans to deal with the Spanish banking sector, below we outline the key points and give our take:

·         Two independent auditors will carry out an evaluation of all the real estate assets held by Spanish banks – the Deputy PM termed this “an exercise in transparency”.

Open Europe take: We have been calling for this for some time, so believe it is a positive step. However, we have seen that similar tests have been fudged in the eurozone and Spain before, so it is very much wait and see. Taking an adverse scenario and ensuring these assets are written down to their real values is key – if they start posting falls in the future it will reignite the uncertainty surrounding the banking sector. The Spanish government also failed to mention that, at least according to the Spanish press, de Guindos was going to be asked to hire independent auditors by his eurozone counterparts at the meeting of eurozone finance ministers next week.

·         By the end of 2012, provisions to cover against losses on real estate loans considered as ‘non problematic’ will have to increase from 7% to 30%.

Open Europe take: This seems far too low. Given comparisons to Ireland we expect real estate prices could fall by another 35% in Spain. Additionally, this move seems to be skipping a step – Spanish banks already have €136bn in ‘doubtful’ loans against only €54bn in provisions, surely provisions against these very risky assets should be increased first or at least in tandem.

·         In absolute terms, this means an increase of around €30bn.

Open Europe take: Again, far too little. We predict that Spanish banks would need to at least double their provisions, taking them up to around €100bn. Similar estimates abound, with RBS calling for an additional €100bn and Roubini Global Economics suggesting it could go as high as €250bn over the next few years. Meeting the Basel III capital requirements will put further strain on the sector.

·         Banks will be allowed to get money from the FROB, but will have to pay 10% interest on it – Spanish Economy Minister Luis de Guindos stressed that this money cannot therefore be seen as state aid. Suggested maximum use of public funds would be €15bn. Heavy use of ‘contingent convertible capital’.

Open Europe take: This seems to be poorly thought out and based on an ideological reaction. Clearly the government is keen to avoid being seen to bail out banks, and rightly so. However, the banks tapping these funds will be those locked out of the interbank funding market (due to high rates), punishing them with 10% interest will make this recourse worthless. Any use of public funds should come with strong conditions but better to focus on letting some banks fail and be wound down in an orderly fashion, while forcing those that take funds to produce ‘living wills’ and give the state equity warrants. Contingent convertible capital can be useful but does not fundamentally solve the problems facing the banks, again it simply delays dealing with the problems and kicks in as a last resort safety mechanism – will do little if provisions are shown to be woefully small or valuations far too high.

·         Spanish banks will be obliged to transfer real estate assets into ad hoc societies tasked to sell them on the markets – i.e. the ‘bad bank’ that dare not speak its name.

Open Europe take: Potentially a large burden for the state, but given the breadth and depth of the problems across the sector some form of ‘bad bank’ scheme looked hard to avoid. The key here will be transferring the assets at realistic values so that they are sellable or can be written off. The Irish experience with NAMA makes this point clear – a bad bank stuck with uncertain assets can be a huge burden to the state. Furthermore, it could also distort the recovery of the sector as a whole, if the overvalued assets pile up on state books it will be hard for the remaining market to adjust – something which is necessary if the Spanish economy is to rebalance and recover.

The market response to the proposals has been lukewarm at best with Spanish borrowing costs rising slightly and the shares of many Spanish banks falling sharply.

There are some positive steps in the proposals and we will reserve full judgement until the complete package is announced and the stress tests have been detailed, however, it again seems to be a step short of what is needed. The key to tackling these banking sector problems is doing so decisively and in one swoop, rather than pushing the problems to tomorrow. Incremental adjustments increase uncertainty and expose the state to a longer and more volatile burden than needed - given the size of the Spanish economy, that is something which the eurozone cannot afford now or in the future. 


Rik said...

Great post.

1. Spain keeps postponing cleaning up the bankingsector. It should have been finalised per last September, if I recall it correctly, but hardly anything has happened.
Meaning it is likely to come up at a bad time (what we see now).
2. I donot see that markets have really another idea that a) the sector will have to be reorganised and b) that will cost a lot of money which c) the Spanish government will have to come up with and d) Spain simply doesnot have and for which there is e) not yet a proper solution (read EZ/ECB rescue package).
3. There looks also to be a management problem. Spain and its CB simply doesnot seem able to get it organised.
It will have to come from them as very few shareholders will be willing (even if they have the money)to put more money in these banks. The state should be pushing reforms/restructurings otherwise little is going to happen. Banks are simply trying to survive.
4. My first calculations after the first stresstest showed roughly a capital gap of 50-100 Bn. This has probably substantially increased by more rubbish coming out of the RE portfolio and massive buying of sov debt. So your estimate of 100 Bn might even be too low (and is most likely still rising as well). 50 Bn seems
much too low anyway.
5. I like the fact that it is supposed to be against businesslike conditions. However as you said if the interest is 10% better make capital of it directly (and de facto fully nationalise the joint).
6. Problem I have with deferring is basically that as we see the matter gets under stress like now there is most likely more stateinvolvement required than when the restructuring of the sector was taken to hand with considerably more pace.
Deferring is logical in a way, but most likely you get it back and with alot of interest when you want it the least.

alternative investment said...

Spain’s banking sector is sitting on a huge toxic asset problem that is not worth what it says on the banks’ accounts. Banks are taking huge losses on real estate loans that have soured, but these are being kept hidden rather then recognized. However, the deeper the Spanish government gets involved in giving aid, the greater the risk the government itself will need a bailout. It simply transfers risk from the private sector to the sovereign.

Rik said...

@Alternative investment

Fully agree.

Its sector was from the beginning of the crisis already heavily overexposed to sov debt (next to the RE debacle).
Getting the Spanish banksector shockproof again should have been an even greater priority for the EZ to get in order than say Greece (which is simply not rescueable, so only the timing of a bankruptcy should be an issue).
However this was (and is) totally messed up:
-the sector should have been reorganised by last September (hardly anything has happened however);
-LTRO increases the exposure and glued the 2, sov and banks completely together. Which only works if one of the parties is strong enough to keep the other with its head above the waterline. Binding 2 cripples like now together, means that if one goes down the other goes with it.
We look to be at the beginning of that process now. Spain takes a hit, the banks get a hit as well (as their guarantor falls de facto partly away). The banks go further down, Spain goes further down as well as their banks are the only ones still buying debt.
It looks like the chain reaction has started now. I do not see anything 'normal' stopping it as they economy will be a disaster for the next 1 or 2 years at least.

So we are running into either another EZ rescue (that will have to use all the resources available) and/or some ECB intervention (but effectively only massive buying of bonds at clearly totally inflated prices will do the job which means a lot of buying for the account of the European taxpayer). Or nothing and let them go bust.

Countries like Spain and Italy should have been back at a primary surplus by now, as that could have meant that with a PSI (especially extend terms) it could have go on without direct financial needs. Now they always need external cash to stay alive. Meaning angry Northeners, hit for the credibility of the ECB, parliamentary approval with the possibility that that won't happen and mass investments of the European taxpayer for something that is imho most likely not going to work.

Anonymous said...

"de Guindos was going to be asked to hire independent auditors by his eurozone counterparts at the meeting of eurozone finance ministers next week."

Seems a little hypocritical of the "Eurozone," bearing in mind that its own (EUSSR) books are s ofraudulent that auitors have refused to sign off onthem for 18 years.

howard said...

Good comments and sadly accurate. Of course providing a degree of clarity to the current opaque quality of not just Spanish but practically all European banks is crucial not to solving the problem initially but to finding out if the problem is capable of being solved by write offs and throwing in more capital. We are looking at a situation which has a large number of moving parts. when Ireland decided it had to admit that its banks were massively over exposed to Irish property lending the myopic capital markets behaved extremely strangely. It was as if they had not known this situation existed and reacted in horror and astonishment. Unfortunately the exercise the Spanish government wishes to undertake may result in the operation being entirely successful but the patient leaving in a body bag. Spanish asset values will react to negative comment exacerbating the problem. Unless there is total independent transparency, whatever the results, they are not going to be credible. Like Rik I do not think there is a solution to be found within Spain or within the Eurozone. There is simply not enough money.