Spain Set to Purge Banks of Property Hangover

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Photographer: Dennis Doyle/Bloomberg

Cranes stand over a construction site in Madrid, Spain. Spanish banks have set aside 105 billion euros since 2008 to absorb a property crash that has left them holding unsold land, apartments and warehouses.

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Photographer: Dennis Doyle/Bloomberg

Cranes stand over a construction site in Madrid, Spain. Spanish banks have set aside 105 billion euros since 2008 to absorb a property crash that has left them holding unsold land, apartments and warehouses. Close

Cranes stand over a construction site in Madrid, Spain. Spanish banks have set aside 105 billion euros since 2008 to... Read More

Photographer: Denis Doyle/Bloomberg

Mariano Rajoy, leader of the conservative People's Party. Close

Mariano Rajoy, leader of the conservative People's Party.

Photographer: Denis Doyle/Bloomberg

Pedestrians cross the street in front of the Bank of Spain in Madrid, Spain. The Bank of Spain classifies 52 percent of the more than 300 billion euros of bank risk associated with property developers as “troubled.” Close

Pedestrians cross the street in front of the Bank of Spain in Madrid, Spain. The Bank of Spain classifies 52 percent... Read More

Photographer: Denis Doyle/Bloomberg

Investors demand 469 basis points of extra yield to own 18-month senior, unsecured notes sold by Banco Bilbao Vizcaya Argentaria SA rather than two-year German government debt, up from 341 basis points when Spain’s second-biggest bank raised 750 million euros from selling the debt on Oct. 28. Close

Investors demand 469 basis points of extra yield to own 18-month senior, unsecured notes sold by Banco Bilbao Vizcaya... Read More

Spanish banks face deeper losses on 176 billion euros ($243 billion) of soured real-estate assets as Mariano Rajoy, the favorite to win national elections on Nov. 20, pledges to enforce a cleanup.

“You have to remove any kind of shadow of doubt over the valuation that you have of these assets in your balance sheet,” Luis de Guindos, named by newspapers as a contender for finance minister in a new People’s Party government formed by Rajoy, said in an interview. De Guindos said he favored stricter rules on how banks account for depreciated land values.

Investors demand 485 basis points of extra yield to own 18- month senior, unsecured notes sold by Banco Bilbao Vizcaya Argentaria SA (BBVA) rather than two-year German government debt, up from 341 basis points when Spain’s second-biggest bank raised 750 million euros from selling the debt on Oct. 28. The yield on 18-month Spanish government paper sold yesterday jumped to 5.159 percent from 3.801 percent last month.

Reluctance of banks to lend threatens to hamper economic growth, undermining trust in government finances and threatening to create a “vicious circle,” said Alberto Recarte, who worked as an economist for the People’s Party from 1992 to 1996. Spain’s 10-year borrowing costs were at 6.24 percent today, up from an average this year of 5.4 percent.

Spanish banks have set aside 105 billion euros since 2008 to absorb a property crash that has left them holding unsold land, apartments and warehouses. The “cleanup and restructuring” of Spain’s banking system is the top pledge Rajoy has made in his electoral program to fund the country’s recovery by boosting the supply of credit.

Forced Recapitalization

The Bank of Spain classifies 52 percent of the more than 300 billion euros of bank risk associated with property developers as “troubled.” Real estate dwarfs other risky assets held by the country’s lenders such as the 13.4 billion euros they hold of Greek, Irish, Italian and Portuguese debt.

“If I were in the PP government, the first thing I would do would be to recapitalize the banks whether they like it or not,” said Recarte. “It would be simple for the Bank of Spain to oblige them to put a market value on their real estate portfolio, and immediately it would become clear that they all need capital.”

Opinion polls show Rajoy, 56, is the favorite to win Spain’s election by beating the Socialist candidate Alfredo Perez Rubalcaba and toppling the incumbent prime minister, Jose Luis Rodriguez Zapatero.

Active Management

Rajoy hasn’t named a choice for finance minister or outlined specifics about the plans for making banks deal with their real estate loans. His election program says his government would make it easier to “actively manage” the industry’s damaged assets so that they can be sold.

De Guindos, a former deputy finance minister in the PP government of Jose Maria Aznar who has been named by El Pais newspaper and Cadena Ser radio station as Rajoy’s possible choice for finance minister, said imposing stricter rules on how financial firms make provisions against deteriorating values for land may present a solution.

“What’s important to me is eliminating all doubts from the point of view of the valuation of this asset class, which is the worst, and then we’ll have to see what the other alternatives are,” said de Guindos, who is now director of the PwC and IE Business School Center for Finance in Madrid.

Raising Capital

While some banks would be able to absorb the losses, others would have to raise capital, a process that may trigger a fresh round of bank sales, de Guindos said. In some cases, the banks would have to tap public money, either from the Spanish government or from Europe, he said.

The Bank of Spain acted in May 2010 to force banks to recognize more real estate losses when it said they would have to set aside provisions to cover at least 30 percent of the value of assets such as property sitting on their books for two years. At present, Banco Santander SA (SAN), Spain’s biggest bank, has about 31 percent of its non-performing real estate assets covered by provisions, compared with 26 percent for BBVA.

Some analysts and bankers have said they would favor a so- called bad bank solution in which the government would buy damaged assets from lenders. The process would disencumber the banks from the burden of covering losses linked to real estate and help them lend while the bad bank would seek to sell off the acquired assets for as long as it takes for prices to recover.

Money Flow

“The only solution the Spanish economy has to make credit flow again is cleaning up the balance sheets of the banks and the only way to do this is through a bad bank,” said Fernando Fernandez, an IE professor and a former International Monetary Fund economist.

A properly run bad bank project would be “a very, very good idea,” Juan Maria Nin, chief executive officer of CaixaBank SA, Spain’s fourth-biggest bank, said on a Nov. 4 webcast for analysts.

Recarte said he is skeptical about the plan because it is too difficult to value the assets that the bad bank would buy.

Government takeovers of failing lenders have fueled concern about whether banks are accurately reporting real estate losses. Caja de Ahorros del Mediterraneo, a savings bank seized by the Bank of Spain in July, was found to have more than half of its property loans in default as its total bad loans ratio jumped to 19 percent in June, double the ratio it had posted in December.

While analysts disagree over how to clean up the balance sheets of banks, they agree it would help make credit flow in an economy that stagnated in the third quarter.

Santander Capital

Santander, which has to add 5.22 billion euros of capital by June by order of the European Banking Authority, has allowed its Spanish loan book to shrink by an annualized 5.6 percent through September. Santander and BBVA have said they can meet the requirements set by the EBA without raising capital.

Instead of focusing on how assets are valued, Spain’s priority should be to create “profitable, powerful and efficient companies” that can absorb losses by generating sustainable cash flow, Miguel Martin, the head of Spain’s banking association, said in a Nov. 10 speech. “A bad bank is nothing more than an instrument for doing something -- what we have to do is create strong companies.”

“The truth is that the Spanish banking system still has to recognize the loss of value of its real estate assets,” said Jaime Garcia Legaz, general secretary of FAES, a Madrid-based research institute linked to the PP, who supports proposals for a “bad bank.” “Once we have this fact, we will know how much capital our banks really have.”

To contact the reporters on this story: Charles Penty at cpenty@bloomberg.net Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net

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