ECB Is Said to Push Bankia Losses as Spain Purges Assets

European authorities are pushing Bankia group to impose losses on junior debt holders as Spain purges a banking system clogged with about 180 billion euros ($234 billion) of bad real estate assets, people familiar with the talks said.

The European Central Bank and European Commission want investors including holders of preference shares to swap their securities for new stock to reduce the cost to the taxpayer, according to two people who asked not to be named because the discussions are private. Profit at Banco Santander SA (SAN), Spain’s biggest lender, slumped in the first nine months as it took a 14.5 billion-euro charge on real estate losses.

Confronting the toxic legacy of Spain’s 10-year building boom is imposing political costs on Prime Minister Mariano Rajoy as he faces protests on the streets of Madrid, a separatist challenge in Catalonia and a battle to avoid a full bailout. His European partners are complicating the task as they blanche at putting capital on the line to backstop Spanish lenders.

“They are dragging their feet because there are still question marks over where the money comes from to plug the gaps,” said Olly Burrows, a London-based credit analyst at Rabobank International. “Regardless of whether or not there is a bailout of Spain, we need to clean up the banking system.”

Bonds Fall

Banco Financiero y de Ahorros SA’s 372.25 million euros of subordinated floating-rate notes due October 2016 fell by more than 7 percent overnight. The securities opened at 21 cents on the euro, compared with 22.6 yesterday, and were at 22.25 as of 1:28 p.m. in Madrid, according to Bloomberg generic prices.

The yield on Spain’s 10-year government bond dropped two basis points to 5.55 percent, after exceeding 7.75 percent in July.

European policy makers, who are still to make the first payment of a 100 billion-euro bank rescue agreed in June, insist Rajoy can’t use public money to rescue retail investors who bought preferred shares as part of publicity drives by banks.

German Chancellor Angela Merkel placed new hurdles in Rajoy’s path at a European Union summit in Brussels last week when she said that any bailout loans disbursed before the bloc completes a banking union will stay on the Spanish government’s balance sheet.

Rajoy Stymied

That ties the sovereign more tightly to its ailing banking system, dashing Rajoy’s plans to transfer bailout loans to the EU rescue fund once the banking union starts. Merkel also damped expectations that the bloc will meet its deadline to bring together lenders under a single supervisor by the start of next year as AAA rated sovereigns in northern Europe backed away from a pledge made in June.

“The problem is the decisions are not being made in Spain,” Burrows added. “There’s stalling on the European level.”

The strictures the EU is imposing on Spain’s banking clean- up make it harder for the government to rebuild Bankia (BKIA), which was nationalized in June, by forcing losses on some of its best retail clients. Economy Minister Luis de Guindos has said in Parliament in Madrid that banks should never have sold preferred shares to individual investors.

Sharing Burden

Under EU rules, junior bondholders must share the burden of rescuing lenders to reduce the cost to taxpayers and the exercise typically involves exchanging the notes for cash or new securities at a discounted value.

In a fresh sign of the weakness in Spanish banks, Santander saw net income drop to 100 million euros in the third quarter from 1.8 billion euros a year earlier as it pushed on with the process of recognizing its real estate losses. The bank, which runs retail operations across Europe and the Americas, said the process of purging its balance sheet of real estate losses ordered by de Guindos is 90 percent complete.

Banco Sabadell SA, Spain’s no. 5 bank, said today that bad loans rose to 8.5 percent of its portfolio in the third quarter from 5.7 percent a year ago.

Santander Chief Executive Officer Alfredo Saenz added his voice to those urging Rajoy to trigger ECB bond-buying by asking for financial help from the EU rescue fund.

“It seems clear that it would reduce the risk premium for the sovereign and reduce the spreads that the most important Spanish banks pay,” Saenz said on a call with analysts today.

Toxic Warehouse

Santander’s 1 billion euros of 4 percent senior bonds due 2017 trade at 318 basis points above the mid-swaps rate, a benchmark for fixed-rate debt, according to Bloomberg prices. That compares with the 250 basis-point yield spread the lender paid when it issued the notes in March.

Officials in Madrid are working on plans to fund a bad bank to warehouse toxic assets from lenders bailed out by the government. The EU demanded that as a condition of the bank rescue package and Rajoy, who has until the end of November to establish the bad bank, has said it won’t end up costing taxpayers.

De Guindos, who changed legislation to limit future sales of preference shares to retail clients after Bankia’s collapse, has said the government is seeking a solution for the bank’s investors. EU Competition Commissioner Joaquin Almunia said in June that Spain could use budget revenue to compensate them.

Spokesmen for the ECB and the Spanish Economy Ministry declined to comment yesterday. Antoine Colombani, an EU spokesman, said the terms of Bankia’s restructuring are being discussed with Spanish authorities. A spokesman for Bankia also declined to comment.

To contact the reporters on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net; Esteban Duarte in Madrid at eduarterubia@bloomberg.net Ben Sills in Madrid at bsills@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net; Paul Armstrong at parmstrong10@bloomberg.net; James Hertling at jhertling@bloomberg.net

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