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Spanish Cleanup Plan May Backfire on Banking System: Euro Credit

Spanish Prime Minister Mariano Rajoy
Spanish prime minister Mariano Rajoy. Photographer: Denis Doyle/Bloomberg

Spanish Prime Minister Mariano Rajoy’s proposal to force banks to recognize further losses from real estate holdings may backfire by saddling healthy lenders with the bill.

“The plan is for a massive effort in provisioning of real estate and consolidation, and that has to be paid for,” said Daragh Quinn, a Madrid-based analyst at Nomura International.

By refusing to use public funds to help purge a system burdened with 176 billion euros ($228 billion) of what the Bank of Spain calls “troubled” assets linked to real estate, Rajoy may not do the job properly or he may hurt solvent banks by leaving them with the costs, said David Moss, director of European equities at F&C Investments in London.

Rajoy wants to make banks accurately value assets piled up on their books as part of his efforts to lower Spain’s borrowing costs and free up the flow of credit in the economy. Investors demand about 763 basis points more yield to hold Bankia SA’s senior unsecured bonds maturing in 2017 than similar German bunds, up from about 46 basis points when the securities were sold in 2007.

Since Rajoy was elected on Nov. 20, the rate on 10-year Spanish debt has declined 124 basis points to 5.45 percent.

Rajoy wants to avoid committing public funds as he battles to bring down a deficit that was 8 percent of gross domestic product in 2011, exceeding the 6 percent target from the outgoing Socialist government. He announced 15 billion euros of immediate spending cuts and tax increases last month to narrow the gap.

“If the public purse doesn’t get used at all, this can only mean this whole process happens more slowly and it might take longer to make the impact that’s needed,” Moss said.

Britain to U.S.

Rajoy’s reluctance to deploy public money compares with the strategy of the U.K., where taxpayers provided 1 trillion pounds ($1.56 trillion) for bailouts and guarantees to shore up the financial system. As part of the U.S. response to bolster its banking industry, the Congress authorized the $700 billion Troubled Asset Relief Program in 2008, of which $411 billion was dispersed.

Government officials in Madrid have started to give details of how the cleanup of damaged real-estate assets pledged in Rajoy’s election manifesto might work. Spanish banks face as much as 50 billion euros of additional provisions, Economy Minister Luis de Guindos, a former head of Lehman Brothers Holdings Inc.’s Iberian business, said earlier this month.

Most lenders can cover the extra provisioning for real estate from their profits and the process could be extended over several years, de Guindos said.

Apartment Values

“There’s an issue, which is also fundamental, which is that banks and savings banks are filling up with real estate assets and apartments and because these apartments are not valued at market prices, they don’t go to market,” de Guindos told state broadcaster TVE today in an interview.

Banks will have to reduce their earnings as part of the cleanup process as the government also coaxes some into mergers, de Guindos told TVE. He said he “absolutely” ruled out setting up a so-called bad bank to acquire damaged assets from lenders because doing so would cost public money. The cleanup process won’t “cost a penny more” to the taxpayer, he told TVE.

Rajoy, 56, has said he favors bank mergers. He is scheduled to unveil additional details of the program by mid-February.

“What the government could be looking to do is to mutualize some of the potential capital shortfall,” Nomura’s Quinn said.

What’s Credible?

Rajoy’s plan to make banks increase provisions looks like an extension of an existing order dating from 2010 for banks to bolster reserves to cover bad real estate, Quinn said. That rule made banks set aside provisions to cover 30 percent of the value of property taken onto their balance sheets after two years.

“Was that a credible response?” said Quinn. “The fact they’re having to do it again gives you your answer.”

Doubts about how the cleanup will be paid for center on the scale of the potential cost for banks with the greatest amount of damaged real estate, said John Raymond, bank analyst at CreditSights Inc. in London.

The 176 billion euros of the so-called troubled real estate-linked assets is 52 percent of total developer loans and provisions have been set aside to cover about a third of the amount, according to the Bank of Spain.

“It’s hard to unsay a number like 50 billion euros once you’ve said it,” Raymond said. “The government might indeed be forced to put some more capital into the banks and it won’t necessarily be easy for them to fund it.”

Santander to Bankia

While companies such as Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA have profitable international units to help absorb property-related losses, other lenders may be vulnerable, said Carlos Joaquim Peixoto, an analyst at Banco BPI SA in Oporto, Portugal.

Bankia and its parent company, formed from the merger of seven savings banks to create Spain’s third-biggest lender, held more than 11 billion euros of acquired or foreclosed real estate as of last March, including a net 3.1 billion euros of land.

It would cost about 3 billion euros to boost the ratio of provisions covering acquired or foreclosed real estate on the group’s books to more than 50 percent from 32 percent as of last March, according to Peixoto.

He also estimates Bankia will have to set aside 2 billion euros over the next two years as other portions of its loan book turn sour. That compares with his estimate for profit before provisions of 4.2 billion euros in the next two years.

Santander Provisions

“My view is that BFA-Bankia will not be able to solve this problem by themselves,” said Ricardo Wehrhahn, a partner at Roland Berger Strategy Consultants in Madrid.

A Bankia spokeswoman, who refused to be identified, declined to comment.

Santander will make a provision of about 4 billion euros against 2011 earnings to anticipate tougher rules on recognizing real estate losses, El Confidencial reported today. A spokesman for the bank, who asked not to be identified by name in line with company policy, declined to comment.

Spain has made healthy banks pay for the restructuring of Caja de Ahorros del Mediterraneo, an Alicante, Spain-based lender that was seized last July by the Bank of Spain because of souring property loans. The nation’s deposit guarantee fund, which is financed by the country’s banks, is set to inject 5.25 billion euros into CAM before it’s acquired by Banco Sabadell SA.

‘Tremendously Unfair’

The government in December ordered banks to increase their contributions to the fund in a step that angered bankers. At a Jan. 19 news conference, Maria Dolores Dancausa, chief executive officer of Madrid-based Bankinter SA, described the extra charges on deposits as “tremendously unfair.”

It’s possible the government may be tempted to force stronger banks such as Santander, BBVA and CaixaBank to absorb weaker companies or those already taken over by the government’s bank rescue fund, Santiago Lopez, a Madrid-based analyst at Exane BNP Paribas, wrote in a Jan. 18 note to clients.

As many as seven lenders, including Banco de Valencia SA, CatalunyaCaixa and Unnim, have either been seized or otherwise taken over by the Bank of Spain. While the probability of enforced takeovers is low, “it is not zero anymore” given the government’s refusal to provide public funds to bail out failing lenders, Lopez said.

In his interview today with TVE, de Guindos said the government had no intention of choosing merger partners for banks.

“If the government passes the cost of bailing out the weaker banks to the stronger banks, then no bank could be investible whilst this event risk persists,” said Georg Grodzki, head of credit research at Legal & General Investment Management in London. “The government would limit its fiscal costs, but the uncertainty about forced bailouts would put off investors even from stronger institutions.”

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