Spanish Bad Bank Risks Investor Conflict With Stressed Lenders

Spanish Bad Bank Risks Investor Conflict With Stressed Lenders
Construction equipment lies abandoned near unfinished homes on a stalled residential housing project in Avila. Photographer: Angel Navarrete/Bloomberg

Spain must ensure a so-called bad bank meets investor demands for yield without undermining the balance sheets of lenders as the government seeks a panacea for the country’s real estate crisis.

“If the new investors do not believe they are going to get a good return on their investment, they will not want to get involved,” said Vanessa Gelado, director of Drago Capital, a Madrid-based real estate fund that’s considering investing in the bad bank. “It’s a very difficult equilibrium to achieve.”

The terms of Spain’s 100 billion-euro ($129 billion) bank bailout oblige Prime Minister Mariano Rajoy to set up an asset management firm to house foreclosed homes and real estate loans from banks that received state aid. The government wants private investors to own the majority of the bank so the debt doesn’t contaminate national accounts as it tries to rein in the euro region’s third-biggest budget deficit.

The strategy pits investor demands for low valuations on assets transferred to the bad bank with the needs of some lenders to support real estate prices to avoid further losses, said Luis Garicano, a professor at the London School of Economics.

“It’s a very difficult balance to achieve, or maybe it’s impossible,” said Garicano in a phone interview. “If you’re the government, you’re trying to attract investors, but at the same time you don’t want to underpay for the assets or you risk undermining the banks and maybe having to recapitalize them unnecessarily.”

Great Opportunity

Spain will set up the bad bank this month and determine which assets will be transferred and at what price. Economy Minister Luis de Guindos has said the bad bank will try to sell the assets it acquires from banks over 10 to 15 years. It will be operational by early December, according to his department.

The bad bank will help the economy by removing toxic assets that consume capital from the balance sheets of lenders, said Gelado of Drago, which has 2.75 billion euros under management.

“If the bad bank is done properly, it could be a great opportunity to remove these assets from the balance sheets of the banks and help them start lending again,” Gelado said.

Basic details about the bad bank, such as its capital structure, remain unclear as the government awaits the results of a stress test of 14 Spanish banking groups by Oliver Wyman Ltd. that is due to be published on Sept. 28.

Asset Transfers

The state aid that weaker banks may eventually need will be depend on how much they can improve their capital situation by transferring assets to the bad bank and taking other steps such as selling businesses, the economy ministry said Sept. 14. The Bank of Spain will determine values for assets to be transferred to the “bad bank” using “commonly accepted methodologies” that will allow for a “realistic estimation,” according to a government decree last month.

The government may ask Spanish lenders to become shareholders in the “bad bank,” said Drago’s Gelado.

“There is a risk of a conflict of interest if you involve the banks in the shareholding of the bad bank,” she said. “It’s in their interest to price the assets as high as possible, but the opposite is true for investors.”

Francisco Gonzalez, chairman of Banco Bilbao Vizcaya Argentaria SA, said in a Sept. 20 speech in Madrid that he thought Oliver Wyman’s stress test may reveal capital needs of 70 billion to 80 billion euros, including 19 billion euros already injected into the system. While Spain’s second-biggest lender was “open to all options” on the bad bank, it would prefer not to take a stake in the short term, he said.

Investor Caution

The government’s desire to have private investors controlling the bad bank means it will have to “find a way to make this an attractive investment, something we consider very complicated unless valuations are realistic or investors are granted guarantees,” Jaime Becerril, an analyst at JPMorgan Cazenove, said in a Sept. 21 report.

Investors will be wary of whether assets have been properly valued and will be particularly cautious about land and property, said Fernando Acuna Ruiz, managing partner of Madrid-based Taurus Iberica Asset Management.

“They also want to know who their partners are going to be and they want their own valuations done of the assets,” he said. “They are not going to trust valuations given by banks.”

Rajoy had resisted setting up a bad bank to clear soured real estate assets from the books of failing lenders until July’s memorandum of understanding for Spain’s bank bailout forced him to set one up.

Optimal Returns

Until then, his government’s strategy had been to make banks speed up recognition of losses on real estate by boosting provisioning levels for land to 80 percent and to 65 percent for unfinished developments.

Private investment funds would typically want returns of 20 percent, presenting a dilemma for a government wary of setting low property transfer values that are read across for the banks, said Emilio Miravet, head of real estate finance at Catella Property Spain SA, an arm of Swedish financial advisory and investment firm Catella AB.

If the “bad bank” were to require an additional charge of as much as 20 percent on finished real estate above the average 26 percent required under existing provisioning requirements, that could add costs of 2.43 billion euros for Banco Popular Espanol SA and 2.98 billion euros for CaixaBank, Morgan Stanley analysts Alvaro Serrano and Sara Minelli wrote in a Sept. 12 report.

The 45 percent average provisioning levels for real estate required by Spain compare with the average discounts of 58 percent when assets were transferred to Ireland’s version of the bad bank, the National Asset Management Agency.

“If you want to attract a private investor, you have to offer a really attractive rate of return, which could mean setting the transfer price really low at the expense of the taxpayers,” Miravet said. “So you want to minimize the expense of the taxpayer whilst attracting private investors -- these are two completely contradictory goals.”

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