Spain Banks Ditch Debt in Pre-Stress Test Makeover: Euro Credit

Spanish lenders have sold lucrative government bond holdings ahead of European Central Bank stress tests, forcing them to think of ways to restore lost revenue.

Banco Popular Espanol SA, a lender that had to raise capital after Spain’s stress tests in 2012, reduced its sovereign debt holdings by 5.6 billion euros ($7.6 billion), or 44 percent, in the fourth quarter. Bankinter SA sold about half its holdings because of uncertainty over how they’ll be treated in the exercise the ECB is planning in its new regulatory role.

During the sovereign debt crisis, Spanish banks piled up on public debt just as foreign investors were dumping the assets. As the ECB’s examination helps prompt a reversal of that trend, lenders will have to rely more on earnings from their core banking business in an economy that’s still crawling out of recession.

“This exercise is helping to hit the re-set button for the Spanish banking system so that it operates under more normal conditions,” said Olly Burrows, a credit research analyst at Rabobank International in London. “Banks hoarding bonds has been a sign of the weakness of their business and indicative of a lack of lending to the real economy.”

Economic Recovery

Spanish banks sold down their holdings as the bond market rallied amid growing appetite for Spanish securities from foreign investors. The yield on Spanish five-year sovereign debt traded at to 2.11 percent at 11 a.m. in Madrid compared with a record 7.59 percent in July 2012 at the peak of the debt crisis.

The economy is recovering after two recessions and a financial crisis that slashed the amount of credit in the economy by about 400 billion euros. As the government forecasts the economy that grew in the third quarter for the first time in two years will expand about 1 percent in 2014, data show lending has started to increase on a monthly basis. Bankinter is among banks forecasting loan growth in 2014.

The ECB’s exercise, which will scrutinize 16 Spanish lenders, may support that trend as banks seek new sources of revenue, even as demand for credit remains weak. As part of the three-part assessment of banks’ assets, the ECB will simulate the effect of an economic downturn on balance sheets. That will include government bond portfolios, although the ECB hasn’t clarified exactly how they will be treated in the test.


Banks holding large amounts of sovereign debt hasn’t just been a Spanish phenomenon. Domestic euro-area government debt accounted for 4.3 percent of total bank assets in December, according to ECB data.

Under European Union rules, banks rate all debt issued by the bloc’s 28 governments as risk-free, avoiding any increase in capital requirements. ECB Supervisory Board Chairman Daniele Nouy said in an interview with the Financial Times today that one of the biggest lessons of the financial crisis was that sovereign bonds are not risk-free assets.

The ECB, which is being advised by Oliver Wyman, the same consultants Spain used for its 2012 stress test, has said it expects the scenarios to be sent to banks by the end of April.

Spanish banks didn’t wait to see the criteria. Their holdings of Spanish government bonds fell to 173.1 billion euros, or 29 percent of the total, in December from 191 billion euros in November and a peak of 203 billion euros, or 35 percent of the total, in August, according to treasury data. At the same time, foreign investors raised their holdings to 243 billion euros, or 41 percent of the total, from 35 percent in August.

Bond Rally

Banks sold into a bond-market rally as the nation prepared to exit its European rescue program and shares in lenders including Bankia, whose collapse prompted the 2012 bailout, surged. That rally allowed banks to make trading gains, providing additional funds to absorb the cost of cleaning up bad loans, according to Antonio Ramirez, a banks analyst at Keefe, Bruyette & Woods in London.

Banco Sabadell SA, Spain’s fifth-biggest bank, which has reduced its government bond holdings by 3.1 billion euros, or 17 percent, since June, reported 251.6 million euros in net trading gains in the fourth quarter, up 38 percent from the year-ago period. Bankia, whose Spanish sovereign bond holdings like those of No. 2 lender Banco Bilbao Vizcaya Argentaria SA are broadly unchanged, said on Feb. 3 its fixed income portfolio contributed about 20 percent of its financial revenues in the fourth quarter and that should remain stable this year.

ECB Funds

Banco Santander SA, the country biggest lender, reduced its exposure to sovereign bonds of all countries to 52 billion euros from 60 billion euros in the last quarter.

While reducing bond holdings, banks have also cut their use of ECB financing amid uncertainty about how the stress test will treat it, Ramirez said. While it’s a sign of normalization, it also removes a cheap source of funding that helped swell margins.

Santander’s Spanish business no longer has any funding under the ECB’s LTRO program, compared with the 35 billion euros it originally took. Banco Popular has cut its LTRO use to 1.25 billion euros from 8.5 billion euros in September, and 17.2 billion euros a year ago.

“The Spanish banks have been trying to tick off some boxes before the stress test exercise,” Ramirez said. “They’ve been ticking three boxes by reducing sovereign exposures and ECB funding and building up provisions.”

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