The new Spanish government’s ministry of finance last month released further details of its requirement for Spanish banks to boost by €50 billion their aggregate provisions against problem real-estate loans before the end of this year.
Of this, €15 billion will be carried as a capital buffer, with €35 billion set aside in new provisions against P&L hits.
It’s a sign of the government’s determination to remove the uncertainty besetting the Spanish financial system stemming from its private-sector debt bubble, and it is likely to drive further and rapid consolidation in the sector.
"With the exception of the strongest institutions – notably Santander, BBVA, and Bankinter – we expect most banks to be unable to comply with the requirements by December 2012," note Barclays Capital credit analysts Jonathan Glionna and Miguel Angel Hernandez. "This could lead to a wave of mergers."
The government’s long-term aim is to accelerate the clean-up of banks’ problem real-estate exposure to enable the banks to lend to the economy and make housing more affordable.
Those banks involved in mergers, such as Banco Popular, Banco Pastor, Banco Sabadell and Caja de Ahorros del Mediterráneo, will be given up to the end of 2013 to meet these requirements and be allowed to fully charge the required write-downs against reserves.
Other banks announcing mergers before the end of May will enjoy the same benefits, as long as they commit to lending growth.
The finance ministry’s announcement has lanced a growing sore on the Spanish banking sector. It has been an open secret for many months that banks have been carrying loans at par value even after considerable forbearance over missed debt service payments and sharply reduced collateral values.
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Investors had lost faith in the carrying values of assets at many banks. "Some of the collateral, especially land collateral, is worth close to zero," one FIG banker tells Euromoney. The Spanish government has not gone far but is demanding that banks increase provisions against land exposure closer to 80%.
Whether the government’s demands restore confidence remains to be seen. The Bank of Spain estimates the banking system’s exposure to property developers and the construction sector was €323 billion as of June, of which €175 billion was deemed to be problematic.
Barclays Capital analysts estimate losses likely still to be uncovered in Spain’s banking system at closer to €90 billion than €50 billion. Analysts at UBS, meanwhile, suggest that total provisioning needs might be closer to €100 billion.
Banks have only until the end of March to present their plans to meet these new requirements and the Bank of Spain will either approve them or add requirements for additional measures by April 20.
Merger plans must be approved by the Bank of Spain by the end of June and by banks’ shareholders by the end of September.
How will banks that cannot earn their way to meet these demands address the shortfall? One suggestion is for the government to inject €15 billion through contingent capital notes. But analysts question whether weak banks, even after merging, might have the earnings power to boost their provisions and capital buffers, and whether strong banks will rescue the weak without some greater protection on their most toxic asset portfolios.
The government might have to inject capital to support some kind of good-bank, bad-bank solution, perhaps up to €15 billion – so not an amount that would badly damage sovereign debt-to-GDP ratios; bondholders might have to accept write-downs; junior debt holders might tender into buy-backs at well below par; or possibly a combination of these measures.
There is still a long way to go to restore the Spanish banking system given that the declining economy, on course to shrink by between 2% and 3% this year, still suffers from signs of rising credit risk, amid high unemployment, which is on course for 24% according to official figures.
Analysts warn that as well as problem real-estate loans, banks might also have to grapple with high loss, given default rates on loans to other small to medium-size enterprises. The banking system’s aggregate loans-to-deposit ratio still stands at more than 150% and investors must wonder about the attractions of depositing money at a weak Spanish bank.
"The LTRO has bought time but it has not been transformative," says William Porter, head of credit strategy at Credit Suisse. "In December, BdeE [Spain’s central bank] figures showed Spanish banks borrowing €127 billion from it. The figure for January rose to €161 billion. This is the counterpart of balances of NCB’s at the ECB, and the latter are effectively the inverse of private sector capital flows to those countries. If the LTRO were transformative, you’d expect those balances to be declining not rising. If €30 billion a month is leaving Spain, then it’s just a matter of time before the banking sector’s problems re-emerge."
UBS analysts Alastair Ryan and John-Paul Crutchley are equally worried. After the Spanish ministry made its announcement, they noted: "The Spanish banking reforms are inadequate, in our view, leaving a system poorly funded and capitalized – reducing credit extended to the real economy – and chronically dependent on the ECB.
"With the new government unlikely to meet its budget targets, the scene is set for a future crisis there."
