We should consider Spain one of the four original bubble markets where residential property markets soared to ridiculous levels during the housing bubble. The bubble has now popped and those countries, the U.K., the U.S., Ireland and Spain, are reeling. To be sure, there were bubbles in other markets as well. However, these four markets should certainly be the big economy markets to watch.
You may have seen the recent report on the Spanish savings bank Caja Castilla-La Mancha where the government was forced to intervene. This is the tip of the iceberg when it comes to the savings banks.
Back in August, you may recall that Dutch Central Bank head Nout Wellink, who is also an ECB governing council member, said the ECB has to stop propping up banks. Most people in European finance knew he was pointing the finger at the Spanish Cajas in particular as they were addicted to ECB credit.
Fast forward to today in the wake of the Caja Castilla-La Mancha episode and reports are emerging of huge potential losses in Spain:
The cajas, which are mutual banks controlled by regional politicians, have a bigger problem with bad debts in Spain than shareholder-owned counterparts such as Santander and BBVA.
The cajas were more aggressive during the good times – loans to developers increased by more than 50pc in 2006, and account for a fifth of their total loan books. This explains why the ratio of non-performing loans stands at 4.5pc for the cajas, against 3.2pc for commercial banks.
It looks like the Bank of Spain, which kept Spanish banks from buying toxic assets out of the US, wasn’t prudent enough at home. True, banks were ordered to build a thick cushion of generic provisions during the good years. But for some cajas, these provisions will be eaten up by losses. In the last year, the sector’s ratio of provisions to bad debts, or coverage ratio, has fallen from about 200pc to just 56pc.
As property prices fall and new developments sit unsold, the cajas’ losses mount. Credit Suisse estimates the cajas will need to raise €60bn just to keep the ratio of equity to non-performing loans at 160pc.
That may be high. Suppose 10pc of whole loan book – and a quarter of the €172bn of loans to developers – go bad. And suppose only 40pc of their value of the loans is recovered. The total losses would be about €34bn – eliminating nearly half of the current equity in the sector.
Savings banks could cover part of the hole with operating profits and existing provisions. But they have only €23bn in provisions now. To get the buffer up to 75pc of non-performing loans, another €16bn needs to be found.
Some of the missing capital – losses and reserves – will be generated by operating profits, running at €15.2bn annually. Add it all up, and there still seems to be a capital hole of nearly €40bn. The gap isn’t spread evenly, and the richer cajas aren’t likely to want to share much with their poorer brethren via mergers. The Boss of Spain’s biggest savings bank, La Caixa, recently said mergers made more sense when financial margins were wider. So in practice, the shortfall is likely to be larger.
Some cajas can sell industrial stakes. But they can’t raise equity from private shareholders, as Santander recently did, because they are not listed. It looks like the government may have to foot most of the bill.
As I have said many times, the banks in Europe are well under-capitalized. Spain is not the only one here and this is going to become ever more apparent as 2009 takes its course.
Spain’s savings banks could face €40bn hole in capital – Telegraph