Judging by Ireland, Spanish banks to take a lot more credit writedowns

By Sober Look

Ireland dealt fairly quickly with its property market bubble by effectively and forcefully nationalizing and recapitalizing its banking sector. They clearly still have a serious problem on their hands, but the nation has been aggressive in addressing the issue of distressed real estate loans. In contrast, Spain’s banking system is nowhere close to fully recognizing the full extent of the problem. Not facing the problem however is not going to make it go away.

Reuters: "Banks are not recognising all of their risk. Many of their debtors are property companies with negative equity who can’t even pay the interest on their debt," Fernando R. Rodriguez de Acuna, chairman of the consultancy, told Reuters by telephone.

There are at least 21,000 "zombie [property developers] companies" in Spain that owe banks 126 billion euros, Rodriguez said, basing his estimates on recent data from Spanish mercantile records.

He said the banks were covered for only 67.5 percent of that risk, leaving 40 billion euros of exposure if all the companies filed for bankruptcy.

The fate of the banks is being watched by international investors who fear Spain may be forced to apply for aid as the euro zone debt crisis enters its third year.

One of the issues the banks are dealing with is poor recovery levels on distressed property loans. Recoveries are considerably lower than anticipated.

FT: Repossessed properties in Spain are selling for about half their original value and are likely to continue to fall in value, according to a new report, underlining the parlous state of the real estate market in Europe’s fourth-largest economy. Valuations on properties that were bundled up in securitisation deals and later repossessed are also significantly lower than data from the official housing price index suggest, according to a report from rating agency Fitch due to be published on Thursday.

Carlos Masip, Madrid-based director at Fitch, said: “If we view the market today we believe that there will continue to be a downward pressure on property prices. Home prices are still unaffordable for many when compared to income levels, there is a short supply of credit and a huge overhang of unsold properties.”

As discussed earlier, the amount of "recognized" bad debt has spiked. But this is thought to be only a part of the total delinquencies the banking system will be facing soon.

Just to give some perspective on the level of Spain’s property crisis, consider the following chart showing housing prices over time in real terms compared to the Eurozone as a whole and to the US. Looking at the chart, consider the fact that the bulk of the loans on the books today were extended during the 2004 to 2009 period – right in the middle of the bubble. That’s when the collateral was valued. This is why the recovery levels are so low and continue to decline.

Spain will have no choice but to recapitalize the banking system as Ireland did a couple of years ago. But to do so the nation will need help from the Eurozone/IMF (as Ireland did). Unlike Ireland however, Spain’s massive banking sector capital requirements will threaten to push the Eurozone to the limit.

CNBC: … economists believe that Spanish banks will have to turn to the euro zone’s rescue fund, the European Financial Stability Facility (EFSF), for help in covering losses caused by a property market crash which has yet to end.

Likewise, investors are fretting about how Rajoy’s center-right government can enforce deep austerity while reviving a recession-bound economy at the same time.

"They’re going to need EFSF money to recapitalize the banking sector," said Carsten Brzeski, a senior economist at ING in Brussels. "I think we’ll only see a real end to the Spanish misery if the real estate market stabilizes."

Editor’s Note: This post first appeared on Sober Look’s website

  1. David_Lazarus says

    It would be a mistake for Spain to re-capitalise its banks. Look how that turned out for the Irish taxpayer. Better to let them all fail then nationalise the remains. Leave the creditors to fight over the scraps. That will keep the liabilities off the tax payers balance sheet, and make recovery much easier. That is what Iceland did. This would keep a banking system that is available for the masses. 

    1. Edward Harrison says

      David, I agree that in Spain you would need to see a nationalisation of failed institutions only after the bonds have been defaulted upon. Under no circumstances should Spain look at Ireland as the model in that regard. I agree that Iceland is a much better precedent for Spain on bondholders if Spain is to avoid ballooning its sovereign debt.

      As I said last year around this time when Ireland was getting IMF help: 

      “Spain needs to steer clear of getting too close to its cajas. It cannot afford to pump them full of taxpayer money and take on contingent liabilities as the Irish have done. This would cause the Spanish to re-couple to the periphery and then the euro zone would be in an existential crisis.”


      The recoupling has already happened for Spain but I think Spain would enter a sovereign debt death spiral if it bailed out large institutions and that would require more in assistance than the Troika can muster using its present arsenal.

  2. Ignacio says

    I agree with David_Lazarus. The Government does not have the obligation neither the necessity to recapitalize the Banks at the expense of taxpayers. What the spanish government should do is to inspect the banks anf force them to recognize and writedown bad debt. Next step would be nationalise those that become bankrupt. 

    It looks like Credit Wriedowns has become a Banker lobbyst!

    1. Edward Harrison says

      Come again, Ignacio. I find that offensive. Credit Writedowns does not lobby. That’s absurd. Please explain yourself.

      While I didn’t write this analysis, I agree with the thrust of it, namely that many more credit writedowns are coming. The question is how these writedowns get resolved in terms of making the banking system stronger. There are a number of options.The option that the Spanish government wants to employ is to calculate what the capital hole is and have the private sector fill that hole by having the institutions raise capital amongst those private investors. That is certainly preferable.Another option is that government pony up money. Clearly this is not preferable but it may become the default option if private investors are unwilling to bid as they did in the US after stress tests.

      The final option is bankruptcy and wind down which would contract credit and destroy the banking system as we saw during the Great Depression in the US. And that is why many analysts are pointing to the likelihood of ‘bailouts’ via government capital infusions. This can be done as it was in Iceland, in Sweden or in Ireland. There are a lot of different ways to do this – some that require less capital from government directly.

      My sense is the Troika would be involved if Spanish institutions cannot find private investors.

      Again, tell me where the bank lobby is.

      1. David_Lazarus says

        If the private sector is unwilling to capitalise the banks then the state should not become the lender of last resort. That is the task of the central bank, the ECB. If they do not wish to fulfil that role then wind the bank up. Force it to default. Do it first thing on a Tuesday or Wednesday morning. Create that Lehmans’ moment and force the creditors hand. Create panic deliberately. Show that the Spanish government will not pick up the tab for German banks. Let the problems hit the core faster rather than the continuous extend and pretend that we have now. WIthout the problems of the Spanish banks the sovereign debts are solvable. 

        1. Edward Harrison says

          Agreed, wIthout the problems of the Spanish banks, the sovereign debts are definitely solvable. I would put the discussion on lenders of last resort differently because the ECB as lender of last resort should only lend to solvent institutions against good collateral. These are clearly insolvent institutions with dodgy collateral and they need to be resolved. The question is how to do that. At a minimum, you need to go down the capital structure line from equity to junior debt to senior debt in order to apportion losses appropriately before you allow nationalisation. 

          You can reasonably expect the government to not wipe out senior debt but still wipe out junior debt and equity before taking an equity stake. Here, the state is not becoming the lender of last resort. It is becoming the owner. If it is done correctly, after having resolved these banks, the state can resell to the private sector as was done in Sweden. 

          I think what you and I both are concerned about is the state taking on bank balance sheets and then being liable for their debt in the way that the US is for Fannie and Freddie. That’s expensive and would end up like Ireland with sovereign bailout and an IMF program or default.

          1. David_Lazarus says

            I still think that senior debt in insolvent institutions should take a hit especially if the level of bad debts starts to eat at the senior debt holdings, otherwise what is going to stop all bank debt being described as senior? Any sovereign purchase should be minimal hence €1 to maximise the funds available for recapitalising the bank. It would then allow sufficient time for the banks to restructure and only then should senior bond holders get a payout, once all previous bad debts and liabilities are cleared. That will maximise their payment but without burdening the state with any costs. 

            Another thing that needs to be included is draconian laws banning for life all directors of an insolvent bank ever becoming a director again. That will encourage banks to avoid collapse especially in future as the life time ban on any directorships will end that gravy train for them.

          2. Edward Harrison says

            Right, it is reasonable that senior take write downs but I would not expect it to be wiped out as I said above.

          3. David_Lazarus says

            Maybe senior bond holders should be allowed to exchange their bonds for shares in the new banks once they are ready to be floated. That will enable the bond holders to sell shares to recover their money, but they will have to wait, and any lost interest will have to be foregone. They had invested in an insolvent banks so should regard themselves lucky that they got anything back. Though breaking up the banks and Caja’s is essential, and a new banking code is essential, with caps on size to eliminate this problem in future. If housing had been the exclusive preserve of savings and loan type mutual organisations then the flood of money into real estate would never have happened. 

          4. Edward Harrison says

            Agree that an debt/equity swap makes sense. It makes even more sense when you think about this actually preventing the state from being on the hook as owner. I think these debt/equity provisions should be standard fare as a slug of capital in the balance sheet of banks. A lot of people were talking about this once but it all seems forgotten. Good point.

      2. Ignacio says

        I did not want to be offensive. I don’t believe that C.W. is a banker lobbyst of course, but i saw that the post position was to push for taxpayer financed bank rescue, and , by the way rescue foreign investment. Put yourself in my position: I am a spanish citizen (taxpayer). My personal debt is = 0, and, because banks made lots of bad loans sold to foreign investors, my taxes are 1) increased and 2) diverted from education or health to guarantee those bad loans. In my opinion, the most important thing is not to writedown bad assets at the expense of the first idiot any policymaker find at hand like me, but to do the rigth thing which is to force bankers and bondholders to be accountable for their mistaken investments.

        1. Edward Harrison says

          Understand completely, Ignacio. I don’t think you were reading the implications right though. It was not a push for taxpayer financed bank rescue but rather a recognition that Spanish financial institutions are insolvent and need more capital. The Irish are the right example in terms of recognising this shortfall.

          The post suggests that this will not be solved via private sector capital infusions and so will therefore fall on government as it has done in Ireland. I agree that this is likely. The question then for taxpayers is how this gets solved politically and as I said to David above the best way to nationalise is to liquidate the capital structure in order from equity to junior to senior debt, with the senior probably not being wiped out.

          Now, in Sweden, the senior was made whole. While in Ireland, there too you got bank debt guarantees, even junior bank debt guarantees. What you want to see is more what happened in Iceland where the government allows the institutions to fail and does not take on its balance sheet liabilities in full. So I agree with you, Ignacio and I think this post is in the right spirit.

        2. Ignacio says

          I forgot to write that my previous phrase was, of course, a provocative exageration. I don’t think that a reasonable reader of Credit Writedowns would ever think that it is a banker friendly site or a bank lobbyst site. If you felt offended about this, I  feel sorry about it. It was never my intention to offend, just to provoke.

          Again, I am sorry about that. Forget it and go on with your excellent blog, Mr.Harrison.   

    2. David_Lazarus says

      Credit Writedown’s is far from being a bank lobbyist. If you think that banks want, is for their bad debts to be transferred to the sovereign for nice clean collateral. What Edward and I are suggesting is that the losses are kept far from the tax payer. That means banks will collapse and that is definitely not what the Troika want.
       The Spanish government need to be strong to avoid being dumped with the bad debts of Spain’s banks. Only once the losses are taken by the counter parties should the Spanish government get involved. Seizing the entire banks retail network and operations for €1. Then running them as state banks until they can be sold, but break the banks up so that they are small and cannot get too big.  Small bank failures can be managed. Big banks failures are impossible to manage well. Create a new banking model which can never harm the sovereign again. In the long term to avoid similar events you need to seriously curtail the scope of the banks to create excessive credit. That will harm long term bank growth prospects and is something that banks would never lobby for.

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