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22 June 2012Kick-off or full time? The funding needs of Spanish banks and what’s next for SpainKey Points
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The IMF estimates of €40bn for Spanish bank recapitalisation look too low. Weestimate that the banking sector needs between €90bn and €110bn, meaning eventhe expected €100bn rescue package may not be enough. The amount needed couldfurther increase if banks struggle to raise provisions against losses on top of theircapital requirements. The external stress tests announced yesterday are equally toolow given that they worked from current data, which may be insufficient or incorrect.
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We expect that this package, along with higher borrowing costs, could increaseSpanish debt to 94% of GDP in 2013 and 112% in 2015 (with only slightly lowergrowth than expected).
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This package will intensify the sovereign-banking-loop in Spain as banks come undermore pressure to load up on Spanish debt. Unless the far-reaching problems in theSpanish banking sector are resolved – which looks unlikely – further reinforcing thisloop could eventually force Spain into a full bailout (as the burden becomes too muchfor one side to stand). This is something for which the Eurozone’s current bailoutfund would not be equipped.
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Ultimately, Spain’s problems are not confined to its banking sector. The state facesfunding costs of €548bn over the next three years, as well problems controllingregional spending and encouraging economic growth – all of which, again, makes therisk of a full bailout for Spain more likely.
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Therefore, in order to avoid the plan being counterproductive, stabilising the country’sbanking sector in longer requires the right conditions – including ‘bail-ins’ and bankwind downs.
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The ESM will not be in place to provide the funds, meaning that the EFSF will haveto. This reduces questions over seniority but will lead to demands for collateral fromFinland – a messy issue which could itself prompt seniority concerns.
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We estimate that total exposure of EU countries to the Spanish economy is around€913bn, a huge amount which highlights the vital importance of ensuring that thisrescue package works the first time around.
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The plan
Spain will access a loan from the EFSF/ESM (the eurozone bailout funds) which it will use torecapitalise its ailing banking sector. The money will be channelled through the FROB (theSpanish bank restructuring fund) but will still be a state liability as it will not go directly to thebanks. However, unlike the other bailouts it will not come with fiscal conditions but onlyconditions for reforming the financial sector. The total level of funds needed will be decidedby the Commission, IMF and the ECB – in conjunction with the external stress testsconducted by Oliver Wyman and Roland Berger – as will the exact reforms needed by thefinancial sector.
1. Is the rescue package large enough?
Despite initial relief at the announcement of the Spanish rescue, markets quickly turned thepressure up as questions over the size and structure of the package took hold. In the pasttwo weeks we have seen Spanish borrowing costs increasing across the board, with tenyear bond yields staying above 7% for sustained periods.
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1.1 Are the IMF estimates too low?
The most important question relating to the package is whether it will be large enough, and ifso, how much is likely to be tapped. The IMF suggested the needs would be €40bn in anadverse scenario. The Berger/Wyman stress tests put the recapitalisation needs at between€16bn and €62bn. The market estimates mostly fall in the range of €60bn to €90bn. Thereare a number of reasons why the IMF and similar estimates should be considered too low:
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The Spanish government has already said that between €30bn and €50bn
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will beneeded to recapitalise a few smaller savings banks – between €10bn and €30bn morethan the estimates the recent IMF report for these banks.
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The IMF assumes a fall in house prices of 24% over the next two years. However, weexpect it to be closer to 35% (as seen in Ireland). Scaling the IMF estimates up based onthese figures (a reasonable assumption given that most losses will stem from exposureto the bust real estate and construction sectors) suggests that, under our scenario,needs could total closer to €60bn.
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Furthermore, the most adverse scenario only sees banks taking a core tier one capitalratio of around 7%. This may suffice for some of the larger stronger banks, but will be toolow for many of the ‘cajas’ (regional banks). This proved to be the case for Bankia, whilein Ireland similar problems hit the Bank of Ireland and AIB which had to increase theircapital ratios to 14% and 18% respectively.
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Further extending the IMF’s estimates tomeet a 10% tier one capital ratio, a fair average given the €400bn exposure to the bustreal estate and constructing sectors, would add another €20bn onto the recapitalisationneeds.These are broad strokes, but building upon the IMF figures we would expect the needs tototal between €90bn and €110bn, particularly if they are to secure the banking sector againstfurther downturns in the Spanish economy and a potential worsening of the eurozone crisis(i.e. a Greek exit).
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Including, Bankia: €19bn; and CatalunyaCaixa, Banco de Valencia and Novagalicia: €11bn to €30bn This is nota hard and fast threshold above which debt becomes unsustainable but it does generally give a good indicationthat markets are becoming increasingly concerned and the prospect of a self-fulfilling bond run looks possible.
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Cited by
FT Alphaville
, ‘Bankia going GUBU…but what about the rest’, 28 May 2012:http://ftalphaville.ft.com/blog/2012/05/28/1018331/bankia-going-gubu-but-what-about-the-rest/ The externalstress tests do extend the core tier one capital target to 9%.
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These estimates build on our more detailed breakdown of Spanish banking needs provided in our April 2012report, ‘Not so bullish now: the short term prospects for Spain inside the euro’, where we estimated that the loan
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Even this could be a lower bound though. The IMF estimates do not tackle the issue of‘forbearance’ (loan repayments which have been delayed so that banks can avoid takinglosses). These are the loans which are likely to default first and most quickly. There isanecdotal evidence that during the height of the crisis there was significant ‘forbearance’ atplay. The graph below shows that, during the financial crisis, there were a huge number ofchanges made to existing mortgage loans, in many cases extensions and easing of terms.As the condition of the Spanish economy continues to worsen, with low growth and highunemployment, these loans will come under more pressure and many will likely default.Ultimately, forbearance cannot continue forever – ignoring the issue hides the true cost ofthis crisis to Spanish banks, while failing to deal with it now stores up problems for the future.
Source: INE
Additionally, the IMF estimates are based on data from the end of 2011 and so do not reflectthe worsening situation in Spain this year, particularly in terms of the value of Spanishsovereign debt to which banks have a large exposure.
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In fact, the IMF procedure does notquestion the current value of assets at all, simply the potential impact of a deterioratingsituation.As we noted back in April, the provisions against doubtful loans fall woefully short – currentlyit stands at €83bn against €140bn in doubtful loans, with only €50bn against €80bn indoubtful loans to the bust real estate and construction sector. With our expected fall in houseprices, this level could easily double. We do partly incorporate this scenario into ourrecapitalisation estimates above, but it also suggests that banks may need to furtherincrease provisions against losses even with additional capital.
1.2 How will the final amount be determined?
The external Berger/Wyman stress tests provided an additional assessment, with RolandBerger putting the needs at an oddly precise €51.8bn and Oliver Wyman putting them atbetween €51bn and €62bn – both above the IMF estimate. It is worth noting though thatthese tests were conducted on the existing data from the Bank of Spain, while both firms ran
loss provisions for Spanish banks against real estate exposure would need to be at least doubled, see here forthe full report:http://www.openeurope.org.uk/Content/Documents/Pdfs/Spain2012.pdf
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See Gavyn Davies’ blog for an excellent concise run down of issues with the IMF assessments. The IMF doestake into account mark to market losses for banks on Spanish sovereign debt held in trading books but not ashold to maturity. Given the severity of the situation in Spain (and our macro projections above) this is probablyoverly optimistic.http://blogs.ft.com/gavyndavies/2012/06/10/the-consequences-of-spains-bank-rescue/#axzz1xTLGmxdVOn the other hand the IMF assessment does not take account of the increasedprovisions mandated by the government this year which may reduce the capital needs of the banks, althoughsince many banks are yet to fill these provisions we do not believe that will be the case.
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N u m b e r o f m o r t g a g e s m o d i f i e d
Spanish mortgages with modified conditions
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