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Western EuropeApril 6 2008

Spain hopes for a soft landing

Spanish banks are tightening up their strategies in preparation for a global slowdown says Jules Stewart.
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Europe’s star performer is in trouble, but the government takes heart in the likelihood of the Spanish economy having a soft landing. Spain’s real gross domestic product (GDP) growth has outperformed that of the developed world by an average of 0.6 percentage points over the past decade.

But with a sharp slowdown in the housing market and the related correction in the residential construction sector, this year’s economic growth is forecast to fall to 2.5% according to the most optimistic forecasts, from 3.8% in 2007, although there is a considerable disparity in GDP growth estimates.

“It seems that there is an increasing difference between the real economy and the published figures for inflation and growth rates, says David Burns, country head of Schroders Investment Management in Madrid.

“Default rates on credit cards are rising sharply and defaults on mortgages are on the up, particularly on second homes, while small to medium enterprises (SMEs) that are sub-contractors to larger firms are losing contracts. It is a bit reminiscent of the situation in the UK in the mid-1990s.”

Recession fear

There is a widespread reluctance to accept the possibility of Spain sliding into a full-blown recession, but Mr Burns says it looks pretty clear that this is already a reality, notwithstanding the official definition of two consecutive quarters of negative growth.

“People are losing their jobs and the economy is contracting,” he says. “If this isn’t a recession, I don’t know what is. On the other hand, I think there is room for Spain to live a little less well and still be in a very good position.”

Spain’s phenomenal economic performance was built largely on the back of low interest rates and immigration, which provided an abundant supply of cheap labour. This gave rise to a property boom that has now gone into a tailspin.

The property bubble combined with high financial leveraging affecting corporates and families make Spain an extreme case in terms of the drivers of the current global financial crisis. Until now, more than 700,000 new housing units were built each year. This figure has now halved and there are fears for more than 200,000 jobs in the construction sector.

There are also worries of a deteriorating law and order situation because almost all of these workers are immigrants with no families to fall back on. Overall, unemployment could soar to 9% during the course of the year, according to estimates by Spanish research institute Analistas Financieros Internacionales.

“The key question is how the government plans to use its almost 2% budget surplus to deal with the downturn,” says Marisa Mazo, strategy director at broker Ahorro Corporación. “It has a €15bn cushion that can be used to offset the crisis by increasing spending on public works and creating more jobs in the public sector. The only way to boost economic growth is by cutting taxes or through higher public spending.

“The second alternative would be preferable, given its knock-on effect on the rest of the economy.” The government also hopes that tourism and other key sectors will help to mitigate the impact of the economic slowdown.

Luis de Guindos Jurado, executive chairman of Lehman Brothers for Spain and Portugal, says the baseline scenario would be for GDP growth of 2% to 2.5% in 2008, a sharp but manageable decline from previous years.

“In this case, Spain could look forward to a soft landing,” he says. “The worst-case and less probable scenario would be a growth rate of 1% to 1.5%, which would put a great deal of stress on the financial system.”

Strategy formulation

Banks are scrambling to devise new strategies to deal with the capital markets crisis. Spanish institutions are fortunate in being ring-fenced from the subprime crisis.

The Bank of Spain, an extremely stringent regulator which one analyst called the “Taliban of European central banks”, does not allow the banks to invest in conduits or structured investment vehicles. Hence there are no portfolio losses for defaults. On the other hand, the liquidity crisis means that long-term financing in the capital markets is more difficult.

Ignacio Muñoz-Alonso, BBVA’s head of corporate and investment banking, Europe, the Middle East and Africa, says that in current conditions, the bank’s wholesale business has mapped out plans for a different and more elaborate use of capital. “We are aware of the advantage that capital provides,” he says. “This allows us to generate fee income by using less capital intensive products, related to advisory services in corporate finance, equities and so on.”

The investment banks are also working on alternative strategies to provide their clients with liquidity. “We are now more focused on capital issues,” says Mr De Guindos.

“For example, we are sole bookrunners of the first placement of equity certificates by a Spanish savings bank, Caja del Mediterráneo, which will be a €750m to €1bn issue later this year. We are also looking at providing financial institutions with liquidity through the possible acquisition of holdings in their industrial portfolios, loan portfolios or private equity funds.”

Investment potential

Enrique Casanueva, country manager at JPMorgan Chase in Madrid, says the bank is looking at a number of ways of investing in the current environment. “We foresee a trend towards smaller and more conservative deals,” he says.

“Equity issuance should help to drive the business. We have a significant pipeline of initial public offerings and equity offerings, although some of them might take longer to close than initially expected.

“The volatility in the equity markets has increased in the past months and there is no certainty of when it will return to normalised levels.”

Merger and acquisition (M&A) activity is largely off the radar in Spain, as elsewhere, in particular transactions carried out with debt market financing. The deals taking place over the coming months will involve shares, according to analysts.

M&A revival

However, most market observers believe that if Spain achieves a soft landing, with GDP growth remaining above 2% this year, M&A activity will come back. “We are going to see more corporate than private equity deals,” says Pedro Fernández de Santaella, head of Barclays Capital for Spain and Portugal.

“At present it is difficult for CEOs to know where the price of assets is, where the country is in the economic cycle and what financing they can count on. If the economy stabilises, activity should pick up in the second half of the year.”

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