A sharp increase in provisioning requirements is likely to drive consolidation in the Spanish banking sector. But the country's largest banks – many of which have remained profitable thanks to their operations in other regions – are cautious about what may lurk on the balance sheets of the troubled savings banks.

The magnitude of Spain’s banking crisis was brought home on May 7, 2012, when the government moved in on banking conglomerate Bankia – which holds 10% of Spanish deposits – by converting €4.46bn of the group’s preference shares into voting shares, thus taking a 45% stake in the group. This came after accountancy firm Deloitte identified a €3.5bn shortfall in the valuation of parent company Banco Financiero y de Ahorros (BFA), which held more than €30bn of problem real estate loans at the end of 2011.

Bankia’s de facto nationalisation reveals the extent of the damage done to the bank’s credibility following the collapse of the Spanish property sector and with it the implosion of the savings banks sector – known as cajas  which account for 50% of the country's financial system. BFA was itself born of an ill-starred attempt to restore stability by merging several cajas all of which held vast amounts of impaired loans on their books – under the umbrella of the giant Caja Madrid.

Overall, real estate assets linked to loans to developers totalled €307bn at the end of 2011, of which €184bn were classified as problematic. Bankia’s chairman and former International Monetary Fund (IMF) chief Rodrigo Rato was forced to step down and was replaced by José Ignacio Goirigolzarri, former CEO of BBVA, Spain’s second largest bank.

Calming a crisis

Three days before the rug was pulled from under Bankia, Spain's economy minister, Luis de Guindos, called an urgent meeting with the country’s most powerful bankers, Banco Santander chairman Emilio Botín, his counterpart at BBVA, Francisco González, and Isidro Fainé, chairman of the country's third largest banking group, La Caixa. Bankia was not the only item on the agenda; they discussed the need to slash the number of players in an overbanked market and put a package of reform measures in place.

This was the fourth attempt in less than two years to restore stability to the Spanish banking system. The government was looking beyond the challenge of cleaning up and strengthening the banks with high exposure to the property market. It was attempting to address the other side of the crisis.

“There are two aspects to the current crisis,” says Antonio Carrascosa, director-general for economic policy at Spain's economy ministry. “On the one hand, we have to deal with the impact of the property sector collapse. But there is also the general economic decline brought on by the recession. Until now, the government had focused its efforts on the property bubble, and we have now asked the banks to set aside higher provisions against their property portfolio, both non-performing and performing, in case there is a worsening in this portfolio.”

The government´s latest reform measures are extreme and also unusual, in that they are premised on a future deterioration that has not yet occurred

Jacobo González-Robatto

Sources close to the government speak of concern that 2013 or 2014 will bring a further deterioration in the banks’ loan portfolios to small and medium-sized enterprises and residential mortgage holders. On May 12, 2012, Mr de Guindos announced his latest reform measures, to the dismay of many bankers.

Provisioning for property loans is required to rise more than fourfold to 29%, equivalent to about €30bn. Banks will have to report independent valuations on their real estate portfolios, which “are likely to be significantly below the current levels”, says Fitch Ratings’ analyst Carmen Muñoz, who views the latest reforms as “a net negative for the sovereign because some banks will require state support”.

Ms Muñoz says that property prices could take a further hit as a result of the new measures since “banks will have to transfer all foreclosed commercial real estate loans that are significantly reserved to a separate company. This is a marked change from the slow foreclosure process pursued by many banks and loan servicers so far.”

Sceptical response

Banco Popular’s CFO, Jacobo González-Robatto, was one of many bankers to express scepticism over the measures. “The government´s latest reform measures are extreme and also unusual, in that they are premised on a future deterioration that has not yet occurred," he says. "We are not happy with the announcement but we can and will comply with the regulations. We acknowledge that this is intended to restore confidence and stability in the system. We rule out the need for any sort of government aid and are fully capable of generating sufficient internal capital to meet the requirements. We are still Europe´s most profitable bank, as measured by our 39% cost-to-income ratio.”

It is also taken for granted that Santander and BBVA, Spain's two largest retail banks, will have no need for state funding. Both banks’ broad geographical business mix has largely insulated them from the Spanish property meltdown.

“Our strategy for dealing with the economic crisis over the past four years is based on diversification and the strengthening of our franchise in key markets, primarily in the UK and Poland, but also in the US and Germany,” says Juan Rodríguez Inciarte, Santander’s senior executive vice-president for strategy.

There are two aspects to the current crisis. On the one hand, we have to deal with the impact of the property sector collapse. But there is also the general economic decline brought on by the recession

Antonio Carrascosa

“We have continued to deploy our classic business model that is based primarily on retail banking. We have strengthened this model by having subsidiaries that are independent in terms of capital and liquidity. This is critical for Santander, for in the current crisis we do not want one market to have an adverse impact on another.”

A numbers game

Part and parcel of the financial reforms is a drive to restructure an overbanked market. This applies in particular to the cajas, whose numbers have shrunk in the past two years from more than 50 to fewer than a dozen. The government would like to see a market composed of 10 or 11 cajas and banks, while some bankers believe that the overhaul should be even more radical.

“In all likelihood that number could be even lower by the end of 2012,” says Mr González-Robatto. As for Banco Popular’s role in that process, he says that the bank would never make an acquisition merely for strategic reasons. “Our overriding criterion is whether it makes business sense from a strictly financial point of view,” he says. “We are looking at the possibility of acquiring a caja, either ourselves or with our partners. Among them we have Crédit Mutuel, with whom we formed a new bank in 2011, Targobank, and the plans are to grow it.”

Santander’s Mr Rodríguez Inciarte says that the bank’s opportunities for growth remain unchanged. Its focus is likely to remain on Latin America, where Santander makes more than 50% of its profit, as well as other markets such as Poland, the US and Germany. “On the other hand, we do not expect to see major growth coming from the UK, Portugal and Spain until these countries return to more normalised conditions,which should be around 2014,” he says.

With regard to Santander’s possible participation in the Spanish banking sector’s restructuring, he says that its policy is “to look at the options presented to us. However, we do not think that Santander requires more critical mass in Spain to compete with other banks.”

Market sources say that the only deal that Santander would be likely to do is one similar to its 2008 deal with UK lender Bradford & Bingley, when it acquired deposits and branches without taking on assets.

The economy ministry’s Mr Carrascosa says that it would be wrong to over-dramatise the problems facing Spain’s banks. “When we compare the Spanish banking sector to that in other countries, the situation does not look too negative,” he says. “The banks´ average loan-to-value ratio is about 60% to 65%. Moreover, the IMF has carried out a stress-test with an extremely negative scenario, and the result was that only 10 banks were found to have serious problems. Of these, eight have been taken over by larger groups or are in the process of being sold. We are dealing with the issues facing the other two, one of which is Bankia.”


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