No Banking Crisis in Spain

End of housing bubble brings retrenchment


One of the striking things about the past year is that there has been no banking crisis in Spain.
The Bank of Spain, which supervises the financial system, took a dim view of the high-yield, high-risk instruments that have wreaked so much havoc in the US and Europe. So it banned offbalance sheet special purpose vehicles (SPVS).
Banks were free to set up SPVs, so long as capital was properly allocated and the risk remained within the bank. This considerably reduced the appeal of these exotic instruments.
But regulatory prudence does not mean the financial system is off the hook. If capital markets remain closed for much longer, the crisis will strike not on the asset side of the balance sheet - where bad loans currently represent only 1 per cent of the total portfolio - but on the liabilities side.
The capital drought is affecting Spain in two ways. It has hugely curtailed the ability of financial groups to continue lending at the rates of 20-30 per cent a year seen during the boom years. And it is affecting banks' ability to repay, or refinance, residential mortgage-backed securities (RMBS).
During the 10-year property boom, banks relied heavily on international capital markets to fund lending at home. Last year, Spanish banks were the second-largest issuers of RMBS after UK banks.
At the height of the boom, estimates Analistas Financieros Internacionales, a Madrid-based economic consultancy, Spanish banks were raising as much as 40 per cent of funding requirements abroad, compared with 15 per cent in 2000-01.
If capital markets remain closed to mortgage-backed paper, banks will face difficulties in refinancing or repaying their liabilities as they mature, beginning with some €40bn in the second half of this year.
The figure doubles to €80bn in 2009 and stays high in the following two years, according to AFI.
Banks and savings institutions continued to issue RMBS and covered bonds totalling almost €50bn after the credit crunch set in.
But these securities were not placed with investors because there were no takers.
Rather, they stayed on the banks' books for use in repo facilities with the European Central Bank.
Spanish bankers admitted they were accumulating a "war chest" of assets that could be used as collateral to access ECB funds in case the wholesale money markets remained closed.
According to data from the Bank of Spain, Spanish banks have doubled their share of the ECB's funding auctions since last summer, from 5 to 10 per cent. On average, banks are drawing about €40bn-€45bn a month in ECB funds.
The 10 per cent figure is proportional to the weight of Spain in the eurozone economy, but there is a snag: ECB funds are available for very short terms, typically a week to a month, and access to the money is not guaranteed, as European banks must compete for limited funds at weekly auctions.
Such short-term funding is no substitute for RMBS with much longer maturities. And ECB money is certainly of no use to fund long-term credit operations such as mortgages.
Almost all the sources of new funding available to Spanish banks are more expensive and on shorter terms than a year ago, which is creating a mismatch in maturities between assets and liabilities.
There is a fierce competition for deposits, with banks and savings banks raising rates offered to depositors.
Banks have been managing liquidity mainly through the issue of short-term commercial paper, with a typical maturity of three months, €90bn of which was outstanding at the end of March, according to AFI.
With these resources - very few of which are available for periods longer than 18 months - AFI estimates bank lending might grow by 5 to 6 per cent this year.
According to AFI, almost €40bn of securitisations, covered bonds and other bank debt fall due in the second half of this year. In 2009, the volume will jump to €80bn, and will remain high during 2010 and 2011.
At some point, the "war chest" of securitisations issued by Spanish banks but remaining on their books will have to come to market.
Analysts worry that if this is done in an uncoordinated way, the flood of paper will swamp the markets once they reopen, like a dam bursting its banks.
This in turn could trigger a collapse in the value of Spanish bank securities.
Emilio Ontiveros, an economics professor and director of AFI, says banks have three lines of defence against a big rise in bad debts: "They are well capitalised, they have excess provisions against non-performing loans, and they are among the most efficient in Europe," he says.
Bad loans in the system would have to treble before banks had to make more provisions. Core capital is strong, and there are no strange products lurking inside the balance sheets.
During the lending boom, the Bank of Spain obliged banks to make "counter-cyclical" provisions: a portion of profits in boom years had to be set aside to cover the expected rise in loan defaults in an economic downturn.
Lorenzo Bernaldo de Quirós, director of Freemarket International Consulting in Madrid, believes the risk of default, particularly among property developers, could trigger a bankingconstruction crisis similar in magnitude to the bankingindustrial crisis of the early 1980s.
Some savings banks, he notes, are shareholders in construction and real estate groups, in addition to being creditors, and this could magnify the problem.
Some smaller savings banks with proportionally bigger exposure to the building industry may be forced to merge, analysts say.
Still, the Bank of Spain insists that no bank will fail during the present downturn.

Source: The Financial Times Limited 2008