UNDER SIEGE : THE STATE OF THE SPANISH BANKS / THE ECONOMIST ( HIGHLY RECOMMENDED READING )

The state of Spanish banks

Under siege

Quantifying the difficulties of a country’s banking system

Jan 13th 2011 | MADRID | from PRINT EDITION

.

Lean times ahead

SPAIN’S public debt, less than two-thirds of GDP last year, is not especially large.

Yet financial markets fear that its government may, like Ireland’s, have to find enormous sums to support the country’s banks. The funding markets briefly welcomed some Spanish lenders after European stress tests last July. But doubts about the financial system have resurfaced with vehemence. Spanish banks, and their regulator, are feeling hard done by.

Only the strongest banks have access to wholesale markets, and at high cost. This year the system is due to redeem some €90 billion ($116 billion) of debt, 45% of it by the two largest banks, estimates Barclays Capital. Banks continue to reduce their reliance on European Central Bank funds, thanks to improved access to the short-term repurchase (“repo”) market. But tapping stable, longer-term financing is essential.


Perception is much worse than reality, says Miguel Fernández Ordóñez, the governor of the Bank of Spain. He reckons the country’s unlisted savings banks will need no more government-assisted capital this year than the €10.6 billion already committed by the state’s €99 billion Fund for Orderly Bank Restructuring (FROB).


Investors think that looks optimistic. The debate in the market is not about whether Spanish lenders will need more capital, but about how much. The list of worries is long. Concerns about the banks affect sovereign debt, which in turn affects the banks in a vicious circle.


Banks’ profitability is sinking, partly because lending margins are being squeezed by a scramble for deposits as a source of stable funding. Savings banks (cajas) are undergoing a thorough restructuring: complex mergers to cut costs have shrunk their number from 45 to 17.


The biggest source of concern remains Spain’s housing bust. Official data show a market deflating lethargically, with prices only 12.8% below their peak.


Ireland’s spectacular bail-out of its banks, just months after they passed the stress tests, also rattled investors.The parallels with Ireland are overdone: Spain’s biggest banks, unlike Ireland’s, are serious businesses. Still, Spanish banks have €323 billion (the equivalent of 31% of GDP) in loans to property developers. Add in construction, and the exposure rises to 42% of GDP. By the end of 2010 Spanish banks had already made €87 billion in provisions for bad loans.


There is no consensus on how much more capital is needed. Moody’s, a ratings agency, estimates that banks may require another €17 billion to push their tier-1 ratio to 8%. UBS says that they could need up to €120 billion to regain the confidence of funding markets.


What would a doomsday scenario look like? Taking the Bank of Spain’s basic “adverse” scenario and adding an Irish-scale calamity from loans to developers and builders, the banking system’s gross losses would be €270 billion, about €60 billion higher than the central bank’s figure. If lenders then made only half of the profits and capital gains in the Bank of Spain’s scenario, they would have to find €140 billion in new capital, or 13% of GDP, to achieve a tier-1 ratio of 10%.


Relative to the size of the economy, this is still far less than the cost of the Irish bail-out.


The actual exposure to pure property development is smaller than the official numbers suggest, says Arturo de Frias, an analyst at Evolution Securities, because of the way loans are classified. He thinks the banks can absorb losses through their ongoing profits, while the cajas will need to raise around €50 billion of new capital.


The Bank of Spain has asked lenders to disclose quarterly details on exposure to property, including collateral, starting with their annual results for 2010. Any sign that the cajas can raise money without government support would also help. Bankers are expecting a few more mergers this year. A change in the law has made it easier for outsiders to invest. But with listed Spanish banks already cheap, cajas would have to sell shares for a song to attract interest.


The Bank of Spain says it wants to minimise the use of public money, and the FROB has raised just €12 billion so far. Time may yet prove Mr Ordóñez right. But if doubts persist, for both banks and sovereign, he may not have much time.