Spain – the big Restructuring

Courtesy of Pater Tenebrarum, The Acting Man

Banking System Clean-Up Gets Underway

As noted in the previous missive, the latest NPL numbers from Spain have seen yet another massive deterioration to 11.23% of all outstanding loans. Spain is trying to get its banking mess under control, by shifting toxic assets into Sareb, the new 'bad bank', while banks are at the same time busy restructuring distressed loans, shoring up their equity and increasing loan loss reserves.

In principle the way Spain is going about this is not different from how it was done in other cases of banking system blow-ups following burst bubbles.

The problem is that this particular exercise is more costly than most (on a relative basis) and that the problem keeps growing at astonishing speed (or perhaps it is not the problem as such, but recognition of it that is now growing faster). The only way to go about it all is to delever – and so both loans and deposits in the banking system are shrinking.

Year-on-year loan growth in Spain (chart via Exane/BNP Paribas) – click for better resolution.

While the markets were for a long time focused on the government's debt problems, the real debt problem in Spain is in the private sector.

Bloomberg reports:

“A rush by recession-hit Spanish businesses and consumers to refinance their loans will test Prime Minister Mariano Rajoy’s pledge of a “definitive” cleanup of the nation’s crisis-hit banks.

Spain’s banks have restructured about 140 billion euros ($185 billion) of loans outside the country’s crippled real estate industry, according to Oliver Wyman, a consulting firm that did a stress test of Spanish lenders. Bad loans surged to a record 11.2 percent of total lending, the Bank of Spain said yesterday.

“We are working with factories, restaurants, any kind of business,” Agusti Bou, who works on restructuring credit at Jausas, a Barcelona-based law firm, said in a phone interview. “There’s going to be a growing default problem because the huge issue in Spain is not the public debt, it’s the private.”

Spain has ordered banks to recognize 84 billion euros of losses to purge their balance sheets of real estate as Rajoy recapitalizes at least four failed lenders with about 40 billion euros of European bailout funds. The strategy focuses on soured property assets and may neglect impending losses on loans to firms and homeowners as the economy shrinks, analysts say.

While small and medium-sized businesses have restructured as much as 21 percent of the 230 billion euros they owe, according to Oliver Wyman, total non-performing loans in the country grew by 7.8 billion euros to 190 billion euros in October, the Bank of Spain said. The nation’s bad-loan ratio will jump to 14.5 percent of all lending, assuming that 30 percent of refinanced credit turns sour within a year, said Daragh Quinn, a banking analyst at Nomura Holdings Inc. in Madrid.” (emphasis added)

That 30% of the refinancings could turn sour again sounds ominously doable to us. One only needs to keep in mind here what has happened to modified mortgage loans in the US so far – and Spain clearly had a far more egregious property bubble, resulting in a commensurately more difficult post bubble environment. In the US, in spite of the unemployment rate falling (which is a highly suspect datum as it were, considering that the number of food stamp recipients keeps hitting new highs), redefault rates are at breathtaking levels.

In Spain unemployment is almost at 25% and still in a rising trend, reflecting the magnitude of the economic bust. So can 30% of the modified loans go sour again? Absolutely.

Deceptive Calm and Desperate Banks

We also happen to think that the calm in the sovereign bond market may give way to fresh worries in 2013 (provided we survive the end of the world scheduled for this Friday – the Mayans ran out of stone tablet space with December 21 2012).

This is mainly due to the fact that the economy's poor performance is likely to once again undermine the government's deficit targets. The markets will eventually push for the ECB to go beyond verbal intervention.

The speed at which the deposit base is declining has slowed, but growth remains negative – click for better resolution.

Bloomberg continues:

Rajoy, 57, said two days ago that the measures Spain has taken to strengthen banks meant 2012 would be remembered as the year it laid the ground for recovery.

“The definitive cleanup of our financial system will contribute decisively to restoring confidence in the Spanish economy,” he told members of his party in a speech in Toledo in central Spain.

With the five-year economic slump showing little sign of easing, businesses and consumers are approaching banks to negotiate lower interest rates and longer maturities on their borrowing. The economy may shrink by 1.5 percent both this year and in 2013, according to the average estimate in a Bloomberg survey of 37 economists. Unemployment, which stands at 26 percent, the highest in the European Union, will reach almost 27 percent next year, the Organization for Economic Cooperation and Development forecast on Nov. 27.

[…]

Spain was the European country with the greatest number of firms seeking protection from creditors since the start of the 2008 global financial crisis, according to Spanish credit rating company Axesor. The number jumped more than 280 percent from 2008 to the end of 2011, outstripping insolvencies in Greece, Ireland and Portugal, it said in a July report.

Spanish companies processed through bankruptcy proceedings climbed an annual 23 percent to 6,142 in the third quarter, according to the National Statistics Institute in Madrid.

Renegotiating the terms of loans may be a good strategy for both banks and companies, said Stuart Percival, a lawyer at the Madrid branch of law firm Clifford Chance.

“I would like to think that once the restructuring has been done, that should allow the companies to move on,” he said in a phone interview. “The point of the process was to allow companies to breathe.”

The danger is that some Spanish lenders may be using refinancing as a tool to delay defaults that are inevitable, said Mikel Echavarren, chief executive officer of Irea, a Madrid-based firm advising clients on loan restructuring.

“All this results in brutal contraction of income for all companies and sectors, with the exception of those that rely on exports,” said Echavarren in a phone interview. “We are refinancing companies ranging from real estate to transport — we even refinanced a hair transplant clinic.” (emphasis added)

The situation in Spain is reminiscent of the old joke along the lines of 'if you owe the bank $1,000, you have a problem. If you owe it $10m., the bank has a problem'. In Spain it's the entire banking system that has a problem.

Quarterly earnings of the Spanish banking system in the aggregate. This shows how much more painful the current crisis is compared to the mid 90's bust – click for better resolution.

BBVA is the one bank considered one of the banks in comparatively good shape. The bank itself says it has 'everything under control' – but even so, its NPLs to businesses have grown to 8.2%.

As Bloomberg notes with regard to how desperate the banks are:

“The Bankia group, which has received almost 18 billion euros of financial aid, is setting aside 8.1 billion euros in provisions this year to cover potential defaults on non-real estate loans, it said last month. Banco Popular said in October it would write off 3.2 billion euros of non-property loans by next year as it cleans up its balance sheet.

Government decrees in February and May have forced Spain’s banks to recognize losses on their real estate assets. Based on Oliver Wyman data, they’ve also restructured at least 108 billion euros in loans to real estate companies, on top of the 140 billion euros of refinancing for other businesses and Spanish consumers.

Bankia and the three other Spanish lenders bailed out by the European Union must transfer their real estate to a so- called bad bank, known as Sareb.

Jesus Maria Ruiz de Arriaga, a partner in law firm Arriaga Asociados specializing in refinancing, said he helped an electronics producer restructure a loan of about 10 million euros in 2011. The terms agreed with two banks, which he declined to identify, included a two-year waiver on repayment of capital.

“The company will have to renegotiate again next year because the economic situation has not improved and its issues are not resolved,” he said in a phone interview from Madrid. “Part of my job is to explain to my customers that it’s the banks that are weak in these situations, not them. The banks are desperate to avoid more losses.” (emphasis added)

While the desperation of the banks is understandable, it is ultimately this desire to avoid losses that has drawn out the depression. However, to the extent that loans are unsound, the write-offs will have to happen sooner or later anyway.

Below we show two more charts from Exane that illustrate the situation further. The first one shows the NPLs disaggregated – into mortgage and 'other' NPLs. The 'other' category is a great deal higher than the total NPL ratio, as mortgages are defaulting much more slowly (as previously discussed, this is a result of their being full-recourse and a political hot potato simultaneously). This latter category is however turning up now, and seems set to keep growing.

The second chart is an updated illustration of the extent of borrowing by Spain's banks from the ECB. This has declined somewhat of late, which is in keeping with the decline in loans and deposits. However, the system clearly remains highly dependent on the central bank.

Mortgage and non-mortgage NPLs at Spain's banks – click for better resolution.

ECB funding to Spain's banks – falling slightly of late, but still at an extremely high level – click for better resolution.

No doubt it is a positive development that something is proactively done in order to tackle the bad debt problem. However, one wonders if the problem is not too big and deteriorating too fast to be resolved at leisure, even with the €100 billion ESM pledge.

Catalonia's Referendum Looms

An entirely different problem fast approaching – Catalonia is getting serious about the independence referendum.

As the WSJ reports:

“Nationalist leaders in Catalonia agreed to form a new government and hold a referendum on independence for the wealthy region, maintaining a push for autonomy that poses a major challenge to Spain's central government.

The deal signed Wednesday will allow Artur Mas of the conservative Convergence and Union party to be sworn in for a new term as the region's leader despite his stinging setback in the election last month he had called to gather support for independence. It puts him in an uneasy coalition with Oriol Junqueras of the Republican Left of Catalonia, traditionally more radical in its support for separatism and in its economic policies.”

[…]

“Mr. Rajoy said it makes no sense for Catalonia to attempt to break away from Spain at a time when EU countries are trying to draw closer and strengthen their position in the global economy.

"Today, the thing that makes no sense is to be small, or to embark on processes of separation or division; it goes against the times," Mr. Rajoy said Wednesday during a parliament session in Madrid.

Privately, government officials say they hope that an alliance between the two Catalan nationalist parties, which has been several weeks in the making, will prove unworkable and break up before it could hold a referendum.” (emphasis added)

Rajoy is quite wrong about that. Separatism doesn't 'go against the times', it is in fact in perfect keeping with the spirit of the times. This is precisely what tends to happen during major economic contractions – the souring social mood as a rule brings forth support for separatism and the splintering of larger into smaller groups. It is the eurocratic elite that is going 'against the times' with its ever greater focus on centralization.

Oriol-Junqueras-and-Artur-Mas