Spain will have to be bailed out in the coming months by the EU and the IMF, say a growing number of investors and analysts, as the country fights to contain its banking crisis. After several days of losses, May 18 saw a rally in bank shares — despite ratings downgrades of 16 banks by Moody’s Investor Services — but markets remain skeptical about the state’s ability to deal with its banking sector problems amid the Greek crisis, the large budget deficit and rising sovereign bond yields.
Ted Scott, director of strategy at F&C Asset Investments in London, says “there will probably have to be a bailout before the end of the year with the help of the European Union and the International Monetary Fund.” He says the government’s measures, announced on May 11, to shore up the banking sector by part-nationalizing banking conglomerate Bankia and by imposing a further €30 billion ($38.3 billion) in provisions to help cover the huge exposure to the real estate bubble will not be enough to restore market confidence. The banks have so far been forced to make a total of €120 billion in provisions, but “the market doesn’t believe the latest provisions announced are sufficient given the scale of the problems,” says Dr. Nicholas Spiro, who runs credit risk consultancy Spiro Sovereign Strategy in London.
Spanish banks have total exposure to real estate developers of €307 billion, according to the Bank of Spain, the country’s central bank, a figure which represents 16 percent of the banks’ total loan book and 29 percent of GDP. Scott believes the provisions will have to be raised to at least 60 percent of that total since there are €184 billion of problem loans, while Spiro argues the scope of provisioning coverage will almost certainly have to be broadened to include other loans, particularly residential mortgages. Total bad loans in the economy amounted to €148 billion, or 8.37 percent of total lending, as at the end of March, the Bank of Spain said on May 18.
The government has set up a €15 billion special fund, known as the Fund for the Orderly Restructuring of Banks (FROB). Already some €10 billion has been allocated to rescuing Bankia, the fourth biggest bank in Spain by assets. But as Scott says, “They need something bigger and bolder, but Spain is in such economic trouble it won’t be able to afford a U.S.-style bazooka.” Spain is desperate to reduce its deficit-to-GDP ratio from 8.5 percent at the end of 2011 to 5.3 percent at the end of 2012, and this will be all the more difficult as the government forecasts a contraction of 1.7 percent in GDP this year. Meanwhile borrowing costs are soaring, with Spain’s 10-year bond yield at a worrying 6.28 percent on May 18 compared to a low this year of 4.91 percent on March 2 following the European Central Bank’s €1 trillion long-term refinancing operation.
The country’s piecemeal approach to reshaping the banks — the announcement on May 11 was the second reform this year and the fourth of the euro zone crisis — is reminiscent of Ireland’s approach to its very similar problems in 2009 and 2010: It was eventually persuaded to accept an EU-IMF bailout. The Spanish government is not yet acknowledging the need for a bailout, but Spanish Prime Minister Mariano Rajoy warned on state television on May 16 there was a serious danger of Spain being shut out of the bond markets unless it continued its deficit-cutting program. The government has also said it wants some kind of support from the European Central Bank. Deputy Economy Minister Jimenez Latorre said at a press conference on May 17 he expected a reaction from the ECB in response to Spain’s funding problems, although he didn’t specify what that might be.
The government has now appointed two independent consultants, BlackRock Solutions and Oliver Wyman, to carry out an audit of the bank loan books and to try to draw a line under the problems. But they are likely to take at least three months to carry out the analysis, and in the meantime the economy, and asset prices, are likely to deteriorate as Spain enters a recession.
Separately, the government mandated Goldman Sachs on May 18 to advise on a recapitalization of Bankia, further details of which are set to be revealed by the government helping the share price to rally on May 18 by 23 percent up to €1.76 by midafternoon. The share price was also boosted by a strong statement of reassurance by new chairman José Ignacio Goirigolzarri, who took over from Rodrigo Rato after the state took a €4.5 billion stake in the bank on May 11. He insisted Bankia was operating as normal after local press reports spread fears of a run on the bank. Bankia, however, a merger of Caja Madrid and six other regional savings banks, has lost more than half its value since it floated in July 2011 at an offer price of €3.75, reaching a market capitalization on debut of around €6.2 billion.
Bankia is one of the two most vulnerable banks, says Daragh Quinn, a credit analyst at Nomura in London, along with Banco Popular. Bankia has €40.7 billion of exposure to real estate developers, of which nearly half is problematic, while Popular’s exposure is €32 billion. The country’s biggest bank, Banco Santander, also has a large exposure of €30 billion — €19.5 billion of that is classed as problematic — but Quinn says the size of its balance sheet — €1.5 trillion at the end of 2011 — and a healthy tier 1 capital ratio of 10 percent mean it is less at risk than other Spanish banks.
Some investors take a relatively sanguine view of Spain’s problems. Anik Sen, a vice president and senior financials analyst for European and U.S. listed equities at PineBridge Investments in London, who is a former head of European financials research at Goldman Sachs, says: “Spain should not be in any immediate danger of a bailout. We estimate that the banks have written off and provisioned about 9 to 10 percent of their total loan book of €1.9 trillion. As a rule of thumb, 15 percent is a level commensurate with past crises in other countries.” But he warns, “a Greek exit would send massive shockwaves through the markets if the euro zone firewall proves ineffective and there could be runs on Spanish banks in the absence of adequate policy responses.” The euro zone firewall consists of the €800 billion held by the European Financial Stability Facility and the European Stabilization Mechanism.
