Wednesday, December 29, 2010

To Calm Investors, Spain to Open Its Books? No

The Bank of Spain has clarified what opening its books means.  As reported by Reuters,
The central bank has told the country's banks to give detailed quarterly reports which include exposure to property developers and bad loan ratios, and to outline financing plans.
"We believe market perception is much worse than reality," a Bank of Spain official said at a recent press briefing.
The central bank officials may believe market perception is much worse than reality, but they are unwilling to make the loan-level data available that would allow the credit market analysts the ability to independently confirm the accuracy of this belief.

Instead of loan-level data, the central bank officials plan to offer quarterly reports with bad loan ratios.  As every credit market analyst knows, the problem with bad loan ratios is in the definition of "what" is included in the total for bad loans.

Do the "Newly Built Ghost Towns" reported in the NY Times get included in the bad loan totals?  Does the other real estate mentioned in the article get included in the bad loan totals?
Still, skeptics abound. One is Jesús Encinar, the founder of Spain’s most popular property Web site, He says that the Spanish authorities are striving to engineer a soft landing of the housing market that would give more time to offload surplus housing at reasonable prices.
But he believes prices still have a long way to fall, by 30 or 40 percent, maybe more. “Some people who said there was no housing bubble are now saying we are at the bottom,” Mr. Encinar said. “But I say we have several years to go.”
He is not alone in scoffing at some of Spain’s numbers. In a report last April, the French bank Société Générale dismissed many of the assertions made by Spain’s banks, pointing out that Spain had one of the fastest rates of expansion in construction, had the largest number of mortgages per capita and was the most overbuilt among its peers. Yet prices had fallen the least. “We find it impossible to reconcile the banks’ claims of asset quality stability and the macro facts,” the report said.
...There is, however, broad agreement that many of Spain’s empty units are in areas where there is little demand for them, particularly along the southern coastal areas where hills have disappeared under vast housing developments. Practically overnight, Spain’s banks have been forced to begin managing vast real estate portfolios, a role most were ill equipped to take on.
“They do not know how to take care of this housing stock or how to rehab properties,” said Raúl García García, from Tinsa.
While some banks have set up networks to sell property, many others are floundering, having trouble just keeping track of the keys. “They take the old guys who are sitting around and say: ‘Hey, you are in charge of real estate now,’ ” Mr. Encinar of said. “Some are not even answering the phone.”
Experts say that whatever is on the market now is only a piece of what is in the pipeline from distressed homeowners and developers. Mr. Encinar says the banks are holding back on putting property on sale, afraid to bring prices crashing down.
Fernando Acuña, co-founder of, a Web site that sells housing on behalf of the banks, said as many as 100,000 repossessed units were now for sale in Spain, a number that “could double or triple.”
Still, eager to begin getting some of the property off their balance sheets, some banks have been offering deep discounts and special mortgage rates.
Experts say the banks are being slightly more choosy these days about who lend to. But the new loans — almost all of which are at variable rates — could create a second wave of defaults down the road when interest rates rise. Next year may produce a new round of defaults from developers as well. In the early days of the crisis, many banks renegotiated their loans. But experts say many of those deals will expire next year, and without any significant change in the economy, most developers will be no better off.
The tension between banks and developers, once happy accomplices in a booming business, is palpable. Mr. Galindo says that the banks are not lending to developers who have half-built projects and that they are favoring customers who want to buy bank-owned property when giving out mortgages.
The biggest challenge for the banks is that they are likely to end up owners of vast amounts of undeveloped land. José Luis Suárez, an expert on real estate at the IESE business school, said 65 percent of bank lending to developers is tied up in land, enough to build 758,000 more housing units. “That gives you an idea of how long it could take for the market to digest all this,” he said.
Using quarterly reports is a risky strategy.
  • What happens if loans that are excluded from the bad loan total in the first quarter are included in the second quarter?  The credit markets know that this is a distinct possibility - remember that the Irish government went through their banks three times trying to identify and remove all the bad loans.  
  • What happens if the credit markets do not believe the bad loan total shown in the first quarter?  Articles like the NY Times piece suggest that the credit markets are assuming a bad loan ratio that exceeds 50% for real estate. 
As mentioned in the Reuters article, there is a downside to not making loan-level data available and instead relying on reports that may subsequently be seen as overly optimistic.
Ireland's experience had shown that waiting too long to restore confidence in the banking sector's credit quality leads to heightened pressure from the interbank markets to inject capital.
A rising tide of bad property loans eventually forced Dublin to seek outside help in managing its finances, and bailing out lenders there could end up costing taxpayers up to 85 billion euros, or over half of annual GDP.
Is this the fate which awaits Spain? 

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