Sunday, January 23, 2011

To work, Spain's rescue of its banks requires current asset-level disclosure

Despite running stress tests that showed that the savings banks, cajas, did not need significantly more capital, the Spanish government announced a restructuring of the savings banks.  In addition, it promised to inject capital into the newly restructured savings banks if private investors were unwilling to.
Forty out of a total of 45 Spanish cajas will merge or form operating alliances with each other as the authorities look to prevent fears over the banking system from morphing into a wider market run on the country as a whole.
Alfredo Perez Rubalcaba, Spain's deputy prime minister, said: "The government is preparing a plan, the aim of which is to increase the solvency and the credibility of the savings banks."
As readers of this blog know, the only way to increase credibility is to make current asset-level information available for each cajas.  This current asset-level information can be used by market analysts to independently determine how much capital each cajas needs.
It is hoped that private investors can be found to put money into the cajas. However, Spain's Fund for Orderly Bank Restructuring could take stakes in those that are unable to attract outside investment.
Private investors are not going to buy existing losses.  They are going to want to examine the current asset-level data even if it is not made available to all market participants to decide for themselves if their investment is just purchasing existing losses or is being made into a viable financial institution capable of generating a return on their investment.

In addition, if investors cannot do their own independent analysis, why should they believe that the Spanish government has injected enough capital into the cajas that were unable to attract private investors?  Investors have the experience of Ireland trying three times to rid its banks of troubled loans.  Why should investors assumed that Spanish regulators are better than their Irish peers and that the firms that advised Ireland will do a better job this time?
Spain's main IBEX index of leading shares closed up nearly 2pc on the back of the news, which helped calm fears of a banking crisis brewing in the country.
Shares in Spain's two largest banks, Banco Santander and BBVA, led the rebound, each rising more than 3pc.
While all of Spain's major banks passed last year's European Union-organised bank stress tests, five out of the 19 cajas included in the test failed it.
Speaking before the announcement of the restructuring plan, analysts at ratings agency Fitch said the country would need a "credible" plan to ensure it maintained its sovereign credit rating at its current level.
David Riley, global head of sovereign ratings at Fitch, said he expected the cost of the recapitalisation of the cajas to come in at about €50bn (£42bn) to €60bn.
"If we get much larger recap costs than we have currently built into our rating, then obviously that would prompt us to have a look at the rating again," Mr Riley said.
Moody's, a rival credit rating agency, last month put out a negative outlook on Spain, citing its worries about the outlook for the banking system, which has struggled with losses largely related to loans to property developers.
The Spanish government creates an insider trading problem if it does not share the current asset-level data with all market participants.  If the cajas data is only shared with a few investors and investment banks, these investors and investment banks have information that they could trade on.  They would know if there is a need for more capital than the rating services currently anticipate.  The trades do not have to be in the securities of the cajas.  They could instead be in securities of the Spanish government.

If private investors do not make investments in the cajas, even if the Spanish government invests funds, it does not end the questions surrounding the solvency of the Spanish financial system.  In the absence of current asset-level data, investors do not know if the government funds were sufficient to restore solvency.

In support of what your humble blogger has been saying, Mohamed El-Erian of Pimco  observed in discussing the Spain's plans for its savings banks, [emphasis added]
“That is the weakest link right now in the financial system,” El-Erian said in an interview on Bloomberg Surveillance. “We are looking to what are they going to do, how are they going to do it, and will that calm sentiment in Spain?
Spain is pushing savings banks, or cajas, to bolster capital and wants them to plug any shortfalls with private funds, using the bank-rescue fund known as FROB only as a last resort. The country is forcing the cajas, regional institutions run as foundations that helped fund the property boom and account for about half of Spain’s loans, to detail their risks linked to developers and real estate by the end of the month.
“They are looking to somehow recapitalise the system, but the big question is, ‘who is going to pay for it?’” said El- Erian, who also serves as co-chief investment officer with Pimco founder Bill Gross at the world’s biggest manager of bond funds.
“It will be very difficult to raise private capital for the cajas. It’s more likely to be public capital.”
The European nation may change the law governing savings banks to make it easier for them to attract private investors, and could also tighten capital requirements, FROB said in a presentation on its website on Friday.
New steps may include incentives to “strengthen solvency and capital quality requirements, preparing the entities in advance to meet the most stringent international capital standards and future stress tests,” FROB said. In a separate statement, the rescue fund said the proposals were “working hypotheses” and legal changes are up to the Spanish government.
To avoid creating an insider trading problem and restore credibility to the solvency of both the cajas and the government, the Spanish government should have the cajas disclose their current asset-level data to all market participants.

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