Tuesday, February 22, 2011

Spanish Banks Raising Capital Hinges on Loan Transparency

Bloomberg reported on the capital raising activities of the Spanish savings banks. [emphasis added]
Spain’s decision to force lenders to meet stricter capital rules or risk state ownership will provide a boon to bankers and lawyers helping them raise funds with stock market listings and asset sales. 
Only if the investors can be convinced that they are investing in solvent institutions.
Spanish banks may raise as much as 20 billion euros ($27.3 billion) by selling stock in initial public offerings and reducing their stakes in publicly traded companies in the next two years, according to bankers working on the plans. 
The hurdle that must be overcome is the 40+ billion euros gap between what the market thinks it would take to restore solvency and what the Spanish government is requiring the banks to raise.
... Finance Minister Elena Salgado confirmed on Feb. 18 that lenders without a stock exchange listing will have to boost core capital levels as high as 10 percent. She provided some leeway by giving them until the end of the first quarter of 2012 to carry out IPOs, after stating last month that the banks would have to meet the capital rules by “autumn.” The savings bank association pushed for more time. 
Salgado is seeking to convince investors the country’s banking system can absorb losses from the property crash without overburdening public finances. The rules require publicly traded banks to have core capital, a measure of financial strength, of at least 8 percent. 
Transparency on Loans 
“At this point, being transparent about the quality of loans and real estate seems much more important than setting rules on capital that may be difficult to meet from a practical point of view,” said Luis de Guindos, a former deputy finance minister in the government of Jose Maria Aznar and a professor at Instituto de Empresa business school in Madrid
Even with the extra time, ... persuade investors they are attractive investments may prove difficult. 
The need to be transparent about the quality of loans is much more practical.  In order to determine if a savings bank is solvent, investors have to be able to analyze its current assets, especially the real estate loans, and see if the value of these assets exceeds its liabilities.  Investors are unlikely to invest if there is a shortfall.

The Wall Street Journal reports that the Spain's central bank said that the savings banks hold 100 billion Euros of 'potentially problematic' real estate and development loans.

Unfortunately, as the Irish central bank can tell them, Spain's central bankers have chosen the wrong way to be more transparent about the quality of the loans.  Like the Irish, the Spanish have chosen to stand between the loan-level data and the market.  Like the Irish, the Spanish have staked their credibility on a number that is highly likely to be wrong.

The reason that disclosure of loan-level data works is that it is not the government telling market participants that there is 100 billion Euros of problematic loans, it is market participants reaching this conclusion on their own.

This difference is huge because the 100 billion Euros number appears to be related to Spain's capacity to recapitalize the savings bank. [emphasis added]
Spain's central bank said the country's ailing savings banks are holding about €100 billion ($136.86 billion) in "potentially problematic" real-estate assets, the first time it has put a number on the extent of those holdings. 
... The figure was disclosed as the head of the Bank of Spain voiced support for the government's plan to boost the solvency levels of those banks, known as cajas
... It reiterated its estimate that all the banks will need to raise about €20 billion to meet the new requirements, a figure many analysts describe as too low, and said it will take stakes in lenders that fail to do so by September through its Fund for Orderly Bank Restructuring, also known as FROB. 
The government, however, has offered some flexibility on the September deadline... This flexibility on the deadline, which was announced in January, was viewed as a sign of weakness on the part of many analysts. 
"The initial guidelines have been watered down," Barclays Capital analyst Antonio Garcia said in a report published over the weekend. His own figure for the banking system's capital shortfall is at least €46 billion, or more than double that of the central bank. 
... Monday, the central bank said the cajas have €217 billion in exposure to construction and real-estate companies. It said that €100 billion of that total exposure is "potentially problematic" and that cajas have provisions to cover 38% of it. Many of the loans they hold are backed by assets that ensure the banks will recover at least a portion of their value. [38 billion in reserves and a 50% recovery would imply the need for 12 billion in new capital]
Speaking at the same press conference, the Bank of Spain's deputy governor sought to offer reassurance that the FROB, which has already injected about €11 billion into banks during the crisis, will have sufficient firepower to recapitalize banks that aren't able to raise funds from private sources. 
After a successful €3 billion bond issue last month, the FROB has €4.5 billion on hand plus a €3 billion credit line it can draw on. "The FROB has a comfortable liquidity position," Javier Ariztegui said. The FROB can be expanded to €99 billion through bond issuance.
In a related Bloomberg article, Spain plans to dramatically watered down the definition of capital it applies to its banks.  A move that is likely to convince investors that they are right that the banks require significantly more capital than the government is acknowledging.

Spain’s Finance Minister Elena Salgado will allow Spain’s savings banks to consider generic provisions and preferred shares as core capital, El Confidencial reported. 
The decision, which will be set out ... in a decree outlining capital requirements, will provoke protest from publicly traded banks and other European countries as the instruments have never been classed as core capital, the newspaper said, citing unidentified people with access to the text of the decree. 
Salgado had previously said that new core capital requirements set for Spanish banks this year would use the definition of core capital set out in Basel III.

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