Monday, March 28, 2011

Spain Shows Why Endorsing Investments is Bad Policy

As regular readers of this blog know, the FDR Framework predicted that the Spanish financial regulators are setting the country up for significant financial instability if the regulators' estimate of the amount of capital needed for the savings banks is too low.

Since that prediction, Moody's has been very vocal in stating that it thinks the estimate is low and cutting the ratings of the sovereign and the banks as a result.

As reported in an article in the Wall Street Journal, investors have tried to verify the Spanish government's estimate of the capital needs of each savings bank prior to investing.  While the investors are not getting access to all the useful, relevant information in an appropriate, timely manner, they are getting substantially more information than was previously available to market participants.

Unfortunately, the results of their analysis of this information suggest that the problem is worse than the savings banks or government is letting on.  As a result, they are not investing.

As it becomes more apparent that the savings banks will not be able to raise the needed capital, this will drive up the cost of funds at both the bank and sovereign level.
Spain's plan to rescue its regional banks is running into headwinds as private investors, who are being asked to pour in cash, and ratings firms raise questions about whether the lenders have admitted to all of their real-estate losses. 
... Eight of Spain's cajas must present their capital-raising plans to regulators by April 10. That has caused a flurry of activity in recent weeks as savings banks sounded out hedge funds and private-equity funds and others pursued initial public offerings. 
But the exercise has stirred questions from investors about the level of reserves that the banks hold against real-estate risk in their portfolios. The banks also have faced questions over whether their executives have distanced themselves sufficiently from local politics; in some cases, they have even been quizzed about managements' own understanding of what is on their books. 
... The pressure on Spain to show that it can clean up its banking sector has heated up in recent days. Moody's Investors Service on Thursday downgraded Spanish banks, citing, in part, greater financial pressures on the Spanish government and its smaller lenders. 
"We remain cautious on the capacity of savings banks to get private funds, to the extent that private investors may have concerns on whether savings banks have undertaken an upfront recognition of losses," said Alberto Postigo, a senior analyst at Moody's. 
... The savings banks have until September, with some exceptions, to raise their core Tier 1 capital ratios—a key measure of financial strength—or turn to the Spanish state for funds. Spanish authorities said earlier this month that the entire banking sector needs €15.1 billion ($21.3 billion) to meet these new rules, although they said a significant amount could come from the private sector. 
Spain's Fund for Orderly Bank Restructuring has made available €15 billion to assist the sector. Sovereign wealth funds from Qatar and United Arab Emirates have also pledged funds to invest in the savings-bank sector, although the recipients haven't been disclosed.
If little capital can be raised from outside investors, "it will be a disappointment for the whole Spanish market," said a Madrid-based fund manager. 
One of Spain's largest savings banks, Banco Base, already has scrapped plans to go public in the face of a lukewarm response from investors and a tight timetable to raise capital, say people close to the bank. It instead will try to sell a partial stake in the market or seek government funds. 
If private investors won't commit to Spanish savings banks, this could sharply raise the cost of funding for all banks, including larger, publicly listed entities, say analysts. 
To be sure, savings bank Mare Nostrum, with €71 billion in assets, is generally liked for its professional board and comparatively low real-estate exposures, said people who have attended its presentations. 
But many investors are still wary. 
"Spain is an attractive market for longer term," said Fred Rizzo, an analyst with T. Rowe Price International Inc. in London. But first, he said, the cajas "need to clean up and recapitalize, then we can make apples-to-apples comparisons with other European banks." 
A litmus test for confidence in the Spanish banking sector will be the success of the offering of the largest entity, Bankia, a lender with €344.5 billion in assets. It is comprised of Caja Madrid, Bancaja of Valencia, and five others, and must raise €5.78 billion to comply with the requirements. 
In some cases, though, Bankia's pitch to investors has fallen flat. 
A banker who attended a recent presentation said that according to calculations based on the bank's literature, the "capital hole" appeared far larger than what the bank planned to raise in the market. Moreover, this person said, the disclosure about asset quality was limited, and management couldn't answer questions about the some structured products on its books. 
A Bankia representative declined to comment on the banker's comments but said the bank has been making progress in consolidating operations and cleaning up its balance sheet, and had recently reached an agreement to cut costs through early retirement for employees. The bank is moving ahead with its IPO, which it hopes to complete before summer.

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