In short, because of their real estate exposure, the smaller and maybe the larger banks are insolvent -- the market value of their assets is less than the book value of their liabilities.
As this blog has repeatedly observed, banks can continue to operate while they are insolvent and, more importantly, while they have negative book equity. It is the ability to operate with negative book equity that allows banks to absorb losses on their bad assets and continue to lend to support the economy.
As always, the lesson of the US savings and loan crisis was that financial institutions operating with negative book equity have an incentive to increase their risk profile.
The way to keep the risk down at Spanish banks with negative book equity is to require them to disclose their current asset, liability and off-balance sheet exposures. With this data, market participants can see if the risk profile changes and exert market discipline.
Spanish banks, under pressure to cut property-backed debt, hold about 30 billion euros ($41 billion) of real estate that’s “unsellable,” according to a risk adviser to Banco Santander SA (SAN) and five other lenders.
“I’m really worried about the small- and medium-sized banks whose business is 100 percent in Spain and based on real- estate growth,” Pablo Cantos, managing partner of Madrid-based MaC Group, said in an interview. “I foresee Spain will be left with just four large banks.”
Spanish lenders hold 308 billion euros of real estate loans, about half of which are “troubled,” according to the Bank of Spain.
The central bank tightened rules last year to force lenders to aside more reserves against property taken onto their books in exchange for unpaid debts, pressing them to sell assets rather than wait for the market to recover from a four- year decline.
Land “in the middle of nowhere” and unfinished residential units will take as long as 40 years to sell, Cantos said....
Land in some parts of Spain is literally worthless, said Fernando Rodriguez de Acuna Martinez, a consultant at Madrid- based adviserR.R. de Acuna & Asociados. More than a third of Spain’s land stock is in urban developments far from city centers. About 43 percent of unsold new homes are in these areas, known as ex-urbs, while 36 percent are in coastal locations built up during the real-estate boom.
“If you take into account population growth for these areas, there’s no demand for them, not now or in ten years,” he said. “Around 35 percent of Spain’s land stock is in the ex- urbs, which means it’s actually worth nothing.”...
“If there were to be a proper mark to market of real estate assets, every Spanish domestic bank would need additional capital,” said Daragh Quinn, an analyst at Nomura Holdings Inc. in Madrid, in a telephone interview....
Banks have made provisions for a potential 105 billion euros of writedowns since the market crashed. Lenders may need to make another 60 billion euros in provisions to clean up their balance sheets, including real-estate debt, according to Rafael Domenech, chief economist for developed nations at BBVA.
“Since the crisis began, banks have only put their lowest- quality assets on sale while they waited for a recovery, so as not to sell the better properties at a loss,” said Fernando Encinar, co-founder of Idealista.com, Spain’s largest property website. Idealista currently advertises 45,912 bank-owned homes in Spain, up from 29,334 in November 2010. In 2008 it didn’t list any.
Spain is struggling to digest the glut of excess homes in a stalling economy where joblessness is among the highest in Europe....
Financial institutions have foreclosed on 200,000 homes and that will balloon to as many as 600,000 in coming years as unemployment continues to rise, according to a report by Taurus Iberica Asset Management, a Spanish mortgage servicer which manages 35,000 foreclosed properties for 25 lenders....
Lack of financing and concern about economic growth has choked investment in Spanish commercial real estate, currently at its lowest level in a decade, according to data compiled by U.K. property broker Savills Plc. (SVS) ...
There is an “enormous” gap between prices offered by banks and what investors are willing to pay, preventing sales of large property portfolios, MaC Group’s Cantos said....
Cantos says that prime assets can be sold at a 30 percent discount, while portfolios comprised of land, residential and commercial real estate may only sell after 70 percent discounts.
“Therein lies the problem,” he said. “Banks have already provisioned for a 30 percent loss, but if you are selling at 70 percent discount, you have to take another 40 percent loss.”
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