Thursday, February 2, 2012

Spain unveils plan to clean-up bad real estate loans in banking system

The Spanish government unveiled its plan for cleaning-up the bad real estate loans in the banking system.

According to articles from Reuters, the NY Times and the Wall Street Journal, the centerpiece of the plan is the requirement that the banks set aside an addition 50 billion euros against the 176 billion euros of bad debt in the banking system.

The primary source of funding for this provision is future bank earnings.  Specifically, bank earnings for the twelve months following the provision.

If these earnings are not sufficient, banks are urged to merge and apply the savings from the merger to fund the provision.  Banks that merge will be able to apply earnings for the next two years to paying for the provision.

If earnings for the next two years prove fails to fund the provision, then the Spanish government is willing to lend money to the banks by purchasing so-called CoCo securities.  These securities convert into equity based on the performance of the banks.

Regular readers will have noticed how closely this plan resembles this blog's blueprint for saving the financial system.

  • Spain's plan and the blueprint require banks to recognize their losses today.

  • Spain's plan and the blueprint require banks to rebuild their book capital through retention of future earnings.

  • Spain's plan and the blueprint keep banks with a viable franchise open and close banks that are unable to generate the future earnings to rebuild their book capital.

There are two major difference between Spain's plan and the blueprint.

  • The blueprint requires that banks provide ultra transparency and disclose to the market on an on-going basis their current asset, liability and off-balance sheet exposure details.  This disclosure is necessary so that market participants can confirm that the banks have in fact fully addressed all their losses.  More importantly, it allows the market to exert discipline to ensure that bank management does not try to gamble on redemption while rebuilding book capital.
  • The blueprint also does not put a limit on how long the banks have to rebuild their book capital through retention of future earnings.  As a practical matter, I don't think that the Spanish government is going to enforce a 12 or 24 month timeframe for rebuilding capital for any bank with a viable franchise.
From Reuters,
Spain's banks must raise 50 billion euros ($65.86 billion) in extra funds to compensate for foreclosed properties and bad loans to housebuilders festering on their balance sheets, under new rules revealed on Thursday. 
The centre-right government gave newly-merged banks and banks planning tie-ups extra time, two years to write down deteriorating assets by setting aside provisions. Other banks will get one year. 
"The Spanish banking system will emerge from this process stronger, with fewer but more solid banks, meaning that Spanish lenders will be among the healthiest in the European Union," the Economy Ministry said in a statement. 
Spain's battered banks have cut back on lending to families and small businesses in a country desperately in need of credit as it continues to battle the euro zone debt crisis and heads into a second recession in four years. 
By cleaning the banks' balance sheets of worthless property assets, hammered in a property crash four years ago, the new government hopes to rekindle investors faith in Spanish banks -- allowing them to borrow on the international money markets and start lending at home again.
The banks have been largely shut out of interbank markets ever since the Greek bail-out in early 2010.
Requiring ultra transparency would really help here, but this is something that the banks should do voluntarily themselves.  After all, ultra transparency is the sign of a bank that can stand on its own two feet.
Banks must make a specific provision from results totalling about 25 billion euros across the entire sector, Economy Minister Luis de Guindos said in a news conference. 
In addition, banks must put aside capital equal to 20 percent of the book value of undeveloped lots and 15 percent of the book value of unfinished developments. That will amount to around 15 billion euros for all the banks and can come from profit, capital hikes or convertible bonds. 
For performing real estate loans, banks must make a generic provision of 7 percent, taken against results, to total around 10 billion euros. Previously banks were not required to make any provisions for those loans. 
The government will lend to banks that struggle to meet the new requirements through convertible shares. If a bank fails to pay back the loan during this time, the state will take it over..... 
Provisions against losses will now rise to between 35 percent and 80 percent, depending on the type of asset or loan. 
Banks looking to merge to meet the new requirements must present their plans before May 30 of this year.

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