Spain's bad bank to acquire troubled real estate loans at adverse scenario discount

Reuters reports that Spain's bad bank will acquire troubled real estate loans from the Spanish banking system using the discounts shown in the adverse scenario for the latest bank stress test.

Left unanswered is the question of is the price that the bad bank acquires the trouble real estate loans at greater than, equal to or less than the current market value of these loans.

If the price is greater than the current market value, the government is simply giving taxpayer money to the banks.

If the price is less than the current market value, the government is simply giving money to the private investors who are suppose to fund the bad bank.

The only way to answer this question is by having the banks disclose the loans to the market prior to their being sold to the bad bank.  With this disclosure, market participants could assess the value of these loans (this is after all, what markets are good at).

Lenders will face steep discounts to transfer property assets into Spain's so-called bad bank, to reflect a worsening economic and property market scenario, a source with knowledge of the process said. 

Newly built housing transferred to the bad bank will be valued at an average 52.2 percent discount to original book value, while second-hand housing will be discounted 47.5 percent, the source said on Tuesday.... 

The government has been setting up an asset management company, or bad bank, to take on up to 90 billion euros ($118 billion) of sour real estate assets sitting on lenders' books since a property bubble crashed in 2008. 

The bad bank is a condition for Spain to receive up to 100 billion euros European Union aid for crippled lenders.... 

"The lenders will have to take additional haircuts of 7 percent compared with the base scenario used in Oliver Wyman's stress test, bringing discounts very close to the assumptions used in the adverse scenario," the source told Reuters. 

In its stress tests of Spanish banks, Oliver Wyman applied writedowns of 45.2 percent on new housing under a base scenario for the economy, and 52.4 percent in a worst-case scenario envisioning 6.5 percent economic contraction over three years. 

For older housing, the consultancy projected losses of 40.5 percent in the base scenario - an economic downturn of 2 percent over two years, followed by a slight recovery - and discounts of 50 percent in the worst case. 

Bank have already made massive writedowns on property investments under two laws passed this year - provisioning 137 billion euros against losses on 307 billion euros of real estate exposure. 

The transfer price to the bad bank goes even further. 

The source also said lenders would be obliged to transfer undeveloped lots with average discounts of 85 percent of their original book value. 

Since peaking in 2007, housing prices have fallen around 30 percent, on average. The bottom of the market may still be two years off, analysts said, adding prices could fall a further 20-30 percent. 

A point your humble blogger made months ago.

The property crash left banks with 184 billion euros bad debt from real estate developers on their balance sheets, and the problems have spread to small businesses and other sectors. 

Please re-read the highlighted text as this is the result of trying to protect bank book capital levels and banker bonuses.  Protecting the banks and banker bonuses puts the burden of the bad debt on the real economy with clearly harmful results.

So, the bad bank's remit could be widened to include non-performing consumer loans, the economy ministry has said, as a deep-rooted recession causes more people to default. 

The European Central Bank, European Commission, International Monetary Fund and Spain's central bank have been discussing the design of the asset management company. 

The prices at which assets will be transferred must be low enough to attract private investors but not so low as to precipitate bigger losses for banks. 

Regular readers know I think the idea of a bad bank is flawed.

Investors in a bad bank require a higher return on their money than do banks on performing loans.  As a result, the loans have to be sold at a higher discount than the discount that is necessary to allow the borrower to service the loan.

While the bad bank has been designed to hold 90 billion euros of assets, the government expects the final size to be smaller. 

Antonio Carrascosa, managing director of Spain's bank restructuring fund (FROB), said last week the final size of the bad bank would be around 60-70 billion euros, implying average discounts on asset prices of more than 50 percent.

The government expects four nationalized lenders - Banco de Valencia (BVA.MC: Quote, Profile,Research, Stock Buzz), Bankia (BKIA.MC: Quote, Profile, Research, Stock Buzz), Catalunya Caixa (CX), and NovaGalicia Banco (NCG) to contribute the bulk of the assets to the bad bank.... 

Spain wants to keep its stake in the bad bank below 50 percent to avoid an impact on public debt, and expects private investors to own at least 55 percent. 

Banking sources told Reuters that Spain's healthy listed banks - BBVA (BBVA.MC: Quote, Profile,Research, Stock Buzz), Caixabank (CABK.MC: Quote, Profile, Research, Stock Buzz) and Santander (SAN.MC: Quote, Profile, Research, Stock Buzz) - would likely be the biggest investors in the bad bank.

So let me see if I understand this, the nationalized banks are transferring troubled loans to a bad bank owned by the strongest banks in Spain.

Is there anyone besides me who thinks that the price the loans will be transferred at will be advantageous to the stronger banks and costly to the Spanish taxpayer?