Monday, October 1, 2012

Test of Spain's latest bank stress test is whether investors willing to invest

In the aftermath of Spain's bank stress tests, are investors gullible enough to believe the numbers and invest in the banks that were represented as almost solvent?  Or will investors remember their experience with Bankia and stay far away?

Since Spanish banks do not provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, there is simply no transparency into the true condition of the banks so that market participants can independently assess their risk.

As a result, nobody can 'invest' in the banks today.  Rather, they can 'blindly bet' on the value of the contents of the black boxes the banks represent.

The last time investors were faced with this choice was Bankia.  Then, the institutional investors stayed away and the retail investors purchased the capital after being assured that it was as safe as their demand deposits.

Staying away turns out to have been the better decision as the value of the contents of the Bankia black box were worth significantly less than was represented.

So now we have our next example of the government trying to tell investors that it is 'safe' to buy the equity of a Spanish bank.  A Bloomberg article reports that Banco Popular Espanol SA is looking to raise 2.5 billion euros.

Why would anyone want to invest in this bank when even the government's stress test says the bank needs more capital than it is raising?

Banco Popular Espanol SA (POP) will seek to raise as much as 2.5 billion euros ($3.2 billion) from a stock sale and suspend its October dividend as the Spanish bank tries to cover a shortfall found in stress tests. The shares plunged. 
The bank expects to book a 2012 loss of 2.3 billion euros, compared with a previous estimate for a profit of 400 million euros, as it speeds up recognition of loan impairments and relies less than it previously planned on capital gains, Chief Financial Officer Jacobo Gonzalez-Robatto said on a webcast for analysts today....
While it is speeding up recognition of loan impairments, is there any reason to believe this covers all of its bad loans?

Unless Banco Popular is willing to provide ultra transparency to prove that all the bad loans are being addressed, it is highly likely that it has a considerable amount of bad loans that it is hiding.
The capital increase may be equivalent to 80 percent of the bank’s current market value. Popular, founded in 1926, is aiming to avoid taking state aid after stress test on the Spanish banking system by consultant Oliver Wyman published on Sept. 28 showed the country’s sixth-biggest lender by assets had a capital shortfall of 3.22 billion euros in an adverse economic scenario. 
“Every man and his dog has known for a long time that Popular would need to raise capital, but it seems the only ones who didn’t were Popular’s management,” Simon Maughan, a financial industry strategist at Olivetree Securities in London, said by phone today....

“We are going to be generous in the rights issue, because that money is from our shareholders,” Gonzalez-Robatto said on today’s webcast. “We are going to invite our shareholders basically to join us in an extremely bright future for Banco Popular.”...
In the absence of ultra transparency, why would a shareholder want to double down and buy more shares in a bank where the bulk of its business is in a country where the economy is contracting, the government is implementing austerity and there is already 25% unemployment?
Popular will set up a so-called internal bad bank to manage soured real estate as it writes down 9.3 billion euros in 2012, an increase from the 7.7 billion euros in its business plan given in the second quarter of this year, Gonzalez-Robatto said....
They just discovered another 2.2 billion euros of bad real estate debt last quarter!
Investors must make clear their willingness to quickly relax financing terms for Spain’s stronger banks to show that the stress-test process is credible, Jose Manuel Campa, a former deputy finance minister, said in an interview. 
Actually, the stress test process was not credible.  That is why there is already another stress test process in the works that is based on a loan by loan 'review'.  That stress test will find at least twice as much capital is needed to restore solvency.

Of course, once that stress test is completed, the Spanish banks will still not be providing ultra transparency so there will be zero reason for investors to believe that the banks are not still hiding something and that their true condition is much worse.
“If we don’t see over the next month or six weeks a significant improvement in the ability to tap the markets by the banks that are considered solvent, regardless of the capital needs, I think that would be a major failure,” said Campa, who is now a professor at the University of Navarra’s IESE business school in Madrid.
 Based on the Bankia experience, there is no reason not to expect investors to stay away.

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