The studies were undertaken in an attempt to quell mounting speculation as to the true health of the sector. The banks were stressed under base and adverse scenarios with the aim of coming up with essentially a worst-case scenario.
The adverse scenario entailed two consecutive years of severe economic recession with real GDP declines of 4.1% and 2.1%, and unemployment rates at 25.1% and 26.8% in 2012 and 2013 respectively. Real-estate prices fall 20% and land prices 50% for a total peak-to-trough fall by 2014 of 37% and 72% respectively.
|Spain's looming losses|
|Expected loss forecast 2012-14|
|Source: Oliver Wyman|
Roland Berger determined that under an adverse scenario the banks would require a recapitalization of €52 billion to maintain a core tier 1 target ratio of 6%. In this scenario, the largest three banks, Santander, BBVA and CaixaBank, do not require recapitalization.
Oliver Wyman deemed the situation slightly worse, necessitating a €62 billion recapitalization, and calculated cumulative expected losses for the existing credit portfolio to reach around €250 billion to €270 billion under the adverse scenario and around €170 billion to €190 billion under the base scenario.
"The idea behind the consultants’ report is simply to calm the market," explains Ignacio Moreno, banking analyst at Citi in London. "There was a desire to have an external agent check the banking sector in addition to the Bank of Spain."
Indeed, it was a key condition of Spain being granted the €100 billion financing package agreed on June 9.
The results, while eagerly anticipated, might do little to calm the market’s anxiety. "We view the Berger-Wyman stress test as merely a variation of the RDL [Royal Decree-Law] audit process carried out in February and May," says Oliver Burrows, credit analyst at Rabobank in London. "This latest round will equally fail to draw a line under market concerns if it is simply more of the same."
What might perhaps provide a more definitive picture of the state of the sector is the additional audit of 14 Spanish banking groups that is now under way. This is being conducted by Deloitte, KPMG, PwC and Ernst & Young. They had been due to report their findings by the end of July but this deadline has now been moved to September – hardly surprising given the scale of the task in hand.
The extent of the non-performing loan problem is the billion-dollar question for Spain. According to Fitch, loan exposure to real estate and construction totalled €397 billion at end-2011 and accounted for 22% of total loans.
The latest RDL in May increased the level of provisioning against loans for construction and real estate from 7% to between 14% and 52% – an indication of how seriously this issue is now being taken and how much provisioning the banks have to do. The average adjusted real-estate NPL ratio – the percentage of real estate loans deemed bad – across the sector has reached 48%, a number that includes non-performing and substandard loans.
The May RDL also raised the prospect of "the transfer to independent asset managers of distressed real estate assets" – in other words, a bad bank. This is something that the banks have long resisted due to the losses that would be crystallized on the transfer of bad loans.
However, it is something that the IMF has specifically endorsed. The May RDL states that assets must be transferred at fair value by the end of this year – or next year for banks in the process of merging.
"A bad bank is inevitable but it won’t solve all the problems," says Burrows. "The idea was initially dismissed as you can’t have a bad bank without a recapitalization. Now you have recapitalization on the table, you have a problem and a solution."
This is progress, but Burrows argues that the authorities must broaden their focus. "The Royal Decrees in February and May involved the same people and focused on the same things," says Burrows. "There is an obsession with non-performing real estate. What about forbearance? Accounting treatment? There have been €27 billion to €28 billion of repossessions – how are they being held on the balance sheet?"
In a comprehensive report published on June 8, Citi’s Moreno deemed the amount of capital needed by the banks at between €25 billion and €80 billion. Citi stressed €1.8 trillion of assets – or 55% of the total balance sheet of the sector. Its own top-down analysis implies a provisioning gap of €203 billion to €262 billion, which forms the capital it says is needed to reach a common equity tier 1 (CET1) ratio of 10%.
Moreno calculates that every additional percentage point to the required CET1 ratio adds an additional €17 billion recapitalization need to the system. The banks likely to be hit hardest are Banco Popular and Banesto, and the only bank that passes Citi’s stress test without needing additional capital is BBVA.
To get to a CET1 of 9.5%, Santander would need an additional €6.5 billion, CaixaBank would need €6.8 billion and Popular €5 billion – 167% of its market cap. This is what the €100 billion bailout announced on June 9 was supposed to address.
It is hard to see where else the required capital will come from.
Unlike in Ireland, Spain’s banks are unlikely to attempt to bail in subordinated bondholders, given the extent to which some banks – particularly those that became Bankia and the regional cajas – sold subordinated paper to the retail investor base. "If there is a bail-in of subordinated retail investors, there is a high risk they would take their deposits away," says Moreno at Citi.
Total subordinated debt in the Spanish banking system is only around €103 billion. The banks have therefore undertaken widespread liability management exercises to try to reduce outstandings.
"Spanish banks have been trying to swap as much subordinated debt as they can and are buying back as much as they can," says Moreno. "This is, however, largely driven by the regulators telling them to do it to avoid legal risk, given that these products may have been mis-sold."
In March, Santander lost a case relating to the mis-selling of convertible bonds in 2007 that were issued in connection with the acquisition of ABN Amro.
Whatever the final bill for recapitalization of the sector is, there will be overwhelming political pressure for the banks to pick up the tab.
"The larger and more profitable banks in the country, Santander and BBVA, will end up paying for the restructuring of the sector," Moreno tells Euromoney. "It is worth remembering that the Spanish banking sector has paid a tax rate of only 20% in the last 15 years. This figure will increase significantly once the financial restructuring finishes.
"Given the more comfortable initial situation for Santander and BBVA, the risk of incremental costs from the Deposit Guarantee Fund levies, higher taxes, rescuing institutions or similar actions is significant."