Spanish banks face up to €62 billion capital shortfall: Wyman Berger stress test

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By:
Louise Bowman
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Report quantifies capital shortfall and likely losses; mechanism of bailout still unclear


The much-speculated-upon scale of Spain’s bank recapitalization has become clearer.

US-based consultants Oliver Wyman and Germany’s Roland Berger, which were mandated to conduct what is essentially a stress test of Spain’s banks in a move designed to quell speculation as to the state of the sector, published their findings today (Thursday) together with a third report from independent consultant, Promontory. Bank of Spain says that the objective of this third report is to “analyze and compare the other two and provide greater clarity and transparency to the entire evaluation process”.

The findings will be presented to banking industry analysts on Friday evening. The reports suggest that the country''s banks face a €51.8 billion capital shortfall (Roland Berger) and a slightly worse €62 billion shortfall (Oliver Wyman). However, the central bank emphasizes that “due to legal restrictions of confidentiality, the assessment of the situation of individual institutions will not be considered.” According to Oliver Wyman, cumulative expected losses for the existing credit portfolio in the period 2012 to 2014 would amount to around €250 billion to €270 billion under an adverse scenario and around €170 billion to €190 billion under a 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.
 
There was some surprise that BlackRock was not involved in the exercise but the US firm was deemed conflicted given that it will be looking to buy distressed banking assets in the country, while Oliver Wyman has a strong franchise in Spain, headed up by managing director Pablo Campos who is particularly well-regarded. There was also political pressure for the German firm to be on the ticket. However, 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.”

The International Monetary Fund (IMF) released its own analysis of the situation during the same weekend that the bailout was hammered out. It believes the banks will need to raise around €40 billion. Fitch Ratings has put the figure at €60 billion and JPMorgan reckons €75 billion.

In a comprehensive report published on June 8, Citi’s Moreno deemed the amount of capital needed at between €25 billion and €80 billion, illustrating the wide range of scenarios in play.

“There are €3.2 trillion bank assets in Spain, so a €60 billion recapitalization is only 2% of total assets,” explains Moreno. “€150 billion would only be 5%. This is why you see such a wide range of figures being discussed – the delta is so big.”

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 billion-dollar question

The extent of the non-performing loan (NPL) 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. Citi estimates there will be losses of between €31 billion to €44 billion across the banks’ real-estate portfolios – 31% to 45% of their gross asset valuation. The NPL ratio in Spain is now 8.16% versus a peak of 9.15% in 1994.

The average adjusted real-estate NPL ratio – the percentage of real-estate loans deemed bad – across the sector has reached 48%, a number which includes non-performing and substandard loans.

Thanks to the long-standing strategy of forcing the healthier banks to take over the distressed regional cajas, the problem of non-performing real-estate assets now pervades the sector. 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. “Experience suggests that, government-owned centralized AMCs might be relatively more efficient when the size of the problem is large, special powers for asset resolution are needed, or the required skills are scarce,” it noted in its June 9 report.

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 to €28 billion of repossessions – how are they being held on the balance sheet?”

Provisioning against disaster

As part of its June report, 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 basis of its assertion that between €25 billion and €80 billion is needed to reach a CET1 ratio of 10%.

Moreno calculates that every additional percentage point to the required equity tier 1 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.

Just to get to a CET1 of 9.5%, Santander would need an additional €6.5 billion, CaixaBank needs €6.8 billion and Popular €5 billion – 167% of its market cap (see table).

This is what the €100 billion bailout announced on June 9 was supposed to address, but the vexed question to how the funds will be disbursed – through FROB or directly via the European Financial Stability Facility/European Stability Mechanism – remains.
“The way the Bank of Spain and the Spanish government has handled this has been a shambles,” says Burrows. “They assumed a bailout headline would be enough to calm the market, when there was such a crucial failing to explain how it would work.”

It is hard to see where else the required capital will come from. There has been some discussion of contingent convertibles (CoCos), but this has been largely dismissed. CoCos are a buffer against future losses and what needs to be done is to address past losses.

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 so this would not make a huge difference anyway. Indeed, it would be easier to bail in the institutional senior investors than the subordinated retail bondholders. But this is unlikely to happen.

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 costs of restructuring the sector have been met by FROB and the Deposit Guarantee Fund, into which the banks contribute on a pro-rata basis.

Given their dominance of the domestic market – Santander owns 18% of the Spanish banking system – the healthier, internationally diversified banks might escape additional costs for now only to face them later.

“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.”

Source: Citi