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Opinion

Spanish banking: Sub-debt crisis

Turmoil in the Spanish banking sector raises the threat of substantial losses for subordinated bondholders.

The Spanish government’s announcement on May 25 that it planned to provide Bankia with a €19 billion capital injection was a welcome intervention by the state but also served to highlight concerns that the level of provisions lenders have taken against distressed real estate portfolios might still be too low.

For subordinated bondholders in Spanish banks this might prove painful, as it was for subordinated bondholders in Irish banks who were eventually forced to take substantial losses. Ultimately, subordinated bondholders in Irish banks recovered only about 20% of par value on average.

The Spanish government has asked banks to set aside an additional €30 billion of loan-loss provisions, bringing the total requested since the beginning of 2012 to €84 billion. Further public capital injections into the banking system, in addition to the €16 billion provided in 2011, will be required to help these banks comply with the new requirements.

In addition to the requirements, the government announced the effective nationalization of Banco Financiero y de Ahorros and Bankia (BFA’s listed operating subsidiary), most recently through the €19 billion capital injection. The creation of asset management companies, similar to Ireland’s National Asset Management Agency, to remove foreclosed real estate assets from bank balance sheets, has also been outlined.

However, looking at Barclays’ base-case outcome, where lifetime loan losses for Spanish banks reach €198 billion (€266 billion under its stress scenario), this would exceed the current stock of provisions by €79 billion, which might force the government to contribute substantial amounts of additional capital to cover the shortfall.

With €65 billion of Spanish bank subordinated debt outstanding, or €47 billion excluding Banco Santander and BBVA, this in turn raises the question as to whether subordinated bondholders in Spanish banks will eventually meet the same fate as subordinated bondholders in Irish banks.

Although similarities abound, there are, however, key differences that might mean the outcome for subordinated bondholders in Spanish banks is less painful. These are the expected loss rate on loans, the ability of the government to support the banking system, and the amount of subordinated bonds held by retail investors.

First, Spanish loan losses should remain lower than Irish loan losses because of the magnitude of the real estate corrections being experienced in each country, with prices declining more in Ireland. For example, Irish real estate prices rose by 4.5 times between 1995 and 2007. This compares with 3 times in Spain and 1.7 times in the euro area as a whole. Considering this, Barclays expects losses on Spanish corporate real estate exposures to peak at about 30%, compared with currently realized losses of 50% in Ireland.

Second, the potential cost of public-sector support looks to be manageable for the Spanish government. Spain’s corporate real estate sector accounted for about 25% of total domestic lending, compared with 40% in Ireland. This means that, at the peak, real estate lending was equivalent to 80% of GDP in Ireland, compared with just over 40% in Spain.

Finally, with most outstanding Spanish bank subordinated debt currently held by retail investors – a result of Spanish banks exploiting their distribution networks and selling sub-debt at a price that was substantially lower than what could be achieved in the institutional market – imposing coercive burden-sharing on them might prove difficult to implement.

Nevertheless, with base-case loan-loss estimates for the Spanish banking sector fluid, and burden-sharing considered a material risk, subordinated bondholders should be anxious about what lies ahead.

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