Spanish Banks Saddled With Property Debt

December 31st, 2009

Spanish savings banks have begun selling off the large property portfolios they acquired as collateral from loan defaults, in an effort to improve solvency ratios, a move that risks further falls in property values that could impair the value of their asset books.

In Spain, the global financial crisis that erupted in 2007 ended a real-estate and construction-based asset boom, plunging the country into a recession that has yet to end, even as many other European economies have returned to growth.

As the unemployment rate has soared to more than 19%, residential-property buyers have defaulted on loans in massive numbers, as have property developers, overleveraged in a moribund market. As lenders have assumed the collateral on defaulted loans, local financial institutions—particularly unlisted savings banks—have collected properties valued at about €8.5 billion ($12.2 billion) over the past 12 months.

So far the banks have held on to the vast majority of these properties, hoping an eventual economic recovery will allow the disposal of these assets at acceptable prices—a strategy they successfully adopted during a recession in the early 1990s. Accumulating properties also stopped a sharp drop in prices, avoiding the painful write-downs banks are required to book when the value of their assets falls.

Until now the strategy has worked. Spanish property prices have been unusually resilient. Average prices have dropped by a modest 9% over the past 12 months. In the last five years of the housing bubble, average prices jumped 71%, according to Housing Ministry data.

But now banks are facing new demands for liquidity that will force them to sell more property. They are drawing up sales strategies, creating real-estate management divisions and offering discounts in an effort to lure buyers.

Solvency pressures on the banks come from several directions. First, the downturn has meant smaller inflows of cash held in deposits and bank accounts. Second, the Bank of Spain recently required local financial institutions to set aside more money to cushion potential losses from a drop in the value of repossessed properties. Banks must now set aside 20%–up from 10%–of the value of a property held on their books for more than one year. Finally, a big restructuring of the savings-bank sector is in the cards, for which banks need funds to clean up their loan books.

Such incentives to liquidate property portfolios have banks looking to sell. “Three of the five real-estate companies that have sold the most properties this year are controlled by financial institutions,” says Manuel Romera, head of the Financial Sector Program at Spain’s IE Business School.

Bank disclosure on property sales is limited. Unlisted savings bank Caja Madrid, Spain’s fourth-largest financial institution by assets, said it has sold 600 properties from January to September for about €100 million and estimates it has €1 billion in real-estate assets. The bank launched a Web site, set up a call center and will have desks at some branches to sell properties.

Smaller rival Caixa Catalunya said it unloaded 800 properties from a total of 3,600 properties it reported owning as of May, while Banco Santander SA, the country’s largest bank by assets, said it unloaded some 1,000 properties from January to October. In April it reported owning some €4 billion in real-estate assets.

However, banks “are realizing that unwinding real-estate assets is much more complicated than expected,” says José Luis Suárez, financial management professor at IESE Business School. “The short-term outlook isn’t positive.”

In the absence of an active real-estate market, the process of price discovery could show market values of many properties are far lower than their book values.

Analysts say that some banks and saving banks, particularly small ones, could suffer losses in the first half of 2010. They say banks with high levels of expenditure to income may be in trouble.

“Growth and employment prospects for Spain are markedly more pessimistic and, together with falling support from immigration and foreign demand, it is difficult to argue in favor of any near-term housing market recovery, especially in the face of a massive supply overhang,” HSBC said.

The research department of Spanish bank BBVA estimated in June that Spanish housing prices would fall by 10% in 2009 and by 12% in 2010. It envisioned a total 30% peak-to-trough drop. A new review in December didn’t change that forecast.

According to the Bank of Spain, 70% of a total of €30 billion in real-estate assets owned by financial institutions is now in the hands of savings banks, many of which are comparatively small and regionally focused.

Were BBVA’s estimate of the fall in house prices to prove accurate, the value of the €30 billion of real-estate assets held by banks could fall some €6.6 billion in the next two years.

To avoid these losses from becoming a bigger problem–perhaps necessitating state intervention—the Bank of Spain is encouraging banks to look for merger partners. The central bank believes that fewer, bigger banks would improve efficiency and strengthen solvency. More than a dozen of the country’s 45 savings banks are now in tie-up talks.

So far, only one Spanish financial institution, savings bank Caja Castilla-La Mancha, has needed a state bailout. But two other banks—the Andalusian savings bank CajaSur and the Catalonian savings bank Caixa Catalunya—have already run into trouble after seeing default levels increase far above the industry average because of their high exposure to real-estate development.

As a result, both of the banks are now discussing mergers. Caixa Catalunya is talking with Caixa Tarragona and Caixa Manresa, which, if a deal goes ahead, would create the fourth-largest savings bank in Spain. CajaSur is talking with Unicaja and Caja Jaén, which would create the sixth-biggest savings bank in Spain by asset volume.

Story from Wall Street Journal

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