Sunday, April 22, 2012

Spanish property crisis will require Ireland-style banking system recapitalization

Ireland dealt fairly quickly with its property market bubble by effectively and forcefully nationalizing and recapitalizing its banking sector. They clearly still have a serious problem on their hands, but the nation has been aggressive in addressing the issue of distressed real estate loans. In contrast, Spain's banking system is nowhere close to fully recognizing the full extent of the problem. Not facing the problem however is not going to make it go away.
Reuters: "Banks are not recognising all of their risk. Many of their debtors are property companies with negative equity who can't even pay the interest on their debt," Fernando R. Rodriguez de Acuna, chairman of the consultancy, told Reuters by telephone.

There are at least 21,000 "zombie [property developers] companies" in Spain that owe banks 126 billion euros, Rodriguez said, basing his estimates on recent data from Spanish mercantile records.

He said the banks were covered for only 67.5 percent of that risk, leaving 40 billion euros of exposure if all the companies filed for bankruptcy.

The fate of the banks is being watched by international investors who fear Spain may be forced to apply for aid as the euro zone debt crisis enters its third year.
One of the issues the banks are dealing with is poor recovery levels on distressed property loans. Recoveries are considerably lower than anticipated.
FT: Repossessed properties in Spain are selling for about half their original value and are likely to continue to fall in value, according to a new report, underlining the parlous state of the real estate market in Europe’s fourth-largest economy. Valuations on properties that were bundled up in securitisation deals and later repossessed are also significantly lower than data from the official housing price index suggest, according to a report from rating agency Fitch due to be published on Thursday.
Carlos Masip, Madrid-based director at Fitch, said: “If we view the market today we believe that there will continue to be a downward pressure on property prices. Home prices are still unaffordable for many when compared to income levels, there is a short supply of credit and a huge overhang of unsold properties.”
As discussed earlier, the amount of "recognized" bad debt has spiked. But this is thought to be only a part of  the total delinquencies the banking system will be facing soon.

Spain's banking system bad loans (Source: WSJ)
Just to give some perspective on the level of Spain's property crisis, consider the following chart showing housing prices over time in real terms compared to the Eurozone as a whole and to the US. Looking at the chart, consider the fact that the bulk of the loans on the books today were extended during the 2004 to 2009 period - right in the middle of the bubble. That's when the collateral was valued. This is why the recovery levels are so low and continue to decline.

Source: IMF

Spain will have no choice but to recapitalize the banking system as Ireland did a couple of years ago. But to do so the nation will need help from the Eurozone/IMF (as Ireland did). Unlike Ireland however, Spain's massive banking sector capital requirements will threaten to push the Eurozone the limit.
CNBC: ... economists believe that Spanish banks will have to turn to the euro zone's rescue fund, the European Financial Stability Facility (EFSF), for help in covering losses caused by a property market crash which has yet to end.

Likewise, investors are fretting about how Rajoy's center-right government can enforce deep austerity while reviving a recession-bound economy at the same time.

"They're going to need EFSF money to recapitalize the banking sector," said Carsten Brzeski, a senior economist at ING in Brussels. "I think we'll only see a real end to the Spanish misery if the real estate market stabilizes."
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