Just when you thought the financial crisis in Europe had reached its boiling point as exemplified by the Greek election message earlier this week, Spain has quietly begun to waive its own white flag.
In an attempt to avoid an international rescue like Ireland needed to shore up its financial system, Spain is now asking lenders to increase their bad-debt provision by another 54 Billion Euros (to 166 Billion) which will be enough to cover defaults on about 50% of loans to property developers and construction companies (according to the Bank of Spain).
It does nothing however, to address the $2 Trillion in home loans and corporate debt.
Taking those into account, banks would need to increase provisions by as much as five times what the government says, or 270 billion euros, according to estimates by the Centre for European Policy Studies, a Brussels-based research group. Plugging that hole would increase Spain’s public debt by almost 50 percent or force it to seek a bailout, following in the footsteps of Ireland, Greece and Portugal.
“How can you only talk about one type of real estate lending when more and more loans are going bad everywhere in the economy?” said Patrick Lee, a London-based analyst covering Spanish banks for Royal Bank of Canada. “Ireland managed to turn its situation around after recognizing losses much more aggressively and thus needed a bailout. I don’t see how Spain can do it without outside support.”
Unemployment in Spain today is 24% and investors are talking in sentences that contain the phrase, “too big to fail.” In Ireland and now Spain, loans to real estate developers are now looking to be the most toxic.
If losses reach only 5 percent of mortgages held by Spanish lenders, the cost to those banks will be about 250 billion euros. That’s three times the 86 billion euros that the Irish domestic banks, bailed out by their government, have lost as real estate prices tumbled there.
“Spain is constantly playing catch-up, so it’s always several steps behind,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a consulting firm in London specializing in sovereign-credit risk. “They should have gone down the Irish route, bit the bullet and taken on the losses. Every time they announce a small new measure, the goal posts have already moved because of deterioration in the economy.”
Without aggressive writedowns, Spanish banks can’t access market funding and the government can’t convince investors its lenders can survive a contracting economy, said Benjamin Hesse, who manages five financial-stock funds at Fidelity Investments in Boston, which has $1.6 trillion under management.
Spanish banks have “a 1.7 trillion-euro loan book, one of the world’s largest, and they haven’t even started marking it,” Hesse said. “The housing bubble was twice the size of the U.S. in terms of peak prices versus 1990 prices. It’s huge. And there’s no way out for Spain.”
Spain’s home-loan defaults were 2.7 percent in December, according to the Spanish mortgage association. Home prices are propped up and default rates under-reported because banks don’t want to recognize losses, according to Borja Mateo, author of “The Truth About the Spanish Real Estate Market.” Developers are still building new houses around the country, even with 2 million vacant homes.
If Spain keeps up the charade, the banks will lose all credibility and soon, not unlike Ireland who tried to stick banks’ creditors with losses and was overruled by the EU, the IMF will declare again that defaulting on senior debt will raise the specter of contagion and spook investors away from all European banks, and thus dis-allow it.
The EU was protecting German and French banks, among the biggest creditors to Irish lenders, said Marshall Auerback, global portfolio strategist for Madison Street Partners LLC, a Denver-based hedge fund.
“Spain will be the new Ireland,” Auerback said. “Germany is forcing once again the socialization of its banks’ losses in a periphery country and creating sovereign risk, just like it did with Ireland.”
“Spain will have to turn to the EU for funds to solve its banking problem,” said Madison Street’s Auerback. “But there’s little money left after the other bailouts, so what will Spain get? That’s what worries everybody.”
Germany is about to own some really nice Greek islands, and it would probably like to add the Canary Islands to its new tourist book. Germans love the sun.