“The mortgage ‘floor clauses’ are a fraud.”

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Thursday, April 7, 2016, could go down in history as a great day for Spanish mortgage holders and a very grim one for many Spanish banks, thanks to a new ruling that the so-called mortgage floor-clauses that were unleashed across the whole financial sector in 2009 are abusive (but not illegal) and lack transparency.

These floor clauses set a minimum interest rate — typically of between 3% and 4.5% — for variable-rate mortgages, even if the Euribor drops far below that figure. In other words, the mortgages are only really variable in one direction: upwards!

Following the latest ruling, the banks named in the suit must reimburse clients all the money they’ve surreptitiously overcharged them since May 2013. And if they want to continue applying floor clauses in the future, the banks must do so in an open and transparent manner, which pretty much defeats the purpose, since if banks were completely up front about the inclusion of floor clauses in their contracts and what that actually means to the mortgage holder, no one in their right mind would accept them.

Thursday’s ruling comes on the heels of a similar sentence by Spain’s Supreme Court in October 2013. But whereas the Supreme Court ruling applied to just three banks, the new one applies to almost all of them. It is also the first time that such a large class action suit, with over 15,000 claimants, has been successful. It is now broadly assumed — meaning by everyone except the banks and their lawyers — that the ruling has set a legal precedent that should now apply to all of the 2.5 million mortgage holders affected by the abusive (but not illegal) practice.

“The banking system is going to resist, but we can tell every client not to pay a single euro more to the banks,” warned Manuel Pardos, the president of the Spanish Association of Consumers and Users of Banks, Saving Banks, Insurance and Financial Products (Adicae), the driving force behind the legal battle to ban floor clauses.

“The floor clauses are a fraud,” he added, but given that they bring in a huge amount of money, some of the banks “will try to hold onto them as long as they can.”

True to form, Catalonia-based Banc de Sabadell, the only major Spanish bank to continue using floor clauses in its mortgages, has already announced its intention to appeal the ruling, claiming that the clauses in their contracts that outline the impact of interest-rate floors are “clear-cut.” In recent months the bank has been pressuring its mortgage customers to sign a “pact of silence,” by which the customers, knowingly or not, pledge never to speak publicly about the conditions of their mortgage — not even to their lawyers — and in return the bank removes the floor clause from the mortgage, without reimbursing a single cent of what it owes.

Sabadell, along with 40 other Spanish banks, has good reason to be concerned about the new ruling. According to Fernando Herrero, the general secretary of Adicae, the floor clauses have cost the average user “some €2,000 per year,” meaning the banks will have to pay back “some billions” to customers.

The financial consultancy firm Analistas Financieros Internacionales (AFI) tried to put a more precise figure on it. The amount they came up with was €5.26 billion. But that’s only going back to May 2013, when Spain’s Supreme Court changed the law, effectively banning the current use of floor clauses. At the time, the court argued that the law couldn’t be applied retroactively to 2009, when the banks began introducing the clauses, since it would potentially cripple their finances.

The latest ruling adopts the same reasoning, but not everybody agrees.

Most importantly, the European Commission believes that the refunds should extend all the way back to the first mortgage payments, the rationale being that if a clause is declared void, “it is so from its origin.” On April 26, the European Court of Justice is scheduled to rule on the matter. If it rules in favor of applying the law retroactively, the banks will end up owing many more billions. AFI’s estimate is €4.47 billion, but it could be a lot more.

The fallout is already having a serious impact on balance sheets as some — but not all — banks try to provision for the big payback. Last year, two of Spain’s biggest banks, Bankia and Caixabank, reported declines in a key profit metric when they stopped applying the interest-rate floors.

For its part, Banco Popular, Spain’s sixth biggest bank, announced 2015 earnings of €105 million, 68% down from the previous year, after having provisioned €350 million to cover interest payment refunds for over 100,000 customers. Without the floor clause in its mortgages with which to gouge its customers, the bank is expected to earn €80 million less on its margins per year, every year from now on.

The same goes for all the other banks — with the exception of the one bank that refused to apply floor clauses to its mortgages, Bankinter, and Santander, which stopped using them straight after the 2013 ruling. In a delicious irony, all the other banks that continued to apply them will now have to learn to survive without the one mechanism that protected them from the profit-shrinking effects of the ECB’s negative interest rate policies  — just when the Euribor goes negative!

For 2016 alone the disappearance of the floor clause is expected to set the banks back over €2 billion in margins, followed by a further €4 billion between 2017 and 2019. Whether they are ready to adapt to this new reality depends on two key factors: the ruling adopted by the European Court of Justice, on April 26; and the extent to which the banks have provisioned for the day after.

The bank most at risk is Banc de Sabadell, according to analysts at Bankinter. It has apparently done less than most other banks to provision its exposure.

If there are casualties along the way, as the Spanish financial daily Expansión points out, the floor-clause drama could end up providing the perfect pretext for massively consolidating Spain’s banking sector, a long-cherished goal of both the ECB and Europe’s biggest financial institutions. As such, the biggest winners will end up being Europe’s top-tier banks, in particular Santander, Spain’s only Systemically Important Financial Institution. No doubt, the Spanish taxpayer will be on hand to fill any balance-sheet holes. By Don Quijones, Raging Bull-Shit

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