Prelude to a Nightmare

Four Things that Keep Spain’s Senior Bankers Awake at Night.

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

Despite reporting reasonably solid-looking annual results last year, Spain’s banking sector continues to bleed on the benchmark index, the Ibex 35. In the last 12 months alone, it has lost over a fifth of its combined share value — €40 billion of stock value that just vanished into the ether!

In recent days the shares of Spain’s biggest bank and only “systemically important financial institution” (i.e. officially ordained Too-Big-to-Fail bank), Grupo Santander, have plumbed lows that have not been seen since the mid-nineties.

A not inconsiderable part of this ugly picture is owed to deteriorating global macroeconomic conditions, in particular the slowdown of China and key markets in Latin America as well as Italy’s recent bail-in/out of its financial sector [read: Who Gets to Pay for the Italian Banking Crisis?]. However, there are a number of key aggravating factors that are almost exclusively domestic in scope and which could pose a very serious threat to the long-term health of Spain’s already much debilitated banking sector.

Here are four of the biggest worries weighing on investors’ minds.

1) The Banks’ Exposure to Colossal Corporate Insolvency.

Ever since the renewable energy giant Abengoa announced, in late November, that it was seeking preliminary protection from creditors, fears have grown about the potential ripple effects of what could end up being Spain’s biggest ever corporate bankruptcy. Since then the company has closed its subsidiaries and stopped servicing its debt in key markets like Mexico, Chile and Brazil while in the U.S. creditors have asked a federal judge to put Abengoa Bioenergy of Nebraska LLC into bankruptcy over its outstanding debt.

Spain’s banks are owed approximately €4.3 billion by the Seville-based company. About 20% of that is unsecured and may get wiped out. Santander is at the top of the pile with €1.56 billion of exposure, followed by publicly owned Bankia (€582 million), Catalonia’s biggest bank, Caixabank (€570 million), Catalonia’s second biggest bank Banco Sabadell (€387 million), Banco Popular (€334 million), Bankinter (€210 million) and the state-owned Institute of Official Credit (ICO, €161 million).

Most of the banks have made no provisions to hedge their exposure – hence their alleged refusal to accept a haircut on any of Abengoa’s debt, which in the end could be unavoidable [read: Spain Braces for Its Biggest Corporate Solvency… Ever!].

2. Bankia’s Duped Shareholders Want Their Money Back.

A couple of years ago, thousands of victims of Spain’s biggest ever financial heist — Bankia’s IPO in 2011, which “allegedly” involved the participation of senior management, the bank’s auditor, Deloitte, Spain’s central bank and market regulators – launched litigation proceedings potentially worth billions of euros.

Last week, Spain’s Supreme Court shocked everyone by ruling that Bankia must refund two retail investors for intentionally misleading them over the state of its finances in the IPO brochure. Now the floodgates are wide open for thousands of fresh new claims. On the bright side (ha!), publicly owned Bankia says it has already provisioned up to €1.84 billion of mostly taxpayer-money to cover potential refunds to retail investors. But with institutional investors — including some of Spain’s other banks — also looking to recoup their funds, the damage might balloon.

3. The Mother of All Pay Outs.

If Bankia’s legal problems bode ill for Spain’s financial sector, imagine what could happen if many of the country’s banks were forced to pay back all the interest they’ve surreptitiously overcharged customers on residential mortgages — for years!

In October last year, Spain’s Supreme Court ruled that the floor clauses introduced by many banks, which set a minimum interest rate that clients have to pay the bank, even if the Euribor drops far below that figure, were abusive. It sentenced three banks — BBVA, Cajamar and Abanca — to return the difference to borrowers, but only on payments made since May 2013, arguing that the banks could not be made liable for all (or even much) of the money, since doing so would potentially cripple their finances.

The European Commission begs to disagree, saying 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.” There are currently 2.5 million mortgages with floor clauses in Spain. If refunds were to be mandated retroactively, which could happen at any moment in the coming months, it would mean billions of euros in damages.

The toll is already being felt. At the end of last year, Banco Popular announced 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 so-called floor clause in its mortgages with which to gouge its customers, the bank is expected to earn €80 million less per year, every year from now on – precisely at a time when its bad loan ratio just soared to a record 14.3%!

4. Prelude to a Sovereign Debt Nightmare.

Arguably the biggest threat to the balance sheets of Spain’s banks are plans currently being hatched in Brussels to set a limit on the sovereign bonds some banks can hold as eligible “risk-free” capital.

According to European Central Bank data, euro-area sovereign bonds accounted for just over 10% of banks’ assets in the Eurozone, or €2.73 trillion ($3 trillion), at the end of 2015 — over €300 billion more than at the end of 2014, on the eve of the ECB’s launch of its negative interest rate policy (NIRP). This trend is particularly acute in countries on the periphery, such as Portugal, Spain and Italy, where banks’ balance sheets are overflowing with bonds of their individual sovereigns — all considered “risk free” for regulatory reporting.

But that could all be about to change. Now fiscally hawkish euro-zone countries such as Germany, the Netherlands, and Finland want the system overhauled before forging ahead with closer banking union, to the barely concealed horror of southern European politicians and bankers.

Italian Finance Minister Pier Carlo Padoan has urged caution on introducing the new rules. “Let’s be very careful about translating into practice rules that look nice on paper,” he warned, adding that any such rules could lead to a sell-off and “instability”. Padoan’s sentiments were echoed by Santiago Fernandez de Liz, the chief economist for financial systems and regulation at Spain’s second biggest lender, BBVA, who cautioned that applying a proposal of this kind in the Eurozone would “reignite the fragmentation” of Europe’s financial markets.

The race is now on to get as much peripheral sovereign debt as possible off the balance sheets of peripheral banks and onto the ECB’s already bloated books. In January the central bank “invested” €6.1 billion in Spanish sovereign debt — 18.9% more than the previous month, raising the total amount it has spent on Spanish bonds since launching QE in March last year to €62.9 billion. Given the likely direction of EU policy, as well as the scale and scope of the risks, challenges and threats clouding the investment horizon in Spain, one can expect this trend to intensify. By Don Quijones, Raging Bull-Shit.

The scheme derailed. Read… Hedge Funds, Wall Street not Happy with the New Spain

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  6 comments for “Prelude to a Nightmare

  1. Mark says:

    “…€40 billion of stock value that just vanished into the ether”, it just went where it came from.
    O boy do I feel sorry for sleepless Spanish bankers.

  2. Vespa P200E says:

    1 by 1 the PIIGS are mired in banking crisis with recent news about Italian and Spanish banking woes… We know about the insolvent Greeks and Portugal skin to Spain issued and sounds like Irish are OK, for now – Cheers or something.

    Add to this mother of all EU bank DB the stalwart with unknown CDS exposure many times over its deposit with its share trading near all time low and huge 2015 and especially Q4 2015 losses.

    Guess super Mario will have to resort to Euro printing out of its perhaps unpayable debts as debts are either paid off (with devalued FIAT or digital currencies) or defaulted.

    At least money printing should help the deflations but alas good luck with inflation monster rearing its ugly head and the CB banksters resort out of NIRP to ZIRP and beyond to fight yesterday’s inflation monster.

    Weimar republic anyone?

    • John Doyle says:

      Not Weimar, but failure of the EU monetary system. Conceived without due diligence and underwritten by the “big players” it was always going to be skewed away from the poorer countries. The reigning Neo-Liberal wish list which became manifest with the treaty is a failure and this failure will, without a drastic revision be its downfall.

  3. walter map says:

    How much do they pay these beauzeaus for these massive screw-ups, anyway? I could crater the banking system half as much for half the price.

    The good news is that eventually they’ll paper over the catastrophe with catastrophic quanitities of fresh debt, and then in a few years they can do it all over again.

    Spare the guillotine, spoil the bankster. I’m sure I’m quoting somebody here.

  4. B.S. says:

    “Given the likely direction of EU policy, ……. one can expect this trend to intensify.”

    It would seem that the “trend” is already in a panic state and is a crash in progress.

    It will only take some event to trigger a full scale blow-out of the banking system.

    “The European Commission begs to disagree, saying 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.” There are currently 2.5 million mortgages with floor clauses in Spain. If refunds were to be mandated retroactively, which could happen at any moment in the coming months, it would mean billions of euros in damages.”

    It will do more than that, I’m afraid. It may be the trigger that shatters the system.

    And the financial effects will be felt world-wide.

  5. MC says:

    I’ll say here again: the European banking system is a house of card, in even worse shape than the Japanese one was in the late 80’s. By comparison the US one is as solid as a rock, which says it all.
    Even if one disregards the embarrassing German banking system (where taxpayer-funded bailouts have become the norm), the Italian and Spanish systems alone are large and shaky enough to keep everybody awake at night. Italy and Spain are the eurozone’s third and fourth economies: they aren’t little Greeces that can be bullied and threatened at will and which will soon forgotten by everybody bar those unlucky enough to live there.
    Even more critical, the mass of debt they hold in their virtual vaults, sovereign and corporate, is the equivalent of a nuclear arsenal. It can be unleashed in the financial equivalent of the Samson Option as a last resort.

    “Fiscal Hawks” in Brussels and Frankfurt may huff and puff as much as they want but they lost the minute they allowed Italy and Spain to join their monetary version of the patented Roach Motel. Even disregarding everything else, Italy’s sovereign debt is a problem that cannot be solved by accounting tricks and press releases.
    That debt has been largely stuffed in the virtual vaults of local banks as risk-free capital. That alone is guarantee enough unless the ECB QE program is massively extended in scope and speed the much vaunted banking union will end up as yet another version of the nightmarish Common Agrarian Policy (CAP): central planning by another name and continuous distribution of taxpayer money to keep a float a highly inefficient system that has gone too far for reform.

    To this must be added the issue of private debt, both household and corporate. Spain swept the problem under the rug for a few years thanks to her bad bank… until the looming defaults by ACS and Abengoa appeared “out of thin air”.
    Italy has not done anything similar for a very simple reason: nobody, not even the Bank of Italy and ABI (the banks’ union) seems to have a remote idea of how many NPL’s have been stuffed in every nook and cranny of the Italian banking system. In a single year estimates went from €120 billion to €200 billion. Now it seems that, after all, a hypthetical Italian bad bank would need to shoulder €350 billion of NPL’s. That’s about 1/7th of the Italian GDP, which has been goosed for a few years now by public spending, which makes up 56% of it (if Athens weeps, Sparta isn’t laughing: France’s GDP is 57% public spending, but at least French roads don’t look like they have been through a decade long civil war).

    The Italian banking system has long suffered to an extreme extent of the problems so common worldwide: loans have long been extended to either large enough customers or the politically well connected without too much thought being given and then shuffled around to make them disappear. To this it must be added the last few years have seen Italy fall prey to the Chinese syndrome: economically unsound projects that could goose the GDP by a few decimal points were greenlighted without any thought being given. Italy’s obsession to show any GDP paper growth to have something to brag about has added to the pile of NPL’s at a moment when banks were already saddled with far too many of them.

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