Spain’s ability to restore investor willingness to buy its bonds hinges on how credibly the nation audits the value of the deteriorating loans of its banks.
The government plans today to appoint two auditors to evaluate the loans of the nation’s banks, which have been pummeled by mounting property losses. The yield on 10-year Spanish debt has jumped 140 basis points since March 1 to 6.26 percent on investor concern that potential bank losses may force the government to fork over billions of euros in support.
“If the independent firms report something similar to what the banks are saying about their loan books, the market would simply not believe them,” said Georg Grodzki, who helps oversee $515 billion at Legal & General Investment Management in London. Should the audit show big losses, questions are sure to emerge over “how the government can afford to plug the hole in the banking system’s balance sheet,” he said.
The audit is part of Spain’s fourth attempt in three years to clean up its lenders, which are poised to set aside about 30 billion euros ($38 billion) against real estate loans on top of the 53.8 billion euros of charges in February. The proposal announced May 11 didn’t dissuade Moody’s Investors Service from downgrading 16 Spanish banks last week and Spain raised more questions about credibility on May 18 when it revised its 2011 deficit, a month after the European Commission had signed off on the original numbers.
Economy Minister Luis de Guindos said today in Madrid that the auditors will have “complete freedom” to carry out the review and that the existing provision rules are “sufficient.”
While analysts at Exane BNP Paribas and Nomura Holdings Inc. welcome the cleanup, they say banks must recognize greater losses on loans to individuals and non-real estate companies in a nation where joblessness exceeds 24 percent and the economy is forecast by the European Commission to contract in 2012 and 2013.
The possibility that Spain, with the revised deficit of 8.9 percent of gross domestic product last year, will need to fund bank bailouts has driven the country’s borrowing costs close to the levels that forced Greece, Ireland and Portugal to seek bailouts. Spanish bonds have fallen 3.6 percent this year, the only decliner in the 17-nation euro region apart from Greece.
“We are still some distance away from Spanish banks becoming investable again,” Grodzki said in a phone interview. “The problem is the gulf between investors’ assumption about the writedown and equity needs of Spanish banks.”
Banco Santander SA (SAN), the country’s biggest lender, has slipped 19 percent this year, while Bankia Group, which was nationalized by the government this month, has shed 47 percent. Banco Bilbao Vizcaya Argentaria SA (BBVA) dropped 25 percent, leaving the benchmark IBEX 35 stock index down 23 percent this year, the biggest decline among major European indexes.
A four-year property slump has driven up loan defaults and heightened investor suspicions that firms’ balance sheets don’t fully reflect the scale of potential losses. The nation’s lenders carry 184 billion euros of what the Bank of Spain terms “problematic” real estate-linked assets. The ratio of bad loans to total lending rose to 8.37 percent in March from less than 1 percent in 2007.
Analysts at HSBC Holdings Plc said in a May 16 report that Spanish banks may have a 97 billion-euro capital shortfall in 2013, assuming the commercial real estate market worsens and credit to households and companies deteriorates.
“It is unclear who will pay and how the bill will be paid and, depending on how big the losses might be and how the cleanup is implemented, the sovereign risk might remain at relatively high levels creating a circular problem for the system,” said Santiago Lopez, an analyst at Exane BNP Paribas in Madrid, in a May 16 report.
European Union officials last week tried to convince De Guindos to take an International Monetary Fund credit line to help shore up the nation’s lenders, Madrid-based ABC newspaper reported yesterday.
Loan-book audits can help, though it may be hard to convince investors they’re truly independent, Grodzki said.
“The fact that the auditors are hired and paid for by the government may raise suspicions, but I would give them the benefit of the doubt for now and hope they won’t try to prove the number, which the government wants to hear,” he said. “Spain is walking a tightrope.”
BlackRock Inc. (BLK:US) was contracted by Ireland’s central bank in January 2011 to audit the balance sheet of six banks. Its role was key in establishing a base of independent information that helped reassure investors, said Dermot O’Leary, an economist at Goodbody Stockbrokers in Dublin.
New York-based BlackRock has been picked by government agencies in Greece, Germany, Switzerland and Sweden since 2008 to value hard-to-value debt portfolios.
“For us there’s a real sense of deja-vu with what’s going on in Spain,” said O’Leary in a phone interview. “In the Irish experience, it wasn’t until there was an external analysis that the market starting giving the benefit of the doubt.”
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