Bloomberg News

Spain Delays and Prays That Zombies Repay Debt: Mortgages

May 29, 2012

Signs advertise properties for sale in Madrid. Photographer: Denis Doyle/Bloomberg

Signs advertise properties for sale in Madrid. Photographer: Denis Doyle/Bloomberg

Spanish banks are masking their full exposure to soured property loans while they continue to prop up zombie developers, leading to credit-rating downgrades and plummeting share prices.

Spain is working to clean up its banks, requiring lenders set aside more for possible losses on loans deemed performing to developers like Metrovacesa SA (MVC), which hasn’t completed a project in more than a year and has none under way. While that represents about 30 billion euros ($38 billion) of increased provisions, it’s not enough because many loans said to be performing aren’t being repaid, according to Mikel Echavarren, chairman of Irea, a Madrid-based finance company specializing in real estate.

“Spain has engaged in a policy of delay and pray,” Echavarren said in an interview. “The problem hasn’t been quantified by anyone because there is huge pressure not to tell the truth.”

The Economy Ministry says that Spanish banks have 184 billion euros of developers’ loans and assets that are “problematic,” while the remaining 123 billion euros are performing. The need for more reserves to cover losses on the loans can’t be ruled out, Nomura International analysts Daragh Quinn and Duncan Farr said in a May 14 report. If Spain took losses on developer loans like Ireland did, Spanish banks would need 8.9 billion euros under the best case to 76.5 billion euros of additional provisions in the worst scenario, Nomura estimates.

Bank Downgrades

Bankia, which Spain nationalized this month, said on May 25 it will seek 19 billion euros of state funds after it made 5.5 billion euros of provisions for non-developer loans, mostly home mortgages and company borrowing. Banco Santander SA (SAN) and Banco Bilbao Vizcaya Argentaria SA (BBVA), Spain’s biggest lenders, were among 16 of the country’s banks downgraded earlier this month by Moody’s Investors Service, which cited a recession and the increase in non-performing loans to real-estate companies.

Many Spanish banks are avoiding property sales so they don’t have to make mark to market valuations, which reflect current prices. Instead, they’re giving developers new loans to pay debt coming due to prevent defaults, said Ruben Manso, an economist at Mansolivar & IAX and a former Bank of Spain inspector.

“The larger banks have been selling bits and pieces and can absorb the losses,” Manso said. “Smaller savings banks are acting in bad faith in their refusal to allow transactions and saying they can’t mark to market because there isn’t one.”

A spokeswoman for CECA, the association for Spanish savings banks, said the group can’t comment on the banks’ commercial policies. She declined to be identified, citing the association’s policy.

Largest Developer

Metrovacesa, once Spain’s largest developer, is typical of the industry, according to Manso. The Madrid-based company, which once owned HSBC Holdings Plc’s London headquarters and had about a 50 billion-euro market value, was taken over by creditors in 2009 after its largest shareholder struggled to service billions of euros of debt.

Santander, BBVA, Banco Espanola de Credito SA, Banco Popular SA (POP), Banco Sabadell SA (SAB) and Bankia, canceled 2.2 billion euros of debts owed by the Sanahuja family in return for about 55 percent of Metrovacesa and purchased a further 10.8 percent of the stock in a deal that valued the company at 57 euros a share. The banks now own about 96 percent of Metrovacesa.

Losses Since 2008

Santander and its Banesto unit, which now own about 35 percent of Metrovacesa, value the stake at 772 million euros, or 2.24 euros a share, according to a spokesman for Santander, who declined to be identified citing company policy. In 2009 and 2011, they made provisions of 269 million euros and 100 million euros against their holding, according to a 2011 report by Santander’s auditor.

Metrovacesa has racked up 1.8 billion euros of losses since 2008. It has debt of 5.1 billion euros and property assets valued at 3.9 billion euros.

“The banks have made writedowns in their Metrovacesa stakes, but they haven’t taken the full hit,” Manso said.

Metrovacesa trades at 39 cents a share, valuing the company at about 385 million euros. UBS AG downgraded the shares to sell on May 22 and changed its target price to 32 cents. In August, its lenders renegotiated the terms of 3.6 billion euros of its debt, extending maturities on 2.47 billion euros of obligations and granting a five-year grace period for interest payments on 1.12 billion euros of loans.

High Occupancy

“Having no controlling stake in Metrovacesa means that its creditor banks don’t have to consolidate the company’s debt or assets and contaminate their own balance sheets,” Manso said. “There are hundreds of cases like Metrovacesa out there, albeit smaller in size, and this distorts the official amount of real estate and bad developer loans that banks profess to have.”

Metrovacesa isn’t a zombie, said a company spokesman, who declined to be identified, citing company policy. Metrovacesa has projects in mind, but the market doesn’t allow homebuilding, he said. The company’s rental assets have an occupancy rate of more than 90 percent, he added.

Santander, Spain’s largest bank, fell 2.4 percent to 4.30 euros at the close of trading in Madrid, compared with a 2.3 percent decline for the nation’s IBEX 35 Index. BBVA fell 2.6 percent to 4.64 euros. Shares of Bankia (BKIA), Spain’s third-largest bank, fell 16 percent to 1.14 euros.

Credit Swaps

The cost of protecting Spanish government debt from losses with credit-default swaps rose 2 basis points to a record 561 basis points, according to data compiled by Bloomberg.

As the yield on Spain’s 10-year bond approaches levels that led to bailouts in Ireland, Portugal and Greece, the Spanish government’s latest steps may not be enough to restore confidence in the country’s banks. Spain’s economy, the euro area’s fourth-largest, has been mired in a recession with 24 percent unemployment after a decade-long, debt-fueled property boom similar to the one in Ireland that ended in 2008.

Prices in Spain “probably haven’t reached the bottom yet, so it would be prudent for them to add in another cushion against the prospect of a further property market price fall,” Irish Bank Resolution Corp. Chairman Alan Dukes said in a May 16 interview. “The situation can change for the worse very rapidly.”

Irish Bank Resolution was formed in 2011 through a merger of Anglo Irish Bank Corp., the country’s third-biggest lender prior to the economic collapse, and Irish Nationwide Building Society. The Anglo Irish side of the bank expected to need 1.5 billion euros of new capital when it was nationalized at the beginning of 2009. By the end of March, the figure had swelled to 4 billion euros, according to Dukes. The Dublin-based bank’s total losses have been estimated to be as much as 28 billion euros when it’s finally wound down.

Before the Crash

Before Ireland’s real-estate crash, banks including Anglo Irish avoided getting appraisals to avoid bringing them before audit committees, according to four people familiar with the matter, who declined to be identified because the information is private.

Anglo Irish gave developers capital to finish projects in 2008 using personal loans. That way, the bank’s primary loan would continue to appear as performing, Irish developer Simon Kelly, who together with his family owes banks 800 million euros, said in a phone interview.

“The Irish property market had to collapse like the Spanish one because the economy was collapsing,” Kelly said. “Spain is looking like a re-run.”

More than half of Spain’s 67,000 developers can be categorized as “zombies,” according R.R. de Acuna & Asociados, a real-estate consulting firm. They have combined debt of 180 billion euros that will lead to 104 billion euros of losses that hasn’t been fully provisioned for, Acuna estimates.

Assets Worth Less

“They aren’t officially bankrupt because they have been refinanced time and time again,” Fernando Rodriguez de Acuna Martinez, a partner at the company, said by telephone. “Their assets are worth much less than their liabilities, they struggle to repay loans and they haven’t revaluated them to reflect today’s prices.”

In Ireland three years ago, developer Liam Carroll’s Ronnie Rentals Ltd. was forced to value its assets to market prices. Accumulated losses at the company more than trebled to 541 million euros in the six months through March 2009 after it provisioned for all known liabilities and anticipated losses, according to accounts filed last year with Ireland’s Companies Registration Office.

The Bank of Spain allows loans that are refinanced before turning delinquent and interest-only loans to be considered “normal” or “performing” on banks’ books, according to Manso.

Masking Delinquency

“You won’t find that data anywhere,” Manso said. “There has been a lot of cheating going on where banks have lent developers new money, classed as new lending, so they can pay off their original loans.” That’s masking delinquency, he said.

Refinancing the current and future zombie developers will cost 30 billion euros over the next two years, according to Acuna. The depreciation of those developer assets from 2012 onwards will generate a further 20 billion euros of losses in that time, he said.

The Bank of Spain doesn’t publish data on the amount of restructured developer loans or interest-only paying loans that are classed as normal. The bank closely monitors refinancing to ensure that arrears aren’t being hidden, said a spokeswoman for the Bank of Spain who declined to be identified.

High Occupancy

Spanish Economy Minister Luis de Guindos said on May 23 that provisioning from the new rules stood at 84 billion euros and coverage of all assets related to developer loans is now 45 percent, far higher than the European average and the 18 percent coverage before the regulations.

“The government has taken very significant steps, but I don’t believe they have fully recognized the deterioration,” Manso said.

Echavarren’s Irea brokered the refinancing of a 200 million-euro loan two years ago for a developer. After two more rounds of refinancing, there is about 180 million euros left on the loan and it’s classified as performing, he said, without identifying the company.

“The probability that this loan will be paid when it comes due is zero,” Echavarren said. “There are dozens of similar cases.”

Spain’s government and banks need to be more like their counterparts in Ireland and be more forthcoming about loan losses, according to Echavarren. He forecasts that the larger Spanish banks with income from international operations will be able to pay for domestic real-estate losses within two years. The rest can’t take such a hit and will have to be nationalized, he said.

“We cannot continue to jeopardize the whole financial system by not telling the truth,” Echavarren said.

To contact the reporters on this story: Sharon Smyth in Madrid at ssmyth2@bloomberg.net; Neil Callanan in London at ncallanan@bloomberg.net.

To contact the editors responsible for this story: Andrew Blackman at ablackman@bloomberg.net; Rob Urban at robprag@bloomberg.net.


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