Member Article

Spain’s banks had been thriving during the property boom. However, its collapse caused large scale defaults from borrowers who suddenly found themselves bankrupt. The value of the assets, property, on which the loans were based, plummeted and the banks found themselves now, not only saddled with bad or ‘toxic’ loans, but also with devalued assets that were hard to sell.

The situation was made worse by the fact that most banks, rather than using saver’s deposits, had actually borrowed money on the international markets to lend to developers and home-buyers. This is considered a much riskier strategy by experts as these borrowed amounts need to be serviced even if the underlying property loan defaults.

Spain started to restructure its financial sector. Merging many of the smaller, weaker banks to try and contain and manage the problem.

In December 2010, Bankia was created as a consolidation of seven regional banks. Bankia was initially owned by holding company Banco Financiero y de Ahorros (BFA) and the seven regional banks, in turn, controlled BFA. The most toxic assets from these regional banks were transferred to BFA, which received EUR 4.5 bn from the Spanish government rescue fund FROB

On 10 May 2012, the Spanish government announced that, due to the size of the potential hidden losses (of toxic loans) on Bankia’s books, it was converting its preference shares in BFA into voting shares, giving it a controlling stake of 45% in Bankia, indicating to the public the seriousness of Bankia’s situation and worrying the financial markets as to the degree of financial difficulties Spain now actually found itself in.

On 25 May, Bankia announced it would need a further EUR 19 bn to recapitalise (on top of the EUR 4.5 bn already spent, the IPO and the partial nationalisation). Bankia also revised its earnings statement for 2011, stating that instead of a profit of EUR 309 mn, it had in fact lost EUR 4.3 bn before taxes and asked for EUR 1.4 bn fiscal credit to reduce its loss. In response Standard & Poor downgraded its rating to junk status.

The exact amount of the losses the Spanish banks are sitting on is not yet known and is the subject of two independent audits which are due to be completed on 21 June 2012. The IMF recently estimated the amount at EUR 40 bn. Fitch Ratings puts it between EUR 60 bn and EUR 100 bn. Some experts believe the actual amount may even be close to EUR 180 bn. To put those numbers in perspective: Spain’s budget for 2012 - considered the most austere in 30 years – included tax rises and spending cuts worth EUR 27 bn; not enough to cover even the lower end of the estimates.

With Spain’s financial and economic situation deteriorating and its bond-yields rising, it has been struggling to find funds in the market at reasonable rates to keep its finances going. The news that its banking sector needed such a potentially huge cash injection to keep it on its feet, caused the markets, Eurozone leaders and ultimately the Spanish government to look at how they were going to find those funds.

On 9 June 2012, the Spanish government conceded to global pressure to accept financial assistance in order to recapitalise its banking sector. It accepted an offer of up to EUR 100 bn of funds which it will draw on once the actual amount of the banking sector losses is known

You can download a copy of the full official statement from the Eurogroup dated 9 June 2012 here: http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/130778.pdf.

The terms of the bail-out are yet to be fully agreed but, according to the statement they will focus on "specific reforms targeting the financial sector, including restructuring plans in line with EU state-aid rules. Spain will present its formal request soon, most likely once it has received the results of its banking sector audit or, at least, any request will likely be conditional upon those results. The IMF will not provide any of the funds, but, instead, it will help monitor the situation. The funds will, most likely, be routed through the FROB, which means that the loan costs will be borne by the government and added to the Spanish debt pile, potentially increasing the debt to GDP ratio by as much as 9 percentage points on top of an already large increase from 68.5% last year, to a predicted 80% for this year.

Due to the fact that the funds are intended solely for the recapitalisation of its banks and that the loan will not be a "full" Troika loan and subject to the stringent financial discipline required under the other bail-outs, the Spanish bail-out has also been hailed as a "lite" bail-out. Nonetheless, the initial response from the markets has been positive, with analysts seeing it as a clear signal, at least, that the Eurozone is prepared to deploy the firewall "pre-emptively".