Europe’s banking authorities are finally beginning to pile pressure on poorly performing banks to clean up their books, something that should have happened a long, long time ago. But as is often the case with European banking regulation, there’s an elevated risk of unintended consequences.
If a bank with a deeply compromised balance sheet is forced to report its loans that have gone bad — the hidden piles of toxic “assets” — at prices that reflect their real value (rather than the illusory prices the bank arrived at with its mark-to-model formula), that bank could suddenly find that its capital has gone up in smoke.
This is more or less what happened with Banco Popular, the mid-sized Spanish bank that went under in June last year. No matter how creative the rescue plans its management came up with — including spinning off a bad bank called “Sunrise” — Popular simply couldn’t find a viable way of disposing of its nonperforming loans without crippling its financial health.
A similar thing appears to be happening with Spain’s fifth largest bank, Banco Sabadell, the Spanish bank that has grown the most in relative terms since the crisis. It has more than doubled in size in the last ten years (from €78.7 billion in assets in 2008 to €173.2 billion in 2017), following the acquisitions of Banco Gallego, Banco Guipuzcoano, Caixa Penedès, and the bankrupt savings bank Caja de Ahorros del Mediterráneo (CAM).
Now it has immense difficulty ridding itself of the impaired assets it acquired when it took over CAM in 2012. But unlike Popular, Sabadell is getting a massive helping hand from Spain’s government.
As part of the acquisition of CAM, it was agreed that Spain’s Deposit Guarantee Fund (DGF) — the fund that’s supposed to guarantee all insured bank deposits in Spain — would cover 80% of the losses accrued on CAM’s €24 billion portfolio of real estate loans. Even before CAM became the property of Sabadell, the DGF injected €5.2 billion — all of it public funds — into CAM.
It was hoped that CAM’s own loan provisions of €3.9 billion, would cover the rest of the losses. But they didn’t come close. In 2014 the provisions were completely wiped out.
A year later, Sabadell asked the DGF for €825 million euros to cover 80% of its losses on CAM’s impaired assets for that year. In 2016, the total annual losses surged to €981 million euros. At the beginning of 2018, Sabadell presented its next bill, for the losses incurred in 2017. It amounted to €1.3 billion. It’s not hard to see the trend!
What is perhaps most surprising is that this is all happening at a time when Spain’s real estate sector is recovering from the crisis. Real estate prices are rising, yet so, too, are the annual losses on the sale of CAM’s assets.
Based on calculations the DGF published in 2017 (with data from 2016), the total forecast losses of the still-covered portfolio could amount to as much as €7.3 billion, of which the DGF would have to cover almost €6 billion. The remainder would be borne by Sabadell. That’s on top of the more than €8 billion of losses already accrued over the last five years.
In other words, by the time this is all done and dusted, well over €10 billion of public funds will have been spent to fill the gaping balance sheet holes left behind by Sabadell’s sale of CAM’s toxic assets.
Some of those assets include loans for real estate projects of a highly dubious, if not fraudulent, nature. According to an investigation by the Bank of Spain, large parcels of land in Valencia, Catalonia, Murcia and Andalucia were sold at insanely inflated prices. From an initial investment of €594 million, 11 real estate projects funded by CAM generated losses of €467 million (78%), of which €405.6 million have been deemed unrecoverable.
This week the judge presiding the case, Carmen Lamela, ruled that the statue of limitations has unfortunately elapsed. As tends to happen with cases of white collar crime in Spain, the accused were cleared — not because they’d been found innocent but because the wheels of justice moved too slowly for a judgement to be reached.
Most of the losses those dodgy loans racked up will now be covered by the DGF. It’s not clear exactly how much Spain’s DGF has left in its coffers today. According to El Mundo, at the end of 2016 its total balance was €1.6 billion — far short of the €6.4 billion it’s supposed to have by 2024. But it could be much worse now: Since late 2016, the fund has had to shell out some €2.2 billion in guarantees on Sabadell’s toxic real estate assets.
Meanwhile, Spain’s second biggest bank, BBVA, is contemplating selling its own stash of guaranteed dodgy assets, which it inherited from its acquisition of bankrupt Catalan savings bank Unnim in 2012. That would mean even more money flowing out of Spain’s deposit guarantee fund.
What happens if the DGF itself, whose primary purpose is to cover insured bank deposits, runs out of funds? The answer is predictable: the government steps in with another taxpayer-funded infusion, which it will try to hide with yet more creative accounting while Europe’s political and monetary authorities steadfastly look the other way.
This is all happening because the ECB is finally prodding banks in the Eurozone to unload their bad loans. But the move comes with big risks attached. It could result in big losses and force banks to raise new capital – no mean feat with bank valuations so low.
How many more Spanish banks are in a similar position to Sabadell? If a country like Spain, whose banking ills were supposed to have been remedied many moons ago, is struggling to cope with this process, just imagine how Italy, whose perennially teetering banks are home to almost one-third of the Eurozone’s entire stock of non performing loans, will fare at the same game! By Don Quijones.
One solution in Italy’s banking crisis is to merge ailing and bailed-out banks — to create bigger ailing banks? Read… Will Italy’s Banking Crisis Spawn a New Frankenbank?
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