tano santos national banking

National banking in a monetary union: the case of Spain

Tano Santos

Columbia Business School

Columbia University


Introduction

●  An overview of the Spanish banking sector in the context of the real estate bubble:

①  Private credit in Spain: The time series and the cross section

•  Growth of private credit: Luis’s presentation

②  Spain: A “banking” economy

•  Banks and Cajas: What were the cajas?

•  The evolution of the aggregate balance sheets:

③  Policy responses to the crisis: Before and after the crisis

④  Going forward

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THE CREDIT CYCLE

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Spain: Credit: The long view

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Credit/GDP Trend

Credit to other resident sectors by credit Institutions (BE041301 ) as a fraction of GDP. Quarterly. 1974Q4 to 2010Q2. The trend is estimated with a backward MA-20. Source: Bank of Spain and INE

Tano Santos


Spain: Credit: The cross sectional view

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Germany Spain France Italy

Loans to other residents granted by monetary financial institutions as a fraction of GDP for Spain, Germany, France and Italy. Quarterly. Smoothed with an MA-4. 1998Q4-2010Q4. Data source: Eurostat

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THE SPANISH BANKING SECTOR

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The Spanish banking sector: A quick look

●  The Spanish banking sector has changed enormously over the last 25 years as a consequence of the rise of the “cajas”

–  Deposit institutions with all banking activities but owned by non-for-profit foundations

–  Supervised by the bank of Spain

–  Strong political connections: To a large extent some of them, not all, dominated by local political elites.

–  Fundamental difference with banks:

•  Corporate governance issues

•  No mechanism for recapitalizations

●  The cajas no longer exist!

7 Tano Santos


The Spanish banking sector: The rise and fall of the cajas

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Banks Cajas

Banks vs. Cajas: Assets of each of these institutions as a fraction of total assets of both.Banks (BE045101) & Cajas (BE046101 ) divided

by total assets, respectively. Monthly. January 1962 to September 2010. Source: Bank of Spain

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Banks Cajas

Banks vs. Cajas: Loans to the private sector by banks (BE041203) and cajas (BE041204) as a fractions of loans to the private sector by credit institutions

(BE041202 ). Monthly. January 1962 to November 2010. Source: Bank of Spain

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The Spanish banking sector: Cajas: The liability side

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Deposits Debt Capital, reserves & OBS

Cajas: Balance sheet – Liabilities as a percentage of total assets Deposits (BE046202; left axis), debt issued (BE046207; right axis), and capital, reserves and “obra benefica y social” (OBS,

BE046208 plus BE046209; right axis ) as a percentage of total assets (BE046201). Monthly. MA-12. December 1962 to September 2010. Source: Bank of Spain

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The Spanish banking sector: Credit institutions: Wholesale funding

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Credit institutions: Debt as a percentage of total assets. Debt (BE04.2.7) as a percentage of total assets (BE04.2.1). Monthly: January1962 to January 2012.

Data source: Bank of Spain

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The Spanish banking sector: The asset side

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Credit institutions: Loans to construction and real estate developers as a percentage of loans granted to firms

(BE4.18.4 plus BE4.18.10 divided by BE4.18.1) Quarterly: 1998Q4-2011Q4. Data source: Bank of Spain

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Credit institutions: Real estate exposure Loans to construction companies, real estate developers and mortgages

as percentage of loans to the private sector (BE4.18.4 plus BE4.18.10 plus BE4.13.4 divided by BE4.13.1)

Quarterly: 1998Q4-2011Q4. Data source: Bank of Spain

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THE POLICY RESPONSE

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The policy response: Did Spaniards know about the bubble?

●  The real estate bubble had been the focus of policy debates since the early 2000s:

①  Fall 2003: Report from the European Commission alerting of the dangers of house appreciation in Spain

②  Fall 2003, Rodrigo Rato, Spanish VPM, acknowledges that the housing market is overheated but that this did not mean a brusque adjustment

③  2002-2003, several studies from the Bank of Spain pointing out that the housing market was overpriced between 8% and 20%

④  2004: General election campaign rotates around the “bricks and mortars” growth model of the conservative party, in power until then.

⑤  Miguel Sebastián, future head of the PM’s economic office and M.A. Fdez.-Ordoñez, future governor of the Bank of Spain, write extensively in the press about the dangers of a brusque bursting of the bubble and its long run impact.

13 Tano Santos


The policy response: Before the crisis

●  The Bank of Spain took some decisions prior to the crisis that were instrumental in the ability of the banking sector to withstand the first hit:

①  Dynamic provisioning

•  Banks had “generic provisions” of about 3% of GDP (€28bn) at the start

•  Spain was unique amongst developed countries in this aspect

•  Buffer: In the private sector and in the public sector (low debt/GDP)

②  Off-balance sheet transactions

•  The Bank of Spain successfully prevented banks from going “Citi” withstanding pressure from the large banks.

14 Tano Santos


The policy response: Before the crisis

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million €Total provisions Specific provisions General provisions

Provisions (in millions of euros) in Spain, 2000-2010: Total, Specific and General Source: Jesus Saurina, Bank of Spain, Working Macroprudential Tools; a presentation given at the 13th Annual

International Banking Conference, Chicago, 23-24, September 2010.

Tano Santos


The policy response: The crisis comes

●  Some (contradictory) ideas have dominated the policy response:

①  The taxpayer should not bear the burden of rescuing the banking sector

②  Debt holders should not suffer losses

•  Given the wholesale funding needs there was a fear that imposing losses to debt holders and the doubts about the extent of real estate losses liquidity would drain for the entire system

•  Debt holders have yet to have a loss (except preferred)

③  The system, in the aggregate, was solvent:

•  Once you include the ability to recap through retained earnings

•  And the reserves that the system had accumulated

16 Tano Santos



●  Given the assumptions, what was the strategy?

–  Strong provisioning against P&L

–  Mergers amongst good and bad financial institutions:

•  Funded with loans from the public sector

•  Asset protection schemes with some, minimal, “bad banks” created

–  Limited recap efforts

–  Losses borne by the FGD (Spanish FDIC): Socialization of losses amongst banks

●  But, first, Fall of 2008 market dries up:

–  Debt guarantee program

17 Tano Santos



●  Throughout one has the feeling that the authorities felt that they did not have a “net:”

–  All promises were fiscal in nature

–  Were depositors going to get nervous in case of substantial losses by the FGD?

–  If losses were to be imposed on debt holders, would wholesale liquidity disappear?

–  If the FROB were to issue massively (up to maximum €100bn), would the market infer something about the extent of losses? Would the sovereign be affected?

●  Still, there was a slow drift linking public and private balance sheets, which eventually limited the set of options available to policy makers.

●  At some point thus the strategy started rotating around what could be funded, rather than funding the actual capital needs

–  Stress testing without funds available compromises credibility

18 Tano Santos



●  There are two responses to the banking crisis:

①  Government:

a)  Debt guarantee program: Approved in the fall of 2008 (RDL 7/2008)

b)  Overhaul of the banking system to, effectively, do away with the cajas (RDL 11/2010)

c)  Creation of SPV (the FROB) to lend and recap banks

d)  Force credit institutions to recognize and provision for losses (RDL 2/2012)

②  Bank of Spain

•  Intervention and merger strategy: Incentivize mergers to avoid losses to the taxpayers (and debt holders)

19 Tano Santos

Columbia Business School 20

March-2009: CCM intervened by the FGD: Capital injection plus asset protection scheme; “good bank” sold to Cajastur

July 2009: RDL 9/2009 FROB1 created: An SPV created to channel public funds to aid the restructuring of the banking sector via debt

October-2008: RDL 7/2008: Debt guarantee program; Maximum size €100bn; Final date: 12/31/09; Renewed several times

May 2010: Cajasur intervened; Asset protection scheme granted by the FROB1; sole loss so far

July 2010: RDL 11/2010: Reform of the cajas; legal framework for recap and governance; cajas to disappear

Summer 2010: Amendment of accounting rules on loan write downs •  Recognition of value of real estate collateral applying significant haircuts and acceleration of provisioning •  Increased minimum provision for foreclosed assets

February 2011: RDL 2/2011 •  8% capital on RWA for banks (10% for those that remained cajas) •  FROB2: The FROB can recap credit institutions in distress

July 2011: Compliance with RDL 2/2011 •  Bankia, Caixabank and Banca Cívica IPOs to comply with RDL 2/2001 capital requirements •  CatalunyaCaixa, Unnim, Novacaixagalicia, CAM request FROB2 assistance

July 2011: CAM intervened •  November 2011: Sale to Sabadell; FGD: Capital inyection of €6bn

plus asset protection scheme; FROB: Liquidity

November 2011: B. Valencia intervened; FROB2 recap €1bn plus €2bn liquidity

December 2011: RDL 20/2011: New debt guarantee program; Max. €100bn

January 2012: RDL 2/2012: New provision and loan los recognition

March 2012: Unnim sold to BBVA for €1; Asset protection scheme

September 2011: Unnim intervened; FROB2 recap €953m

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The policy response: The timeline

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The policy response: The merger strategy

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Cajas: Loan-to-Deposit ratio for the top fifteen cajas by assets as of December 2009. Source: Citi “Spanish Savings Banks: Survival of the Fittest,” June 4th, 2010

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Merger to create Bankia/BFA: Balance sheet >€300bn

Merger with Caja 3: Balance sheet €65bn

Merger Unicaja-Caja España: €80bn

Merger with Banca Cívica; absorption by La Caixa

Merger to create Novacaixagalicia Merger to create Mare Nostrum

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The policy response: Credibility

●  The Spanish authorities faced credibility issues from the beginning of the crisis:

–  Difficult inference for investors: Were the lack of loss recognition real, gambling for survival or simply that recognizing the losses would affect the sovereign?

●  In addition authorities did not handle early interventions well sending mixed signals:

–  Example: Caja Castilla-La Mancha (CCM)

•  Intervened by the BoS on March 2009 after merger with Unicaja fell apart

•  PwC did due diligence on behalf of Unicaja on the 2008 numbers and uncovered an equity gap of €3bn.

•  NPL ratios jumped from 9.32% to 14.15% after intervention casting doubts on the numbers in the entire sector

•  Intervention wiped out 90% of the funds at the FGD. Obscure sale to Cajastur.

24 Tano Santos



●  The CAM (€70.8bn balance sheet as of December 31st 2011) as an example:

–  Caja del Mediterráneo (CAM) was in the middle of the real estate boom

•  Operations in eastern Spain

•  Heavy political control by the conservative party in power in the region of Valencia for the last 20 years. Now also in power in Madrid.

–  CCM: Castilla-La Mancha, socialist party, in power for 20 years too.

–  2010 stress tests: Evaluated as part of Banco Base, a merger encouraged by the Bank of Spain of good and bad cajas (Cajastur, C. Cantabría and C. Extremadura.)

•  Capital needs: 0

–  Banco Base falls apart in March 30th 2011: CAM is left “hanging”

25 Tano Santos



●  April 28th 2011: CAM requests FROB2 recap. of €2.8bn to meet the RDL 2/2011

–  With that recap, CAM below the 5% but not with the generic provisions

●  July 21st 2010: Bank of Spain grants 10 days to CAM’s board to present a viable plan

●  July 22nd 2011: CAM’s board requests the Bank of Spain intervention

–  Recap of €2.8bn and €3.0 credit line

●  NPL of CAM in 2011: 20.8%

●  December 7th 2011: Sale to Banco Sabadell

1.  FGD acquires 100% of CAM for €5,249bn for a posterior sale to Sabadell for €1

2.  FGD grants a 10-year asset protection scheme to Sabadell to absorb 80% of the losses of a set of assets valued at €24.6bn, after provisions of €3.9bn.

3.  FROB extends liquidity line of €12.5bn 26 Tano Santos



ISIN Amount

guaranteed (€mill)

Interest (%) Issue date Maturity date

ES0314400096 1.500 3,125 26/03/2009 26/03/2012

ES0314400104 200 3,350 27/04/2009 27/04/2012

ES0314400112 73 Quart.: Euribor (3m) + 90pb 08/05/2009 08/05/2011

ES0314400120 1.000 2,875 14/05/2009 14/05/2012

ES0314400146 45 3,000 29/05/2009 29/05/2012

ES0314400153 136 2,875 19/06/2009 19/06/2012

ES0314400161 1.000 2.850 30/07/2009 30/07/2012

ES0314400187 1.000 3,000 12/11/2009 12/11/2014

ES0314400195 500 Biannual: Euribor (6m) + 33pb 01/12/2009 01/12/2014

ES0314400187 357 3,000 23/06/2010 23/06/2014

Total 5.811

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Caja del Mediterráneo: Debt issuance under the debt guarantee program Source: Tesoro Público

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●  Loans to real estate developers kept growing and peaked in 2009Q2 at €324.6bn

–  Real estate developer cycle difficult to stop

–  At that time delinquent loans were “only”

€26bn

●  These type of plots created some form of “ cognitive dissonance”

–  How come the level was not dropping faster?

–  What percentage of these loans were being

refinanced?

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Loans to real estate developers Delinquent

Loans (in €bn) to real estate developers (BE4.18.10) and delinquent loans (BE4.18.21)


Tano Santos

Columbia Business School 29


€66bn against P&L

€17bn against generic provisions

€22bn against reserves in restructuring

•  There has been substantial write-offs

in the system

•  Against reserves and P&L

•  Total: €105bn

•  There has been some injection of public

capital via equity & preferreds

•  About €20bn

•  Some private capital in the IPO of

Bankia, SEO of Sabadell, …

•  But all in all little in terns of fresh capital

to absorb losses Write-offs: January 2008-june 2011 Source: AFI

Tano Santos



€mn %RWA

BFA-Bankia 4,465 2.3

NovaCaixaGalicia 3,627 7.2

CatalunyaCaixa 2,968 6.1

CAM 2,800 6.1

Banca Civica 977 2.2

Unnim 953 5.6

Grupo BMN 915 2.3

Caja España-Duero 525 2.1

BBK-cajasur 392 1.3

17,617

●  The FROB has distributed relatively little to

institutions in distress

●  The only loss so far are the €392mn on an asset

protection scheme granted to BBK when it took

over Cajasur

●  Of the list there are two pending resolution

CatalunyaCaixa and NovaCaixaGalicia

●  Banco de Valencia was intervened late in 2011 and

the FROB injected €1bn

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FROB injections up to November 2011

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The policy response: An evaluation

●  Good things:

–  Resolution of secular problems in the Spanish banking sector

–  The cajas no longer exist

–  Removal of political influence in the Spanish credit sector

●  Spanish authorities have not succeeded in removing the doubts over the losses:

–  Merger strategy made the problem of adverse selection worse making it difficult for private capital to come in.

–  Wholesale funding is closed for most Spanish banks

–  They are wholly dependent on LTRO liquidity

–  Credit crunch: New credit down by 30% in 2011

31 Tano Santos


GOING FORWARD

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Going forward: NPL ratios: The aggregate picture

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NPL ratio: Private sector credit (BE4.53.12 divided by 4.53.1) Monthly: January 1970- February 2012

Data source: Bank of Spain

February 2012: 8.24%

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Construction Real Estate Developers

NPL ratio (%): Construction and real estate developers (BE4.18.15 Divided by 4.18.4 & BE4.18.21 divided by 4.18.10))


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Going forward: NPL ratios: The aggregate picture

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NPL ratio: Mortgages (BE4.13.17 divided by BE4.13.4) Quarterly: 1998Q4-2011Q4 Data source: Bank of Spain

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Unemployment rate (right axis)

Mortgages NPL, 1 year euribor and unemployment rate Quarterly: 2005Q1-2011Q4. Data source: Bank of Spain & INE


Going forward: Private estimates

●  The private estimates of capital needs vary widely

●  This creates enormous problems for the Spanish authorities who are left with little options: Either the satisfy the most pessimistic of the estimates or doubts will persist.

●  There are challenges in estimating the extent of losses:

–  A unique situation in Spain’s banking history

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JPM BBVA GS Bar Fitch Moodys UBS

Private estimates of recapitalization needs for the Spanish banking system. Source: “Spain: Stressed Out”, independent Strategy, April 2012

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Going forward: LTRO and the diabolic loop

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Credit Institutions: Assets (in €bn) other than shares issued by the public sector (BE4.4.4)

Data Source: Table 8.1.b Balance sheet Bank of Spain

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Going Forward: Options

●  There are two options:

①  Bad bank à la NAMA

•  Example: Buy all real estate developer loans, mark them down by 60% (as in NAMA)

•  This would provide capital relief from RWAs of €26bn

•  Assuming Tier-1 targets of 9-10% leaves an estimated capital deficit of €60bn

•  Other losses? Political problems (what about me)?

②  Intervention of other institutions and creation of “several” bad banks

•  Take on problematic systemic institutions, chop them off creating a very good bank that can attract private capital and a bad bank

37 Tano Santos

tano santos national banking

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