The 2011 edition of European bail outs has begun. The WSJ has just announced that the Spanish government is about to inject a fresh round of billions of euros into its insolvent savings banks (cajas) sector. This is not at all surprising. Back in July 2010, Zero Hedge penned the following article, "The Ticking Time Bomb That Are The Spanish Cajas" which predicted just this development, and it is troubling that it has taken the country this long to acknowledge just how bad things are. We can only speculate that in the meantime the fundamentals have deteriorated materially. Bottom line: Europe is getting tired of kicking the can and may be forced to come to grips with reality far sooner than Ben Bernanke hoped. As for the question where all this bailout money is coming from... it is better left unasked.
The Ticking Time Bomb That Are The Spanish Cajas, Zero Hedge, July 5, 2010
Even with Spain's Cajas, or savings banks, completing the country's
most aggressive sector restructuring in history, after nearly 90%, or 39 out of 45 merged or
participated in some form of "cold fusion" and benefiting from the
financial assistance of the Spanish central bank, there has been
precious little written about the actual holdings of this most
aggressive lender of mortgage to Spain's 20% unemployed population.
Until today: a new report by CreditSights' David Watts indicates that
investor worries about the Spanish banking system are very well founded
and likely underestimate just how bad the true situation actually is. In
"Spanish RMBS: Insider Caja Loan Books", Watts concludes that the Cajas
are likely hiding losses on home loans by taking
non-performing mortgages out of securitized pools. Absent this
unsymmetrical onboarding of risk, the overall deterioration of the
broader pool would have become ineligible as collateral in ECB refi
operations. In essence, Watts says, "by buying the loans out of the mortgage pool, the cajas would be taking those weaker loans onto their own books."
This implies that the 3.7% serious delinquency rate reported by the
cajas is in reality far higher, and likely "underestimates their
potential losses." And what's worst: as ever more delinquencies mount
courtesy of austerity, and the Cajas run out of cash to constantly buy
up the weakest performing loans, all of Spain is about to lose ECB
collateral access to its hundreds of billions in securitized RMBS,
completely locking the country out of any access to liquidity, even that
of the ultimate backstop, the European Central Bank.
cajas are notoriously secretive about the state of their loan books.
Which is why CreditSights took a bottoms-up approach, looking at a
sample of 143 Spanish residential mortgage-backed
securities collateralized by 136 billion euros ($170 billion) of loans,
of which 45% was originated by cajas.
an attempt to better understand the stresses that Spanish mortgages are
under, we use Spanish RMBS investor reports to assess loan performance
and compare how Caja-originated loans compare to those extended by the
larger, more-diversified Spanish commercial banks such as BBVA and
Santander. The performance of mortgages within caja-securitisations is noticeably weaker than for Spain's commercial banks.
CreditSights points out, the outstanding balance of securitized Spanish
resi mortgages is estimated to have reached €168 billion, representing
15.3% of all mortgage lending in the country. Yet taking advantage of
ECB generosity to take on all sorts of worthless assets on the left side
of the ledger supporting the euro, "even with investors globally taking
a much more sceptical approach to RMBS following the US subprime
crisis, issuance of RMBS in the Spanish market has remained relatively
strong as issuers have retained deals primarily to use as collateral against ECB open-market operations."
In essence, the ker structural difference between the US and Europe can
be summarized in the previous sentence: while US banks were at least
smart enough to know they need to offboard RMBS associated risk to even
dumber investors, in Europe, it was the ECB which for many years running
was the backstop, thus preventing the need for prudent risk management.
The end result: the collapse of the Spanish deposit savings system.
chart below shows the dramatic surge in RMBS retention at about the
time the subprime market in the US blew up. The primary "beneficiary" of
this stupidity - the cajas.
to the reason why the cajas are avoided like the plague by virtually
everyone, the chart below says it all: while everyone was enjoying the
credit fuelled binge on the way up (very much as the US was), the
reversion has yet to catch up with reality. The truth is that even as
the quarterly change in lending has plunged, the property price index is
massively higher than where it should be currently. Once the benefits
of record low Euribor and other artificial props finally expire, look
for Spanish real estate prices to literally plummet destroying not just
the local banking system, but that of the entire interlinked European
a quick detour into Spanish CMBS. Watts explains: "As a percentage of
GDP, Spanish household sector has debts of 85% and housing-related debts
equivalent to around 65% of GDP. Indeed, including loans for
residential development (commercial real estate lending), total
housing-sector related lending is equivalent to 104% of GDP, nearly
double where it was in 2003. That means that we estimate that Spanish property developers have debt equivalent to almost 30% of GDP."
This is simply another massive risk overhang that the banks never
offloaded, and has so far flown very successfully beneath the radar. Yet
unlike RMBS, the ECB does not accept CMBS as collateral against refi ops, leading one to scratch their head why the banks were so stupid in this particular case.
CreditSights has this last warning to add on Spanish development loans:
the US experience with development loans and the fact that much of this
developer-related lending was no doubt focused on the worst affected
markets - retirement and vacation properties - we think these loans are
probably performing more poorly than the ordinary residential mortgage
lending that we track within our RMBS sample. As a result, our sample may understate the true scale of problem loans within the Spanish banking sector.
to the actual results of CreditSights broader analysis of , the chart
below summarizes that as the deterioration in Spanish unemployment
accelerated, delinquencies remained somewhat flat, primarily courtesy of
a collapsing Euribor rate. As we have pointed out recently, now that
the LTRO has matured, Euribor and Libor have only one way to go: up.
back to the split between caja-originated mortgage versus those issued
by the large banks, Watts confirms that there is a material
underperformance when it comes to Cajas: "the most obvious takeaway is
that mortgages originated by cajas have been running at higher
delinquency levels than mortgages originated by Spain's commercial banks
for at least the part four years." The chart below demonstrates just
how much worse the Cajas books' are, even based on doctored public data,
key question posed by Watts, and whose answer is truly troubling, is
the following: what is driving the volatility in the caja's mortgage
performance. The explanation offered: "we believe this phenomenon might
be partially explained by the removal of delinquent mortgages from
Spanish RMBS pools by the originating bank during the first and second
quarters of 2009. Mortgage repayments exhibited a dramatic rise during
this period. The average repayment rate on securitised caja-mortgages
rose by 360 bps from 6.7% in the fourth quarter of 2008 to 10.3% in the
first quarter of 2009."
And the punchline that should shut up "all is well in Spain" apologists once and for all:
understand that both cajas and Spanish banks have been supporting their
RMBS by buying some delinquent mortgages out of the pool.
Buying mortgages out of the pool will reduce delinquency rates and will
also boost repayment rates - to the RMBS, the loan is considered to have
been refinanced by the caja. Issuers are not obliged to provide such
support to their RMBS transactions but the rise in delinquencies may
have threatened ratings on retained deals, meaning that they would have
become ineligible as collateral in ECB refinancing operations. By buying
the loans out of the mortgage pool, the cajas would be taking those
weaker loans onto their own books. That means that the current
3.7% serious delinquency rate (the orange line on the right-hand chart
above) may flatter the performance of the cajas' mortgage books and
underestimate their potential losses.
CreditSights concludes with a somewhat much somber bigger picture analysis:
further decline in interest rates has for the moment allowed the
aggressive levels of leverage not to implode, despite falling Spanish
wages and rising unemployment. Indeed, Spanish mortgages are
performing only slightly worse than UK prime loans and are performing
considerably better than UK-performing loans.
those ostensibly reassuring numbers lurk weaker performance in caja loan
books and the prospect of substantially weaker performance on
non-mortgage lending (i.e., loans to property developers). What's more,
if Spanish government austerity packages have knock-on effects for
Spanish household incomes, most obviously as a result of reductions in
public-sector wages, then this level of mortgage indebtedness will
become less sustainable and would no doubt precipitate further rises in
And the most dire
side-effect of an avalanche of increasing delinquencies, and the
resultant inability of the cajas to mask the deterioration by buying
back all the worst-performing loans, would be the loss of ECB access. In
the meantime, the cajas would get destroyed as they already are the
proud owners of the very worst loans available: "Any mortgages that
cajas have been purchasing out of their RMBS loan pools could have been
artificially reducing the level of bad loans in RMBS while
simultaneously undermining the quality of cajas own assets" CreditSights
Our own conclusion is simpler: got STD CDS yet? And yes, at 264 bps, Spain CDS is cheaper than a deserted Salamanca hotel.