Spanish Financial Sector M.O.U. - Analysis

Via Peter Tchir of TF Market Advisors [9],

Spain MOU: I give it a C+ or B-

The devil is in the details and we finally have the Spanish Bank rescue details [10].

The cost is not mentioned. We do not know the cost of the borrowing or how long it will last for. That ultimately will be key. Short dated, high coupon loans will not help much. Long dated, low coupon loans will help.

The seniority issue doesn’t seem too bad but reading the documentation it looks like it must have been extremely contentious as it can’t help but say it is going to Spain time and again where it was unnecessary.

The other reason the seniority doesn’t look too bad is because it doesn’t look like much money will get doled out. The timing seems far too long. This is a political fix and one where they live in some bankers world rather than a traders world. I am VERY concerned about the long timeframe for implementation. The immediate availability of €30 billion is good, but I have my doubts that it will be distributed.

Concerns about “conditionality” seem overdone. Virtually all of the new conditions apply to the financial sector and many are common sense and things that should have already been getting done. Yes, they include the mention of Spain’s obligations, but that is only briefly mentioned, and by and large is just what Spain has already agreed to (though now maybe there will be repercussions if they don’t meet those targets). In any case, the conditions for Spain seem to only hit in 2014, which is definitely a lifetime away.

The use of a “bad asset” vehicle makes me nervous. I think that adds a level of complexity and risks taking time and using money and resources inefficiently.

So I give it a C- or B+ because it looks like it will take too long to implement, is cumbersome, and no details on the cost are yet available. I think they went out of their way to avoid the subordination issue which is a positive, but offset by the fact that costs aren’t known and we need to see money actually put into the banks.

The rest is my first take as I went through the document.

Conditionality

Well, right in the first paragraph the issue of conditionality is brought to the forefront. “Conditionality will be financial-sector specific and will include both bank-specific conditionality in line with State aid rules and horizontal conditionality”. I admit, I have no idea what “horizontal” conditionality means but I assume it means that some conditionality will apply to the country as well as the banks. The convoluted way of saying that makes me suspicious. Why not just say it? Seriously, what is “horizontal conditionality”?

It goes on to state that Spain has to comply with its commitments under the EDP, etc. That doesn’t seem surprising, but the market was hoping for no conditionality for some reason so it seems disappointed.

Seniority

“assistance will be subsequently taken over by the ESM, once this institution is fully operational, without gaining seniority status”. They actually spell that out. I’m impressed as that is a big step, though I have my doubts about when ESM will come on line.

Recent Economic and Financial Developments and Outlook

Not much to say here, though they do try to carve out the “few large and internationally diversified credit institutions” as still having access to markets.

Key Objectives and Restoring Soundness and Timeline

They give a little “shout out” to the Spanish authorities for taking steps to address the problems.

They are heading down a “bad” bank path, which I never understand. It always seems that the pile of bad assets just grows when you go down that path, but others like the idea and it seems a focus of the strategy.

The belief that some transferring bad assets to some external asset management company is part of their strategy. Is the name “Le Lane de Maiden” taken?

The “first tranche” of €30 billion will be ready this month. Since not all of the conditions will be met, the approval to release looks rigorous but the money will be there, coming from the EFSF. Expect big issuance from the EFSF if they are going to have €30 billion ready.

Then the plan starts to go further downhill. Stress tests are to be completed in second half of September. Banks will then be categorized into need based groups sometime in October. This is starting to drag on. The plan comes with a very nice chart, but it seems to drag on.

The focus is disappointingly on stress tests and good vs bad asset segregation.

At least the document is written with some comic relief. We get two new acronyms though I have to say the Expert Coordination Committee might be the best one yet.

In accordance with the appropriate governance structure established in the Terms of Reference for this exercise, a Strategic Coordination Committee (“SCC”), involving, together with the Spanish authorities, the European Commission, the ECB, the EBA and the IMF and an Expert Coordination Committee (“ECC”) will closely oversee the work carried out by the independent firms. The latter will provide full updates every two weeks to the SCC.

There is a lot of spaced devoted to describing burden sharing and recap versus “resolution”. Resolution is just a fancy way of saying shutting the insolvent ones down.

I like the idea that real capital will be injected and that it does appear as though it will be done with care, but I am getting nervous that there is nothing indicating a real desire to see banks grow and create new business. Just turning the banks into better functioning zombies will not help the Spanish economy.

The “AMC” or Le Lane de Maiden will receive what looks like an equity injection from the FROB and then will attempt to issue debt. So there will be leverage on the bad asset side. The transfers from banks to the AMC will be at the “real (long-tem) economic value (REV) of the assets”. I’m assuming that is somewhere in between actual value and book value. Seems like a joke as someone gets to make up a number that these are “really worth”. That seems a direct contradiction about burden sharing as it lets banks sell assets at prices that are artificially high and sticks the assets on a balance sheet that won’t be funded by existing bank shareholders, but by the citizens.

Horizontal Conditionality Explained

It starts with “Spanish credit institutions” having to meet a variety of guidelines and regulations. I assume that most of these are conditions you would want the banks to have as an investor anyways.

Something paragraph about concentrations and related party transactions – not sure if that is good or bad, but the review isn’t until January 2013 so I’m not overly concerned either way.

Another page or so of conditions but focused on credit institutions and frankly they seem reasonable.

It looks like the Banco de España is meant to take some powers currently controlled by the Ministry of Economy. It looks like they are trying to separate the central bank from the government. I assume this is part of the effort to create a Eurozone banking system that is more uniform.

By 2013 there will be no active bankers in the governing bodies of the FROB. Wow, more progressive than our own Fed.

Public Finances, Macroeconomic Imbalances…

Okay, this must be where the conditions get bad. Well it looks like they have until 2014 to meet some deficit targets, and since the percentages of GDP are left blank, it looks like there is wiggle room. At the rate this crisis is evolving, 2014 seems like a lifetime away, and it looks like it is just following the EDP recommendations.

Some of the things Spain is supposed to do, look like it will hurt the housing industry rather than helping it, but some reforms look like ones we could use ourselves – “reduce delays in obtaining business licenses, and eliminate barriers to doing business”.

Programme Modalities and Monitoring

Man, they really like using the word modality in Europe. This part looks bad as it states that “Spain would require an EFSF loan”. Only later do they mention that FROB is involved. This definitely makes it look more like Spain than FROB with a Spanish guarantee.

The programme duration is 18 months. I hope that is the time to allocate the capital and not when the loans are supposed to be paid back. I’m not sure why this would take 18 months, even with the bizarre method they have chosen. A fast injection done over 3 months would give the Spanish economy a much better chance of turning the corner. This is likely to just drag out with weak banks barely staying afloat rather than aggressively pursuing new business.

Lots of monitoring, but the bulk of it seems to be at the financial institution level, though they do mention the Macroeconomic Imbalances procedure and the Excessive Deficit Procedure, but the Excess of 3 Letter Acronyms Pact (ELAP) has not been finalized.

Annex 2 – Conditionality

There are 32 Conditions. Here they are and my quick thoughts.