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.
Spain's 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.
In 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.
As 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.
The 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.
As 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 financial system.
And 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:
Given 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.
As 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.
So 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, than banks:
The 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:
We 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:
A 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.
But behind 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 delinquencies.
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 concludes.
Our own conclusion is simpler: got STD CDS yet? And yes, at 264 bps, Spain CDS is cheaper than a deserted Salamanca hotel.