Spain banks take property risk to avoid bad loans

MADRID (Reuters) - Spanish banks are returning to property ownership to avoid loading more bad loans on to their balance sheets but the strategy is risky and unlikely to be as profitable as their real estate buying spree 15 years ago.

Spain’s eight biggest banks last year formed or resurrected property wings that have bought up 7.8 billion euros ($9.9 billion) worth of property from struggling home-owners and developers.

“The banks are taking on a huge number of assets .... and they are now having to strengthen their real estate units to manage this avalanche,” said Fortis analyst Emilio Rotondo.

The main threat to Spanish banks has come not from the toxic U.S. mortgage debt that has poisoned U.S. and British institutions, but a rapidly deepening recession propelling their bad loan rate to an expected 7 percent this year and 9 percent in 2010 from 2.8 percent last October, according to the Bank of Spain.

Mindful of the need to keep bad loans to a minimum, bankers are doing everything to stop another major developer filing for administration as Spain’s biggest house builder Martinsa Fadesa

did last summer.

Not only will creditors likely take years to recover debts from Martinsa but the default also ramped up non-performing loan (NPL) rates as they provisioned 25 percent of the loan, or 250 million euros in the case of No.2 savings bank Caja Madrid.

“By buying real estate assets the banks stop loans becoming bad loans. In so doing, the client’s debt with the bank is canceled and they avoid not only increasing bad loans, but they also avoid having to make more provisions,” said Nuria Alvarez, an analyst at Madrid brokerage Renta 4.

The tactic is not new.

Banks owned large chunks of the industry after the 1993-95 recession before making up to seven times their original investment by selling them on in the 1997-2007 property bubble says Robert Tornabell, banking professor and former Dean of Barcelona’s ESADE business school.


However analysts say that the banks’ haste to buy property, rather than allow failing businesses to go bust, artificially lowers NPLs and only delays future loan losses that will hit sooner or later as the market takes years to revive.

Standard & Poors has said it expects house prices to fall 30 percent from peak to trough and may not hit bottom until 2010. In contrast to the last downturn, the stock of unsold new homes could touch a daunting 1.5 million by year’s end, surveyors Tinsa estimate -- equivalent to over three years of peak demand.

“I’m sure that if asset values were 10 percent below their book value banks would be more than happy to sell them tomorrow. The problem is that you can’t get rid of them, so they will have to keep them and take the pain little by little,” said Antonio Ramirez, a London based analyst at Keefe Bruyette & Wood.

A key issue is therefore the extent to which banks have enough financial leeway to tuck assets away until the market returns.

Ramirez said Bankinter was best placed to ride out the storm thanks to its strong asset quality and BBVA was in a good relative position thanks to its cautious approach. However Banco Popular has seen a much faster deterioration in its NPL ratio which would fast eat into generic provisions.

But while the double digit profit growth seen at Spanish banks over recent years is likely to be sharply eroded by increased provisioning needs in 2009 and 2010, the main banks’ capital base is solid and government intervention on the scale seen in other European countries is ruled out.


Bank balance sheets for last year show Spain’s major players are already making provisions for the falling value of property assets, some of them up to 10 percent of book value.

Santander bought 2.6 billion euros of property last year at 10 percent under the market rate, it said, adding that had it not swapped that debt for property, loans on 13 percent of those assets would have defaulted.

In order to clear some of these assets, Spain’s biggest bank has already offered employees homes at discounts of up to 45 percent.

“Santander has been much more active than BBVA in buying properties,” said KBW’s Ramirez. “We have a question mark over the future value of its much bigger real estate portfolio.”

One senior banker who asked not to be named said investments in bricks and mortar still retained some safe-haven status at a time when volatile markets were wiping out other asset classes.

And Fox Pitt Kelton analyst Jagoba Garcia said that by buying before a company files creditor protection, banks get to pick prime assets rather than scraps.

“You are in a better position than when you have to divide up any spoils with other creditors,” he said.

Keen to strengthen banks, the Spanish government has tabled legislation, firstly to give banks greater guarantees when borrowers go into administration and secondly to introduce real estate investment trusts (REITs) into the financial system.

Although property companies have branded the bill bringing REITs to Spain as unwieldy, analysts say that for banks REITs -- traded companies pooling property assets -- offered an important vehicle to offload billions of the assets that are likely to continue mounting for some time to come.

Writing by Ben Harding; Editing by David Cowell