Over the weekend Cajasur one of Spain’s regional caja’s or savings banks was taken over by the Bank of Spain. It had previously been in merger talks with one of its fellow cajas since back in July 2009 and in essence Unicaja, a bigger and profitable savings bank in Malaga, was going to take it over. However these talks broke down on Friday evening and within a few hours the Bank of Spain had stepped in as Cajasur on its own no longer had a viable future. Whilst in itself Cajasur is not massively structurally significant the principles behind her failure are as she was heavily involved in the ailing Spanish property market and is an example of how there has been very little reform of the Spanish banking system so far. And of course this comes just after Spain has announced further austerity measures for her public-sector. This is not an inspiring combination in my view. There are indeed echoes of how Japan behaved in the early 1990s when trouble hit her banking sector in this.
This regional savings bank represents around 0.6% of the assets of the Spanish banking sector and had a loan book of approximately 13 billion Euros. The bank was based in Cordoba and was in fact run by the Roman Catholic church which had formed it in 1864. However she had the highest level of non performing loans in the Spanish banking system at an estimated rate of 7.9%. Losses were beginning to mount as after losing some 596 million Euros last year she had lost a further 114 million Euros in the first quarter of this year.
Plainly the business was no longer viable, however there is an interesting and revealing fact from Friday’s events. Yet again (by turning down a merger) we have a bank board which seems to have been what psychologists would call “in denial”. In spite of the seriousness of their position they felt able to turn down the merger. This sort of “denial” has been very common as banks have hit trouble around the world during the credit crunch.
The caja’s (cajas de ahorros)
These are a group of regional savings banks in Spain which are unlisted and were usually formed for charitable purposes. There are 45 of them and there are in many ways similar to building societies in the UK although there was never the wave of de-mutualisations which occurred in the UK.
However as Spain’s property boom developed the Cajas did begin to behave like some of the demutualised UK building societies in that they stepped up their share of lending to the property sector. In essence they grew faster than their listed peers such as BBVA and Santander during Spain’s decade-long construction and property boom, in part because they lent more to real-estate developers. As the housing bubble started to deflate and the economy went into recession at the end of 2008, Spanish banks saw their bad loans rise at unprecedented speed,according to the Bank of Spain non-performing loans are at a 14 year high.
However there are a lot of questions as to whether even these high levels of non-performing loans fully represent the state of the caja’s finances and to look at this fully one needs to consider Spain’s property boom. Even in the current situation half of the cajas are estimated to need to merge. Of course you may be wondering like me how mergers will particularly improve things if the real problem is non-performing loans. There is the suspicion of things being concealed and swept under the carpet.
Spain’s Property Boom
As one looks back over the last decade it becomes clear that Spain had as large a housing bubble as that of Florida or Ireland. An example of this is that property prices rose in real teams, by over 100% between 1999 and 2007. However in a tale familiar to many property booms that led to the credit crunch there was no slacking or reduction in the pace as Spain’s banks and cajas continued funding one of the largest real estate booms in the world such that 860,000 housing starts took place in 2006. Indeed two-thirds of the housing units built-in Europe between 1999 and 2007 were built in Spain. By the end of the construction boom (end of 2008), the stock of loans to real estate developers and builders reached almost 500 billion euros, which is equivalent to half of Spain’s GDP. This lending bonanza appears foolish in hindsight and investment banks now estimate that up to 50% of loans to developers will be irrecoverable. (Thank you to a paper from the LSE by Vicente Cuñat and Luis Garicano for these figures).
But the Spanish property market does not appear to have fully adjusted to this new reality. So far Spanish house prices have fallen by much less than you might expect considering the scale of the building that went on and the rush to lend to the sector. Societe Generale estimated recently that they had fallen by not much over 10% so far. You get the feeling that the pain is being spread out over a longer period and is being delayed which is where echoes of Japan and her experience come in.
Bringing the cajas and the property market together
One cannot but help the feeling that losses on Spanish loans to her property market are set to continue and probably accelerate as it would appear that her property market still has a fair bit of adjustment to do. It is also true that problems in the commercial property market often take their time to fully develop. In terms of individuals ability to service their loans then an unemployment rate now over 20% cannot help.
By the end of the property boom the cajas were providing 50% of the loan finance so unfortunately they expanded their lending just at the wrong time which is a familiar theme during the credit crunch for various institutions. But as you look at the 45 cajas right now there has been very little reform with only 2 of them including Cajasur in the hands of the Bank of Spain. I cannot avoid the view that more needs to be done and Spain has been delaying this hoping for economic growth as a way out again just like Japan in the 1990s.
Spain’s economy and fiscal deficit
Where is this relevant is if we feed the state of the property market and the cajas into Spain’s overall economy. If one takes the view that Spain’s government was hoping for economic growth to help bail out the cajas and the property market then one can also see why it was anxious not to extend its austerity programme as it plainly did not want any negative impact on Spain’s growth prospects. However Spain has been pressurised by events into a new tougher austerity plan as I wrote on the 14th May.
There will be further cuts amounting to 0.5% of Gross Domestic Product(GDP) in 2010 and a further 1% of GDP in 2011 which added together come to cuts of approximately 15 billion euros. The plan is to reduce Spain’s fiscal deficit to 6% of GDP in 2011/12 which contrasts with a level of 11.2% in 2009/10. She still plans to meet the euro zone’s’s 3% of GDP target in 2013
So the austerity programme increase is likely to impact on Spain’s economic growth adversely. It is also plain I think that Spain was hoping for economic growth to bail out her property market and cajas in effect a type of waiting game. Of course effects from these will feed back into economic growth and indeed Spain’s fiscal deficit. Indeed whilst I type this how different this approach feels to that of Ireland who approached her fiscal and property market problems much more decisively. Before this crisis is over I suspect Spain may end up wishing that she had done the same.
Furthermore today’s financial news is full of other countries who are Spain’s trading partners all talking or planning austerity measures. For example the UK will announce some £6 billion of public-sector cuts and even Germany is now planning a fiscal reduction of some ten billion Euros. It could be a difficult few years for Spain.
Whilst Cajasur in itself is not particularly significant the principles behind it are. For example if the Spanish press is accurate and the total losses on its loan book do approach 2 billion Euros then as its capital was only 229 million Euros a few concerned eyes might turn to other cajas and wonder what the real state of play is. So there is the fear that provisions in the caja sector as a whole will have to rise and one cannot avoid the feeling that the cajas will be less likely to loan money going forwards probably just at the time the Spanish economy most needs finance.
So from a situation where Spain’s financial sector was well-regarded due to the way it was regulated cracks are beginning to appear and as she has delayed many reform to her cajas and her fiscal problems they are appearing at the same time. Only time will tell whether these delays were a minor or a major mistake. But there are echoes of how Japan responded to her property crisis in how Spain has behaved and that is hardly a recommendation when you consider what happened next in Japan.