Neil Unmack is constructive about Spain in general, and Spanish banks in particular: Santander knows its own loan book better than anyone, he says, and if it’s happy to buy back billions of euros of its own bonds at 82% of par, it probably knows something the market doesn’t.
On the other hand the notorious Variant Perception report on Spain and its banks, quoting Edward Hugh at some length, makes for very sobering reading. Read at in the light of the report, Santander’s buy-back begins to look more like an act of desperation than one of strength — and one which bondholders would do well to tender into.
It’s undeniable that the implosion of Spain’s formerly-hot construction sector is going to blow holes in a lot of balance sheets; the only question is where and when. The gist of the Variant Perception report is simple: the problems of Spain’s construction industry and homeowners have become the problem’s of Spain’s lenders, and the problems of Spain’s lenders are going to a major problem for all of Europe, going forwards. Meanwhile, Spain will become Ireland-but-worse, as real interest rates soar thanks to deflation and extreme levels unemployment, combined with low wages, depress the entire economy for the foreseeable future.
That said, it’s important to draw a distinction between Spanish banks in Spain, which are largely domestic savings banks, and Spanish banks as they exist in the imagination of the international capital markets (Santander and BBVA). Santander is a well-managed and internationally-diversified bank, which does retail banking extremely well. BBVA owns the largest bank in Mexico, Bancomer, and has built an extremely strong franchise stretching from Texas, through Mexico and central America, and down through the Andes. While neither bank will be immune to a national disaster in its country of origin, their international holdings will help to soften the blow.
At heart, however, the situation in Spain will be familiar to many US observers: consumers augmented their low wages by making huge amounts of money in a soaring property market. And now that the property market has stopped soaring, they’re left with hundreds of billions of euros in loans, an enormous percentage of which will end up in default. The problem in Spain is exacerbated by the fact that much of the property bubble was concentrated in the beach-home market on the coast, where the willingness of homeowners to pay mortgages on underwater properties is much lower than historical data would suggest.
The problems in Spain have taken longer to emerge than those in the US or Ireland for two reasons. Firstly, Spanish lending standards were generally tighter than in Anglophone countries, giving banks more of a cushion to absorb losses or refinance souring loans. And secondly, the massive influx of liquidity which hit the world in 2008 as a response to the global economic crisis is helping to hide the scale of the problem in Spain: it’s worth noting that Santander is tendering for more than $23 billion in mortgage-backed bonds “through its normal liquidity facilities”. But neither of these two factors is sufficient to withstand an economic crisis of the one facing Spain. My feeling is that the pessimists (and the other Neil) are right — the situation in the country is going to get much worse, and spill over into the rest of Europe, long before it gets better. We haven’t hit bottom yet.