Leslie Crawford had another very useful article in the Financial Times last week (a handy addition to this earlier one).
According to Crawford the Spanish banks are accumulating a “war chest” of assets to be used later as collateral to access European Central Bank credit in the event their liquidity needs rise even while wholesale money markets in asset backed paper continue to remain closed to them.
It is important to remember here that the huge expansion in mortgage credit in the country in recent years has been largely fed by the banking sector’s widespread use of mortgage-backed bonds to fund lending growth (the so called Cedulas Hipotecarias, see my post on this here), and that the Spanish banks have been second only to the UK in Europe in this respect.
In recent months, and with the Cedula market effectively shut, Spanish banks have been steadily increasing their use of funding from weekly liquidity auctions conducted by the ECB, which has long accepted mortgage-backed bonds as collateral.
The banks have done this by securitising pools of mortgage debt, which they keep on their balance sheets rather selling, and these are pledged to the ECB in exchange for funding. Now I am macro economist, rather than a banking specialist, and it is not immediately clear to me what the banks who are doing this hope to achieve in this way, since if they are themselves effectively having to buy their own bonds using cash, and cash is at the end of the day even more liquid than bonds, where is the benefit? One answer could be that they are issuing new mortgages backed by these bonds, and then using the bonds as collateral for the ECB loans, in which case they are effectively swopping cash - which earns of course no yield - in their reserves for securities which do pay yield, since indirectly this yield is paid by those who pay the mortagages which are being used as backing (and are of course themselves "illiquid"). The recent widely publicised offer by Banco Santander to take-over mortgages (and customers) from other banks, always providing that these mortgages originated prior to 2002, could be an indication that this is in fact the objective. But again all of this only makes sense if the banks in question are increasing their reserves as a "war chest" against anticipated future losses on the mortgage side of their business, and what we need to think about from a macro economic point of view are the implications of this increase in the cash reserve ratio (ignoring for the moment the fact that they may be doing this via the "eating their own" bonds technique, which may reduce the damege to bank profitability, but does little to offset the money supply contraction implied as far as I can see). Certainly this would seem to imply yet another channel of indirect credit tightening.
And of course none of this tells us very much about two crucial questions: what the rate of new mortgage issue is going to be moving forward (since the banks are offering a maximum loan to value ratio of 80% in an environment where few people have savings), and what the position of the smaller - regional cajas - banks is here, since they are evidently the most exposed to the whole problem. The cedula-backed bonds have been largely issued on a 10 year renewable basis, and start coming-up for rollover in substantial quantities after 2010. Basically some 300 billion euros need to be "rolled over" during 7 years, and since the existing holders are likely to cash in, it isn't at all clear where the regional cajas are going to find the resources needed to do this. So could the Spanish government be faced with an inevitable "Northern Rock" type solution here? This is doubly the case, since noone at this point has any realistic idea of the actual forward path of Spanish property values over the 2010 to 2017 horizon, and this is basically the reason why the asset back securities market is closed to Spanish products - and unlikely to open any time soon - and basically why the cedulas are so different from the German Pfandebriefe (with which they are so often compared) since the latter where sold on the market AFTER the correction in property prices following the end of the 1995 boom, and were thus pretty resistant to further downward movement, and in any event in the German case the bonds were ultimately backed by government guarantees to the deposit holders in issuing banks, and so in this sense the investment grade rating had a certain logic to it.
So we only have questions here as we move forward.
Nonetheless recent Spanish banking data does make interesting reading. According to data released by Spain's central bank, Spanish banks doubled their share of the ECB’s weekly funding auctions in the final quarter of last year, taking their borrowing up to €44bn in December from a running average of about €20bn over the previous 15 months. This extra lending from the ECB of almost €24bn outstrips the quarterly amounts raised previously by Spanish banks from securitisation markets, which is an important comparison because the banks have increasingly used mainly mortgage-backed securities as collateral with the ECB. This jump has increased its share of Europe-wide borrowing from 5 per cent of the ECB’s total to 10 per cent, a number which more or less proportional to the weight of Spain in the eurozone economy, but what is so striking is the rapid rate of expansion. Before this money wasn't needed, and now it is.
Jean-Claude Trichet, the ECB president, who in fact came on a vistit to Spain only last week, went out of his way to stress that in no way was the Spanish or any other eurozone banking system being bailed out. “We have not changed our rules [in order to accept mortgage backed bonds],” he is quoted as saying.
Another noteworthy detail about this sudden "eat your own bonds" expansion, is that larger amounts of securitised bonds are being created appears to be being used. Santander, Spain’s largest bank, said it has €30bn in loan-backed securities on its books that it could use as collateral, while BBVA, Spain’s second- biggest lender, has €60bn in such bonds available.
Popular, a mid-sized bank that relied on wholesale markets for 42 per cent of its funding before the credit crisis, says it has €11.4bn in bonds that could be used in ECB auctions, but says it has to date not resorted to raising funds via the ECB.
So the bottom line here is that the European Central Bank has effectively been indirectly responsible for funding new lending in Spain in recent months, replacing banks’ traditional use of wholesale capital markets, since these have been effectively strangled by the global credit crunch. And so there is one last point to think about. Spain has been running a substantial external deficit, one which it needs a constant inward flow of funds to underpin.
During the last seven years, external funding into the cedulas (which ammounted to some 60% of the total) essentially offset the deficit. But now these flows have stopped, so how is Spain going to finance its deficit? Another way of thinking about this would be to say that private borrowers were effectively attracting the funds into spain which then paid the current account deficit. Or if you prefer, (on a sort of back of the envelope basis) not a single barrel of oil consumed in Spain since 2000 has to date been paid for. It has all been supplied on tick. So the problem now is that not only does Spain actually have to start paying for its oil, it also has to pay back all the oil which was consumed between 2000 and 2007 (as it will discover when "rollover time" on the cedulas arrives). Or is the ECB also going to reinvent itself here, becoming payer of the last resort on the individual national external deficits?
