Last Monday morning when most of Spain's citizens were busy watch YouTube videos or TV coverage of Rodolfo Chiquilicuatre doing his buffoonery at the Eurovision Song Contest, many readers of the English speaking press were hard at it peering into another video, the one of the FT's Ralph Atkins interviewing Spain's representative on the ECB executive board José Manuel González-Páramo (transcript here, curiously whilst almost everyone in Spain seems to know who Chiquilicuatre is, almost no one has heard of González-Páramo).
The Spanish representative was busy trying to allay fears that European banks have become over-dependent on European Central Bank liquidity injections and in particular trying to deny that the Spanish banks are gearing their operations to take advantage of its extra help.(In other words while good Rodolfo was dando-nos a todos verguenza ajena, González-Páramo was simply doing his job, and dando la cara).
“I don’t think in any way the banking system is becoming addicted,” said José Manuel González-Páramo, ECB executive board member, in an interview with the Financial Times. “They are now behaving a little bit different than they were behaving before August 2007, but the reasons behind that are quite obvious to everyone.”If González-Páramo was having to work hard to keep the Spanish end up, this was in part a response to the growing concern that Spanish banks are creating ever riskier collateral to swap with the ECB, far riskier collateral than the central bank ever envisaged (see below), that the ECB already holds too much risky collateral, and that the funding was being used to far to great an extent to keep "business as usual" going, rather than bridge finance to enable a sizeable restructuring of the Spanish economy. Just such a view was expressed earlier this month by Yves Mersch, Luxembourg’s central bank governor – who, like Mr González-Páramo, sits on the ECB’s governing council – when he indicated that the type of collateral now being accepted by the ECB was “a matter of high concern”.
Since the global financial market crisis erupted last year, finance houses have been able to fall back on the ECB’s liquidity operations, available to a large number of banks on the basis of a broad range of collateral, including some mortgage-backed securities. To address financial market tensions, the ECB has also altered the way it provides finance.
Slowdown in Bank Lending
Evidence of the difficulties that Spain's banks are having is everywhere. Take bank lending for example. According to the most recent data we have from the Bank of Spain, lending to Spanish households was up by 4.245 billion euros in March when compared with February, and year on year lending to households was up by only 10.6%.
I say "only" here since this rate of increase in lending is only about half what it was at the start of 2007, and as such it is only about half the rate of new mortgage generation that the extensive Spanish construction industry needs simply to keep turning over.
The reason for this decline in the rate of new lending creation is obvious: the liquidity crunch, which is now the principal reason why Spanish banks are steadily lending less and less extra money in new mortgages each month, although evidently since all of this is now producing a substantial slowdown in the real economy, with unemployment rising and take home pay under constant pressure from inflation we are steadily moving from a construction crisis fuelled by a lack of availability of funds for mortgages to one which will be increasingly driven by absence of demand for them as the "affordability" issue steadily locks-in on those who would like to buy their own home.
The fundamental situation is that since the Spanish banks are short of cash they are simply able to lend less. It is this, and not the 4% repo rate set by the ECB, which is the principal reason the value of mortgages created on urban buildings in Spain (at approximately 16,575 million euros) was down in March 2008 by 36.7% over March 2007. In housing, the capital loaned exceeded 9,975 million euros, 41.9% less than in March 2007. 105,608 properties were mortgaged in March 2008, a decrease of 37.77% over March 2007.
The Spanish banks are, of course, able to raise money, but much of this is on a short term basis, and not appropriate for long term lending on products such as mortgages. Moody's recently suggested that Spanish savings banks are trying to attract foreign investors (especially German pension and investment funds) with private placements of tailor-made securities. But such issues are typically in the 30 to 300 million euro range - a far cry from the earlier jumbo cedulas. In addition maturity on these securities is much shorter, typically three years. (To those readers who have no idea at this point what cedulas hipotecarias actually are, I would say fear not, since neither did I when I set out on this venture, but perhaps it is worth reading through my working notes on the topic since they may help you become just a bit more familiar with the meaning of an expression which is - unfortunately - only too likely to become as much a part of the 2008/09 economics lexicon as "sub-prime" was in the 2007 one).
Another strategy the banks have been using has been to issue short term (typically three month) paper, and there was roughly 90 billion euros worth of it outstanding at the end of March. Banks are also trying frantically to attract more deposits, and since the end of last year some 20 billion euros have been transferred out of investment funds into long term deposits. The however do not come cheap, and the price the banks are paying for this money is prohibitively expensive - some of it even pays 7% - for it to be used as a basis for mortgage finance, for mortgage finance since mortagages are still widely on offer for around 0.5% over 1 year euribor (or 5.25% or so).
Thus the problem for the banks is really how to find a stable long term source of finance for their mortgage business given the fact that the wholesale money markets have been virtually closed in their faces. In this connection the Financial Times's Leslie Crawford had a piece in the May Issue of Financial World which examined some of the funding problems the Spanish banks are having. As Crawford says "with every month that the capital markets remain closed to them, the problems of the Spanish banks grow more acute". And since we have no idea at the present time at what level Spanish property prices will finally settle (and thus what the true market value of the pool of mortgages which effectively backs the cedulas actually is) then it would seem that the day the doors will once more open again (at least at prices the Spanish banks would be interested in) is far from being at hand.
Crawford cites the Madrid based consultancy Analystas Financeros Internacionales (AFI) to the effect that during Spanish banks were raising approximately 40% of their funding requirements outside Spain at the height of the boom, as compared with only 15% in 2000-2001.
According to AFI foolowing the August blow-out the Spanish banks and savings banks did continue to issue residential mortgage backed securities (cedulas) in the second half of 2007 (to the tune of an estimated 50 billion euros, although this number seems rather high to me), but none of these were placed with external investors (since there were effectively no takers), but rather they were kept on the books for use in repo facilities with the ECB as needed.
Data from the Bank of Spain show that Spanish banks have doubled their share of the ECB's weekly funding auctions since August 2007 - up to 10% of the total from a previous 5% - and that in February Spanish banks borrowed 44 billion euro out of a total 442 billion euro.
The big issue is of course that there is now no market for the earlier jumbo bond offerings. Worse, many of the original jumbos were offered with maturities of between five and eight years. So these cedulas will effectively soon be coming up for rollover.
I would say that the greatest risk points for the Spanish economy at this stage are:
1/ the potential liquidity crisis which may be constituted by the need to refinance the cedulas.
2/ the potential increase in the quantity of bad debt provision which the Spanish banks may need to set aside as and when the builders themselves start going bankrupt in serious style. With anything up to an estimated 1 million unsold properties on the books in Spain at the moment, and with the banks being de facto owners of these properties through their financing of the builders, this avenue is the most important short term threat of debt delinquency, and not unpaid mortgages (IMHO). And the sums involved are by no means chickenfeed, and could well be very similar in magnitude to the quantities owing on the cedulas. ie the whole problem is very large indeed.
Of course later, as the financial problem ripples its way through the real economy, the ability of individual households to meet their mortgage obligations may well become a problem, but we are a long way from that at this point, and sufficient unto the day is the evil thereof is very much the case here I think.
AFI estimate that around 40 billion euros in cedulas and other bank debt come up for refinancing in the second half of 2008, that in 2009 this number will rise to around 80 billion euros, and that the number will remain high through 2010 and 2011. That is to say my rule of thumb guess that we may be facing around 300 billion euros in rollover issues (or around 25% of Spanish annual GDP) in the coming years does not seem to be too far off the mark. And as I say, we may need to make similar provision for equivalent exposure to bankrupt builders etc.
According to this report in El Economista the President of the Confederación Española de Cajas de Ahorro Juan Ramón Quintás has been in discussions with the Spanish government about the problems the regional savings banks are having and are going to have, and one of the solutions under discussion is that the fondo de Reserva de la Seguridad Social should buy bonos and cedulas to help with liquidity. Help! Well it's not my pension they may be about to start playing with, but still.