Raining in Spain
Globalisation has had the effect of ensuring that one nation’s problems are even more likely to be the world’s problems. And one nation’s troubled institutions are often in a very similar crisis to similar institutions in other countries.
So, the sub-prime property crisis started in the United States, but because the securitised financial instruments used in America were the same as those used in many other places (and because banks around the world found they had financed US mortgage lending) much of the world ended up with a nearly identical problem.
To illustrate the point in another way, while many UK building societies are finding themselves over-stretched and overexposed to unwise and excessive property lending, so have their cousins in Spain. Cajas are municipally-backed mutual savings and loans institutions that are part of the foundation of the Spanish financial system. And they are now in very deep trouble.
Collectively, the 45 cajas account for about half of the Spanish banking sector. Caja Madrid is the country’s second largest savings bank and fourth largest financial institution. Caja Laboral is part of the Mondragon Co-operative Corporation – the iconic Basque federation of co-operative institutions that was an affront to the dictator General Franco and an inspiration to a generation of co-operators in the UK and around the world.
Like other mortgage lenders, Spain’s cajas now find that they loaned far too much for house purchases on properties that are now worth much less than they were in the boom. Spain’s property sector burst far more dramatically than elsewhere in the Mediterranean and in a manner akin to the crisis in the US, Ireland and the UK. This may, in part, have been connected to the influence the British have had in buying-up properties in much of the country, importing with them inflated prices and bad borrowing habits.
Now the Spanish government has had to start bailing-out the cajas. The first rescue was the Caja Castilla-La Mancha, given a €9bn guarantee in March to prevent its collapse. Spain had sought a rescue merger with Unicaja, but this fell through. (Any resonance with UK building societies here?) The caja’s management was forced to retire as part of the terms of the deal.
There are fears that other cajas are now vulnerable. The giant Caja Madrid is reportedly unable to service €143m of repayments on a large mortgage-backed bond, following heavy bad debts on the underlying loans to customers. Apparently, 16% of the mortgages are either three months or more in arrears, or the borrowers have advised they are unable to make repayments. In total, Caja Madrid has issed more than $9bn of mortgage-backed bonds. The caja is thought to be considering issuing up to €3bn worth of shares to give it an additional capital buffer to tide it through the crisis.
Other cajas are also in serious problems. Spain’s largest bank is the Santander, which seems to be emerging from the global collapse of the financial system in amazingly good health. It has just announced that it is rebranding its disparate empire of collapsed former building societies – Abbey, Alliance & Leicester and Bradford & Bingley – under the sole Santander name. Its acquisition spree has been enabled by it apparently having concentrated on its role as a retail bank, avoiding exposure to bad loans. (It did, though, finance investments in the fraudulent Madoff funds.)
Moody’s warns that more cajas could fail in the coming months. Some 36 cajas and other Spanish banks have been warned they may be downgraded by the credit ratings agency, which expects more loans – consumer debt, as well as mortgages – to turn bad. At present, defaults on loans in Spain are running at a worrying 4.27%. Credit Suisse expects they could yet rise to double that.
The underlying factor that concerns Credit Suisse is that Spanish unemployment is predicted to rise to a staggering 20% plus during next year, owing to the country’s dependence on the construction and property sectors. It is, of course, also highly exposed to a tourism industry, that could have its worst year in 2009 for some time. Spain is not expected by the European Commission to emerge from recession for another two years or so, the last member state to do so. (Ireland might, though, be a worthy competitor in this role.)
Moody’s has not said so, but I wonder whether its observations of the plight of the Spanish cajas has influenced its downgrades of nine UK building societies. Despite some recent upturns in house price values, many observers believe the UK property market has another 10% or so to fall yet. It is not impossible that the British economy could worsen severely in coming months, in a parallel dive to that of Spain. Moody’s appears to take this view, given the assumptions it made when assessing the building societies.
A few days ago I was reading a submission by the Chartered Institute of Management Accountants, suggesting revisions to the Combined Code – which provides the basis for the corporate governance of institutions. One of CIMA’s observations was that non-executive directors need to be capable of independent thought, able to challenge executives and free from the trap of the herd instinct.
Sadly, across the world, much of the mutual sector has yielded to that herd instinct. Financial mutuals followed the US and UK banks’ securitisation of mortgages model, believing this was an opportunity for them to earn much higher returns and increase lending. In doing so, they formed their own herd of sheep, copying practices that seemed to be successful.
Those sheep are now, in the terminology of the City, ‘taking a haircut’, losing the fleeces grown over many decades. Tragically, the result is that the mutual sector globally is likely to be smaller at the end of this year than it was at its beginning.