Government presents reform of financial system aimed at reorganising and consolidating the sector

02 February 2012

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EFE

On Thursday, the Minister for Economic Affairs and Competition, Luis de Guindos, explained the reform of the financial system with which the Government intends to achieve a more organised sector of a better size, thus enabling it to fulfil its main purpose: lending money to families and businesses to achieve a return to economic growth and job creation.

The new outline for reorganising and consolidating the financial sector, which is expected to be approved on Friday at the Council of Ministers meeting, is one of the key elements (together with the budgetary and labour reforms) of the Government's structural reform programme, which in turn forms part of the commitments assumed by Spain with its European partners, and is fundamental to recovering the confidence of the international financial markets.

The reform aims to dissipate market doubts over the valuation of property assets (land, developments and homes) held by financial entities on their books, a process that will encourage properties to be put on the market at more accessible prices.

The financial sector will emerge stronger from this process. Fewer entities will exist after this process but those that do will be of a more sound nature, meaning that Spanish entities will be among the best organised and structured in the EU. No other country in the European Union has designed a similar asset reorganisation process, in spite of the fact that the financial crisis has affected some of them to a greater extent.

Unlike the situation in other countries, the reform in Spain will have no impact on the public deficit. In other words, the reform will be implemented at absolutely no cost to the taxpayer given that the reorganisation processes will be assumed by the entities themselves and the costs paid for from results or capital, for which reasonable periods are established.

Reorganisation of real estate assets

EFE

Real estate assets associated with loans to developers throughout the Spanish financial system are worth a total of 323 billion euros (at 30 June 2011), of which 175 billion fall into the category of problematic (88 billion in land and ongoing developments and 87 billion in completed developments and delivered homes). The average levels of current coverage of entities over all problematic assets stand at 31% (land), 27% (ongoing developments) and 25% (completed developments and homes).

The uncertainty surrounding the valuation of these assets is one of the factors making it difficult for the entities to access the wholesale financial markets, thus leading to the corresponding reduction of credit for financing the private sector of the economy.

It is therefore essential to clarify the situation and obtain a valuation of these assets that is more in line with the market.

With this objective in mind, additional reorganisation processes will be undertaken for a value of 50 billion euros through new capital provisions and safety nets. Those entities that participate in merger processes (consolidation) will be in a more flexible position to adapt to the new framework. The goal is to adjust the excess capacity that exists in the sector as a whole and for that to improve the efficiency of the new entities. In short, there will be fewer entities but they will be better organised.

A specific provision is planned for problematic assets (an extraordinary amount charged to results) amounting to approximately 25 billion euros. A safety net of 20% for land assets and 15% for ongoing developments is also planned, which will be charged to non-distributed profits, capital increases or the conversion of hybrids (preferentials, convertible bonds, subordinate debt, etc.) for an estimated amount of approximately 15 billion euros.

As for non-problematic assets associated with property development, a general provision of 7% is planned to cover a possible deterioration in the future given that they represent a greater risk than the rest of the credit portfolio. This provision will be made against results and is estimated at approximately 10 billion euros. The deadline for implementing the specific provision, the general provision and the capital provision will be 31 December 2012.

Following the reform, the specific provisions plus the capital safety net will cover 80% of problematic assets (31% until now) in the case of land, 65% in the case of ongoing promotions (previously 27%) and 35% in the case of completed developments and homes (previously 25%).

The total sum of the reorganisation, considering the provisions and the capital safety net, will amount to 50 billion euros. This is an extraordinary sum and will therefore only be called for once. It is a highly substantial reorganisation effort given that the effort made by the Spanish banking sector between 2008 and 2011 (with specific provisions) amounted to 66 billion euros in total.

Increased concentration to gain efficiency

The system of mergers established in the regulations to be approved on Friday by the Council of Ministers states that those entities opting for this method will need to present a feasibility plan and corporate governance measures that enable rapid and efficient integration. Furthermore, those entities undergoing a merger process will need to assume commitments linked to making more credit available.

The deadlines for concluding the concentration processes will be extremely short. The entities will need to present their merger plans before 30 May and requests will be decided on within a month.

In order to encourage this process of mergers and consolidation, entities will be given two years to complete the reorganisation process being demanded of them. The required reorganisation of assets may be made against the asset value. In the event of requesting finance from the Fund for Ordered Bank Restructuring (Spanish acronym: FROB), this may be done via convertible contingency bonds. The equity of the FROB will be increased to 15 billion euros in such a way as to improve its lending capacity.

In short, this significant reorganisation effort will lead to better access by credit entities to the capital markets and an improved flow of credit into the real economy, with the subsequent positive impact on production and employment. It will also make it easier for property assets being held by banks to come onto the market, with the subsequent drop in property prices.