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Mortgage Delinquencies Swept Under the Rug

Back in August of 2012, we wrote about "Spain's Curiously Low Mortgage Defaults" and noted that the CEO of Santander essentially accused doubters of being retards. Here is how he explained the phenomenon at the time:

"JPMorgan Chase & Co. (NYSE:JPM), the world's largest bond underwriter, predicts that Spanish mortgage arrears will surge as unemployment rises. That's also the view from the international debt market, which has driven up yields on Spain's bonds in a bet the country will have to bail out banks.

In Spain, Banco Santander SA Chief Executive Officer Alfredo Saenz said yesterday that's nonsense. "Mortgages get paid in good times and in bad," he said in a news conference at the bank's headquarters outside Madrid. "Anyone raising this problem as one of the issues for the Spanish financial system is saying something stupid."

(emphasis added)

Not everyone was taken in though. As one observer noted:

"There does seem to be a strange contrast between the high level of unemployment and the surprisingly low level of delinquencies on mortgages," said Georg Grodzki, who helps oversee $515 billion as head of credit research at Legal & General Plc in London. "This raises the issue of whether loans have been amended to make them look current when in fact they are distressed."

(emphasis added)

Wonder no longer! The answer to the question has just arrived, via the Wall Street Journal. Contrary to Mr. Saenz' assertion, those who said that this was going to be problem not only were not 'stupid,' but rightly suspected that he and his colleagues were engaged in dubious 'extend & pretend' machinations designed to hide the true state of the mortgage delinquency situation. It has now turned out that this suspicion was well founded.

The WSJ writes: "Spain's Banks Boost Books by Refinancing Loans to Homeowners"

Who would have thought! It may prove slightly embarrassing that this is coming out after the EU has arranged a €100 billion bailout for Spain's banks.

"It has puzzled Spanish bank analysts for years: Why did the country's mortgage delinquency rate rise so slowly even as unemployment soared above 26%?

A big part of the answer-revealed by a spate of bank earnings reports in recent days-is that Spanish lenders had been making their loan books look healthier than they really were by refinancing big numbers of loans to struggling homeowners and businesses.

The lower interest rates and easier terms of refinancing helped hundreds of thousands of Spaniards like Juan Carlos Díaz, who stopped making mortgage payments more than a year ago, remain in their homes and keep their businesses afloat longer than otherwise would have been possible. It has also helped banks bury a growing risk in their credit portfolios and avoid recognizing losses on debts they are unlikely to recover.

Now, more stringent disclosure guidelines from Spanish banking authorities are bringing these risks into the open. Partly as a result, mortgage delinquency is rising fast-a trend that could damp recent investor enthusiasm for a bailed-out banking industry rebounding from a property-market crash.

(emphasis added)

Will Mr. Saenz apologize for insulting all those who had been wondering about the tricks Spain's banks used to try to pull the wool over everyone's eyes? Probably not. Meanwhile, in spite of Sareb (Spain's 'bad bank' - is there a good one?) taking almost €40 billion of bad loans off the books of Spanish banks, NPLs have just soared to a new all time high:


Spain's NPLs soar to a new all time high of 12.12%. They would be even higher if not for Sareb (Spain's 'bad bank') taking bad assets off the banks' books late last year.

Apparently the only reason why we are now officially apprised of all this is that the rules have been changed, necessitating disclosure. The WSJ among other things actually lets us in on Santander's 'extend and pretend' practices as well.

"The Bank of Spain, the country's central bank, began forcing banks in April to re-evaluate and disclose their refinanced loan books out of concern that some lenders had been taking advantage of relatively loose guidelines to mask the deteriorating creditworthiness of their clients. As Spain's economic slump deepened, the Bank of Spain said at the time, "Difficulties considered to be temporary in many cases have become structural."

[...]

The results have been striking. Since December 2012, the amount of refinanced home mortgages gone sour has doubled at Spain's six largest banks even as their refinanced loan books grew a little, according to the banks' financial statements. The Bank of Spain has said banks had refinanced roughly one of every 12 outstanding home mortgages, or €50.8 billion ($68.5 billion). All doubtful loans, including those to businesses and government entities, now account for 46% of the six banks' refinanced total, compared with 36% in December.

Banco Santander SA, Spain's biggest bank by assets, reclassified €2 billion worth of mortgages as nonperforming due to the rule change. In 2011, the bank offered a three-year grace period to customers who had seen their income drop more than 25% and were having trouble servicing their loans. By June, the bank says, just over 22,000 customers had signed on to the moratorium. Many of these loans have now been reclassified as nonperforming. A Santander executive in July said that 93% of the loans that were reclassified actually continue to pay monthly mortgage payments.

(emphasis added)

It is a small miracle that the Bank of Spain has enforced such stringent new rules. Readers may recall that the BoS as for years sotto voce declared that the problems of Spain's banks were insignificant. 'Nothing to see here, move along', was the motto. This has presumably changed due to the conditions attached to the EU bailout.

Real Estate Prices Keep Plunging

As the WSJ notes, it may well be that more time bombs are lurking in Spanish bank balance sheets. The 'extend & pretend' strategy is no longer working - to hope that things will get better is like 'hoping one will win the lottery' as one observer remarks:

"Spanish banks are devoting billions of euros in provisions to cover newly recognized refinanced loans gone bad. The hit, though large, is manageable for Spain's banks. But it will drag on bank profits this year and likely next year, said Santiago López, a bank analyst with Exane BNP Paribas.

It also raises questions about whether banks have continued to sweep under the rug loan losses lurking on their balance sheets, a concern that has dogged the sector since the start of Spain's economic crisis. For years following the real estate crash in 2008, analysts say, lenders applied an "extend-and-pretend" approach by refinancing ailing real-estate developers. Ultimately, banks were forced to recognize those losses, spurring last year's €41 billion European Union bailout of Spain's banking system.

Refinancing struggling homeowners "only pushes the problem forward without finding long-lasting solutions because in the end, the debts only grow while the borrower's capacity to repay doesn't improve," said Carlos Baños, chairman of AFES, an association that advises mortgage holders who have trouble paying their debts. "These days it's hard to see things getting better unless you win the lottery."

(emphasis added)

If Santi says the hit is 'manageable', we believe him - he is an analyst who has rightly been extremely skeptical of the claims made by Spain's bank managers over the years, and to our knowledge, he never shies away from voicing a negative opinion if appropriate.

Of course, one must keep in mind that we are talking about a moving target here. Now that houses are increasingly foreclosed upon, the pressure on real estate prices is bound to increase further. This, in turn, is going to increase the losses associated with mortgages that were issued during the bubble era.

Indeed, one of the reasons why it is so hard to see things getting better is that house prices continue to plummet. In Spain there is one house for every 1.7 inhabitants, and the population is shrinking. It is hard to tell at what level this market will actually clear.

(click to enlarge)
Spain's real estate prices continue to plunge.

Since Mr. Saenz gave his fateful interview, the rate of non-performing home loans as a percentage of total NPLs has increased from about 2.6% to 5.2%, or more than €30 billion, at present. 'Doubtful refinanced mortgages' at the six largest banks have jumped to €15.84 billion from €8.36 billion 10 months ago.

Our bet would be that further increases in all these categories are still to come. Meanwhile, Spain's banks can at least hope that unemployment has finally crested, and a number of other positive developments can be seen in Spain's economy lately. The entire government bond yield curve has sharply declined for instance, but one must not forget that this is largely a side-effect of the three-card Monte played between commercial banks, the government and the ECB (whereby the banks load up on government debt and obtain funding for this carry trade from the central bank).

(click to enlarge)

Spain's government bond yield curve in three observation time windows.

Other recently reported positive data points are an improvement in consumer confidence and the first year-on-year growth in retail sales since 2010:

(click to enlarge)Spain: consumer confidence and retail sales. The first glimmer of hope in many a moon.

Conclusion:

Spain is far from out of the woods, although a few economic indicators point to things no longer getting worse, with the occasional bright spot actually emerging. However, the banking system's woes seem not over. With mortgage NPLs now just above 5% of all NPLs, there still seems to be a lot of room for growth in that particular segment. Lastly, below is an infographic on Spain's regions that has been posted at the FT recently, which shows their economic output, financial situation as well as other information. Among upcoming political events like elections we find the soon-to-be-held election in Catalonia, which could lead to a referendum on independence. This is Spain's richest region, and if it ceased to pay tribute to Madrid, the latter would obviously have a big problem. As Edward Hugh always points out, very few people seem to have the possible secession of Catalonia on their radar - but it is actually something that could very easily happen. Stay tuned.

(click to enlarge)


Charts and tables by: Reuters, FT

Source: Spain's Banking Woes