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Friday, August 29, 2008

Spain Retail Sales Continue Their Decline

Retail sales in Spain fell for an eighth consecutive month in July as record oil prices and the knock-on effects of a housing market slowdown driven by a creeping financial crisis in the banking sector continued to hit consumers' purchasing power.

Retail sales fell a seasonally and working day adjusted 6 percent from July 2007, the second-biggest decline registered since the series began in 2005, according to the latest data from the National Statistics Institute. The largest decline ever on this time series was in fact the 7.9 percent slump registered in June. Adjusted sales were down 0.4 percent from June.



Car sales slumped 28 percent in July from July 2007, the Spanish Automakers Association said this month.

We should not expect this rapid rate of decline to be sustained going forward, even as the economic crisis deepens, since by the time we get to November we will start to see the "low base effect" from 2007, since of course we started entering negative annual numbers in the late autumn of 2007. According to the seasonally adjusted time series the INE supply to Eurostat, the all time peak in Spanish sales was in July 2007, and it will be a long long time (years) before we ever get back to that level. At least this is my forecast, now let's go and see.

Caja Madrid and Banco Popular Struggle To Sell Loans

As I say, this whol problem is being driven by a credit crunch related financial problem in Spain's banking system (and not by interest rate policy at the ECB) and Reuter's Elena Moya reports just this morning on the difficulties Banco Popular and Caja Madrid are now having selling their debt, and how they have had to delay and significantly reduce sales of non-performing loans (NPLs) due to lack of interest.

Of course, what "lack of interest" means here is that they are asking too much. And why, you may ask, do these banks want to sell their NPLs? Well in the first place they need liquidity, and in the second place selling the NPLs is a profit and loss issue, and not an issue for their loan delinquency ratio (since they no longer have the delinquency), and of course the credit ratings agencies are looking at the collateralisation levels on their bad debt provisions (these are what you will normally see quoted in the newspaper articles) a lot more closely than they are looking at declared profits at this point.

Thus, Spain's financial institutions, under pressure to clean up their books, are under growing pressure to cut prices to move the debt.

PriceWaterhouseCoopers, for example, the accountancy firm which advises Caja Madrid on its NPL sales, recently cut the size of one transaction to about 130 million euros ($191.6 million) from an initial asking price estimated to have been around 300 million euros. This is a very substantial reduction - I mean they don't seem to be getting much more than 30% off their debt at this point - and this suggests the level of pressure they are under.

Moya suggests that private equity firms and distressed fund investors which have recently bought distressed assets in Spain -- including Lehman Brothers, Apollo and Carval want to replicate the very attractive deals obtained in the US, such as Lone Star's purchase of a $30.6 billion distressed portfolio from Merrill Lynch at 22 cents per dollar, or a previous sale of UBS assets to fund manager BlackRock.

International investors also require further discounts in Spain as banks normally provide insufficient information, or use old or unrealistic valuation when setting up transactions. Martinsa Fadesa, the real estate firm which filed for Spain's biggest insolvency ever in July, for example, recently acknowledged that the 10 billion-euro valuation of its assets was totally out of date.


The number of bad loans held by Spanish banks jumpedby more than 10 percent in June, taking the rise to 164 percent over the past 12 months, according to Bank of Spain data earlier this month. Fitch Ratings recently downgraded six sets of Spanish mortgage securities issued by Banco Santander, highlighting "the high percentage of loans written off during recent periods".

"The substantial arrears within the transactions suggest the current pace of write-offs will continue, leading to further reserve fund draws in the coming quarters" Fitch said.


Consumer Price Inflation Falls Back Slightly In August


On mildly positive piece of news is that Spain's inflation rate eased back slightly in August, to an annual rate of 4.9 percent, thanks mainly to lower oil prices, according to a preliminary flash estimate from the National Statistics Institute yesterday. The institute said the harmonized consumer price index fell 0.4 percentage points in August, only the second drop in the past 12 months. The yearly rate compares to an annual 5.3% in July and 2.2 percent in August 2007.


Thursday, August 28, 2008

Spain's Budget Deficit Rising Sharply and Other Matters

by Edward Hugh: Palamos (Costa Brava)





Well, hello everyone. I'm supposed to be on holiday at the moment, but since economic events simply refuse to stand still (not even for me, and especially not in Russia), what else can I do. In theory I'm resting quietly in that nice looking building behind the Palamos lighthouse you can see in the photo above, and since time and Spain's developing economic crisis stand still for no man, then here I am sitting sweating it out in the local cyber cafe.

Rising Government Deficit



Spain's central government budget deficit seems to have shot up in July - reaching 9.97 billion euros ($14.75 billion) in the first seven months of 2008. The government did not provide a monthly figure for July, but the accumulated deficit for the first half of the year totalled 4.68 billion euros, so it looks like the July deficit alone as 5.29 billion euros (which presumeably has something to do with the impact on the balance of the government anti crisis measures, like the 400 euro cheques.

A sharp slowdown in economic activity, especially in the building sector, cut net non-financial revenues by 4.2 percent while net non-financial spending rose by 5.9 percent. Spain posted a record budget surplus of 2.2 percent of GDP in 2007, while the economy grew by 3.7 percent.

The Economy Ministry said on Thursday the deficit was equivalent to 0.89 percent of annual gross domestic product and that it compared with a surplus of 7.52 billion euros in the same period last year.But since the deficit was accumulated in only 7 months, then the annual rate would seem to be nearer 1.5% of GDP (up from an annual rate of only 1% of GDP in June and of course rising rapidly). At this speed, it would not be surprising if we were clocking up deficit at the annual rate of 3% by December (which means in theory no more additional measures with breaking the EU limit), and the deficit for 2008 as a whole now looks set to be more than 2% of GDP at a first guess approximation.

GDP Growth Detailed Figures Released

The INE confirmed the 0.1% q-o-q growth rate yesterday (I will try and go through the data a bit more over the weekend) and one thing stands out: investment in Spain slumped, falling by 1.7 percent from the previous quarter. Household consumption increased 0.1 percent after 0.3 percent in the previous three months and government spending propped up the expansion, increasing 1 percent after 0.7 percent.





Also, and as noted in my last post on the May balance of payments data, second quarter growth was actually supported by Spain's external account (which normally cuts into growth) and net trade added 0.3 of a percentage point (that is to say more than the total growth for the quarter, not due to improving exports, but due to falling imports. That is why you can get a strange statistical effect whereby everyone "feels" worse off since they are consuming at a slower rate, but headline GDP gets a boost from the slower consumption. (You can see the same effect in German GDP numbers earlier in the week, and in the US data today).

Basically, my view is that the positive growth registered in Q2 2008 will be the last positive q-o-q reading for the next several quarters.



Mortgage Lending Down Again


Home mortgages fell by 37.7% year on year in June, compared with a drop of 36.2% in May. A total of 43,090 homes were sold in June, compared to 61,595 in June 2007. Transactions in June were also down 6% on May. The capital value of the mortgages loaned in June was 37.1% less than in June 2007.




With stress in financial markets ongoing and unemployment rising rapidly, it is hard to find any convincing reason why the Spanish housing market should improve any time soon. In fact, the situation is likely to get a lot worse before it gets better. We have yet to see year on year falls in the official house price index and it seems only a matter of time until we do.


ECB Pressure ON Spanish Cedula Funding Continues



The debate about what to do about the creation of mortgage backed securities expressly for deposit at the ECB continues. According to Unicredit SpA Spain's banks have accumulated 89 billion euros of their own asset-backed securities, more than any euro-region country, for use with the ECB as collateral in auctions. As reported on this blog here, various influential members of the central bank governing body have been loudly indicating that the ECB is about to change the rules. Many of these securities may have been specifically created with a view to refinancing the cedulas which need to be rolled over in the autumn, but frankly I will believe it when I see it as far as any ECB action goes, since with all the rumpus they have created over their interest rate policy they would hardly want to find themselves being balmed for a major banking crisis in Spain at this point.


Large Estate Agents Slimming Down Rapidly

El Pais is reporting that the 10 largest estate agents in Spain have closed more than half their offices in the last six months. The collapse in home sales has forced 2 national chains of estate agents into administration (MC Inmobiliaria from Andalucia, and Expofincas from Catalonia). 2 others, Fincas Corral and Don Piso, have been put up for sale, though so far without any takers. At the end of last year, 9 of the 10 biggest agents in Spain had more than 100 offices around the country. Today, only 3 of them have more than 100 offices. They have gone from a combined total of 3,000 offices at the end of last year to just 1,434 today.

Monday, August 25, 2008

Spanish Producer Prices Hit 24 Year High In July

Spain's producer prices rose at an incredible 10.2% annual rate in July - the fastest pace in almost 24 years in July as record oil prices increased costs for Spanish manufacturers. Producer prices were up 1.4 percent from June, the biggest monthly increase in more than two years.




Crude oil prices a record $147.27 a barrel in New York in mid July, and that helped push euro-zone consumer price inflation to more than a 16-year high, in the process making it harder for European Central Bank to cut interest rates, even as the region's economy slows.

The price of intermediate goods in Spain rose 7.3 percent from a year earlier, compared with 6.3 percent in June, signaling further rises in consumer prices are in the pipeline.

Oil has now fallen back 22 percent from its July record and it is likely that Spain's producer price inflation peaked in July. Also the economic slowdown should, in theory, make it difficult for companies to pass on higher production costs to consumers. But what is hard to understand at this point is why German producer prices - where oil costs cannot have risen very differently - are only up by 8.9% in July, or why German monthly consumer prices rose at 3.5%, while Spain's consumer prices gained 5.3 percent in July from a year earlier. This is hardly evidence of an economy that is responding and correcting going into the slowdown, in fact it is quite the opposite, and demonstrates the presence of an economy with a high level of structural rigidities and time delays in response, which will only, unfortunately, add to the pain during the coming long recession.


ECB To Make "Changes" Yves Mersch Says


ECB council member Yves Mersch said in an interview with Bloomberg - given at Jackson Hole - that the European Central Bank is about to announce changes to the rules governing its money-market auctions in coming weeks to head off the risk of abuse by financial institutions.

These comments comments the controversy which has arisen surrounding a recent press interview with Dutch policy maker Nout Wellink where Wellink stated that banks shouldn't become too dependent on the ECB for funding (see my last post for more details on all this).

Two items which are being widely talked about as the most likely candidates for such changes are risk control measures, and restrictions on the place of issue for marketable assets eligible as collateral. The first is to address the concern that some banks are creating securities (like cedulas hipotecarias) specifically for use as collateral at the ECB which are being accepted by the ECB as having investment grade despite only having been rated by one agency (as opposed to the two which was standard practice in the past).

The second addresses the concern that securities may be being issued in one country of origin, deposited in the vaults of the ECB as collateral for borrowing, and then the funds themselves transferred for lending to bank deposits in a third country - for example Dutch banks might be raising money in the Netherlands (or German banks in Germany) and then transferring funds for aggressive lending in Spain (in order to gain market share against Spain's highly stretched national banks). There is no direct evidence that this is happening, but JP Morgan did estimate back in May that 240 billion euros of securities had been specifically created by eurozone banks with a view to being deposited at the ECB, and Spains banks only owe the ECB a total of 49 billion euros, so someone somewhere is doing something with all that money.

It is hard to know really what has been happening, since if there is one thing the ECB isn't it is transparent, and so we are only left clutching at straws and making suppositions. One recent piece of evidence we do have is that U.K. mortgage lender Nationwide Building Society said Aug. 18 it's planning to expand into Ireland, a member of the euro region, to take advantage of ``funding opportunities.'' But this would seem to refer to a non zone institution leveraging funds for use outside the zone (in the UK for example, which may well be happening), but what I am suggesting may well be happening is some sort of Credit Default Swap type "put" by canny non-Spanish banks who want future market share in Spain raising securities and making risky loans in the full expectation that since there is going to have to be some type of bail out for Spain, then they will get bailed out too.

Anyway, this is likely to remain a rather obscure topic, since as Mersch says in the interview, the ECB's response to any abuse case ``would not necessarily be a question to be discussed publicly.''

I am sure it wouldn't.

Thursday, August 21, 2008

Spain's Trade Deficit Rises in June 2008 As Does The Noise Level Surrounding ECB Funding of Spanish Banks

Spain's trade deficit hit 51.5 billion euros ($76.32 billion) in the first six months of the year, up 11.4 percent from the same period a year earlier, the Industry, Tourism and Trade Ministry said on Thursday. In the month of June alone, the trade deficit came in at 8.66 billion euros, up 4.2 percent from the same month a year earlier. Exports fell 4 percent in the month compared to June 2007 and and imports fell by 1.2 percent. Spain's trade deficit is the main component of its gaping current account deficit - the broadest measure of the nation's commerce with the rest of the world - which is running at about 10 percent of gross domestic product.


Money At The ECB Auctions

As reported on this blog at the end of last week, the European Central Bank lent a record 49.4 billion euros ($73.6 billion) to Spain's banks in July, with lending to Spain rising from 47.1 billion euros in June and 18 billion euros a year ago. This little data point now seems to be attracting rather a lot of interest, since Ambrose has a piece over at the Daily Telegraph, while the Wall Street Journal Blog adds its two cents worth.

The source of all the recent fuss is an interview which the President of the Dutch Central Bank Nout Wellink gave to the newspaper Financieele Dagblad (you can find a translation of the whole article by the US blogger Edward Harrison here).

So the knotty little problem of Spanish funding from the ECB is rearing its ugly head yet one more time. Personally my feeling is that this issue is being rather overblown at this point. Ambrose is scratching around in the right areas, but I think he doesn't fully understand the problem (see more below).

The point is that Spanish bank borrowing at this point is not that high PROPRORTIONATELY. Total ECB funding of eurozone banks is running at around 460 billion, so the Spanish banks are still only up to about 10.65%, which is not that much above their participation in ECB financing (the so called "key" -7.55%).

As all the authoritative commentators point out the Spanish banks are not standing out especially for their use of the ECB facility (although they have accelerated their recourse to this facility very rapidly since last August), and have mainly drawn according to the weight of their share in the eurozone itself. One explanation for the fact that they have not tried to obtain more (since I am sure they need it) may be found in statements made during the most recent appearance of Bank of Spain governor, Miguel A. Fernandez Ordoñez, before the Economy and Taxation Commission of the Spanish Congress. There he stated (June 24, p9) that Spanish banks have increased their participation in eurosystem fundings, "without going far beyond the equivalent participation in the key of Bank of Spain in ECB´s capital".

The rule they have been trying to apply is not to go much beyond the key subscription of the BoE to the ECB capital (which is 7.55%).

My feeling is that this situation is being policed as best they can by the Bank of Spain, and they are trying to hold a line, although obviously things are now starting to get out of hand, as witnessed by the latest months increase - up to 49.4 billion euros in July, from 47.1 billion euros in June - which edges them up just that little bit further beyond their participation share, and this is what is causing all the fuss. Clearly as Not Wellink suggests things can't go on like this.

Not Wellink is also clearly right when he says "If we see banks becoming very dependent on central banks, then we must push them to tap other sources of funding," but the problem is that the market will now demand a lot more from the Spanish Banks for refunding the cedulas, and this would mean that something legally would have to change in Spain to enable the banks to charge ALL their customers significantly more than the small surcharge over euribor-one-year they currently receive to be able to service the refinance. And this "small change" in the mortgage regulations is obviously something the Spanish government can't face up to politically.

The principal point about the Spanish use of the ECB facility is not so much the quantity, as who it is that is doing the borrowing. If it is - as the Daily Telegraph suggests - mainly small regional cajas, then this is even more serious. It is more serious since normally you would expect the Spanish banks to go in convoy, and the big ones help the little ones. But as we have been seeing on this blog, even rather large entities like Caja Madrid and Banco Popular are themselves now having problems, and thus the big fish no longer have the liquidity themselves to help the small ones. I would take it that this is the real problem, and that the money being sought at the ECB auctions is only the tip of the iceberg.

Basically the Spanish banking system has a problem just as large in its way as the FannyMae and FreddyMac one, since they have 300 billion euros or so in ceduas hipotecarias to refinance over the next 5 years (not counting all the other RMBS's which are knocking about, which have equal or greater value, even if the term on these may not present the same sort of problem), starting with 40 billion or so this autumn.

But Spain has no Hank Paulson with his bazooka to come to the rescue. And as we can see in the US arming up the bazooka can simply make its use unavoidable, and this is obviously what the unnamed source behind this Daily Telegraph quote was obviously getting at:

"Nobody dares pinpoint the country involved because as soon as we do it will cause a market reaction and lead to a meltdown for the banks"

But all of this is, unfortunately, now more or less inevitable.

Incidentally, despite what Ambrose says, the ECB money isn't precisely taxpayers money at this point. They are simply making loans from the resources they have via the reserves deposited with them through the eurozone banking system, and they have some money of their own via seinorage, I guess. And they are lending it, not giving it. The point at issue is simply that they are accepting what are really junk bond status cedulas as if they had investment grade, with the helpful support at this point of rating agencies like Moody's who at the same time deny this status to much more sustainable debt in places like India, Brazil and Peru.

But even the ratings agencies are now getting nervous, and are busily working their way through numerous trances of debt issued by the Spanish banks conduits - Santander's Hipotecario 4, Caja Madrid's RMBS III FTA etc - and indeed, as the WSJ article notes, many Spanish banks are now only able to get a rating from a single agency on their new issues (which often go straight to the ECB) while previously it was standard parctice to have two.


So the question we really need to face up to is: who is the Brussels equivalent of Hank Paulson, and just when is he or she going to arm up the bazooka, because the Spanish banking system - just like FannyMae and FreddyMac - is going to need a substantial re-capitalisation, if not outright nationalisation, and the Spanish treasury does not have the resources for this alone. And don't miss the point that it may well be difficult for the Spanish treasury to guarantee bank deposits as happened in Germany (after 1995) and Japan (after 1992) or has happened recently in the UK in the case of Northern Rock, since under the terms of the cedulas if a bank fails the cedula holders have to be paid out in full before any depositor receives a penny (and maybe they even have access to the underlying asset, that's why the interest they carry was so cheap, they were meant to be watertight, just as safe as the best sovereign debt, just as safe as.... houses, and indeed, being realistic, they were expected to be even safer than Italian or Greek sovereign debt).

So compared to all this that is to come (plus other little memoranda items here and ther like the 30 billion euro debt of Ferrovial I was reporting on yesterday) the 49 billion euros currently outstanding at the ECB could be considered to be a mere trifle, and certainly only a warm up taster.

Now I said above I felt that Ambrose doesn't really understand the full extent of the current problem, and I think this is clear when he says the following:

"This "soft bail-out" is largely underwritten by German and North European taxpayers, though it is occurring in a surreptitious way."


My feeling is he is confusing two issue here, the current account deficit, and the problem of who is later going to pay for all the broken plates. Spain's CA deficit has been paid for basically up to now by savers in Germany, Holland and Finland (ie in those eurozone countries running CA surplues), but these savers - via their agents - now want to be paid more for the risk they are assuming, and this is at the heart of the present difficulty, since what Spain had to offer as a warranty to back the lending was property, and this property is in the process of a revaluation.

Indirectly this fininacing difficulty is showing up on the books of the ECB, since the banking system in these CA suplus countries is a net saver, and not a net borrower. At the same time of course, due to their recent housing boom, some Dutch banks need ECB help, even though the country itself runs a large net CA surplus (6.5% GDP 2007). So the issue is a complicated one.

I don't think taxpayers money from other countries is arriving in any direct form to the Spanish banks at this point. The theoretical issue is why some countries - Germany, Holland, Finland - have been running surpluses, while others - France, Ireland, Spain, Portugal, Greece - have been running deficits. (Of course the UK also has a CA deficit, but it is not in the eurozone, but this makes it hard to say that it is simply a "Latin" phenomenon).

EMU was posited on structural convergence taking place between countries. This is just not happening, and it is this absence of convergence, rather than the difficulties in applying a one size fits all monetary policy, that is really the big underlying issue. There are various possible explanations why countries are not converging, but one of my strong feelings is that demographic assymetries have a lot to do with the situation.


Back To the Cajas


So winding up this section on ECB finance and the Spanish banking system, why don't we go back to where we started:the regional cajas.The Spanish newspaper Expansion has an interesting article today (Spanish only I'm afraid)about the state of Spain's saving banks - the Cajas de Ahorro. Basically Expansion reports that a total of ten regional cajas have now seen the level of bad debts rise above the 2% mark, which is the quantity set aside by the Confederación Española de Cajas de Ahorros as the benchmark provision for this eventuality. As Expansion notes there is nothing especially alarming in this number when compared with levels prevailing in other countries, what is worrying is the rate of increase, since Spanish banks and cajas have traditionally had very low levels of loan defaults, and indeed while the ten savings banks now have a provisions ratio of under 100%, even as late as the end of 2007 the ratio for the whole group was 217%.


Expansion does not offer us a list of the ten main offenders, but it does say that of the 35 cajas who have reported to date on their first half performance, 11 have default levels above the 2% provision. Expansion also mentions that a number of the cajas were negatively affected by the entry in administration of Martinsa Fadesa, and mentions the example of Caja Sabadell where the default level has risen to 3.24% following the impact of Martinsa Fadesa.

Expansion also single out Caja España, who reported last Thursday, as the caja with the highest default ratio - 3.9% - among those who have reported so far. Caja España has doubled its provisions, but has still to give a figure for its cover ratio. Among the larger cajas Expansion single out Caja de Ahorros Mediterraneos (CAM) which has the lowest cover ratio (only 50.6%) followed by Caixa Catalunya with 91.7%. (Incidentally Expansion also reports that CAM shares have fallen 5% in the month since they started trading despite the fact that Lehmann Brothers - who arranged the float - have bought 1.3 million shares at a price of 5.64 euros each and significantly above the current market price of 5.55 euros). They also make the point that many Cajas are currently busy trying to "clean up" their books a bit as regards loan defaults by selling the loans off at a loss, a move which does not recover the full value of the debt, but technically moves the number out of the bad debts section of the accounts and directly into the profit and loss section.

Eurozone Recession On the Horizon?

Is the first zone wide recession in the short history of the eurozone about to be registered? Certainly the flash PMI estimates for August give the impression that it might. The Royal Bank of Scotland Group Plc's composite index came in at 48 after 47.8 reading in July. Any result under 50 indicates contraction. Unfortunately we only get flash estimate breakdowns for France and Germany, but it isn't that difficult to deduce from the composite number that Spain and Italy continue to contract - although given that the composite rebounded slightly, while both services and manufacturing slowed in Germany, and in France manufacturing contracted more sharply in July while the contraction eased a bit in services, then it may be that Spain and Italy weren't contracting quite so strongly in August as they were in July.

Germany


The German manufacturing index fell to 49.9 in August, its lowest level in three years, after slipping back index to 50.9 in July.





Helping to push down the manufacturing indicator was the export component, which fell to its lowest level since June 2003, according to the report from Markit Economics.

The services PMI reading was not much better, falling to 50.6 in August from 52.1 in June. As things stand German services are riding just shy of contraction if the flash reading is borne out in the final result.




In its report, Markit Economics noted that the business expectations sub-index for Germany had slipped to the lowest level since November 2002.

France

Activity in France's manufacturing sector contracted at the sharpest rate in over six years in August, with a contraction of 45.1 being registered, down on July's 47.1 and the lowest level since December 2001.



The service index came in at 48.5, above July's 47.5 but still only its second time in negative territory since mid-2003. New business logged by service firms shrank at its fastest pace since the data was first collected in May 1998.




"If you extrapolate these figures through to the third quarter you're probably looking at stagnation of GDP (gross domestic product)... This is not a harbinger of imminent upturn," said Chris Williamson at data compiler Markit Economics. "Nothing points to a fundamental turnaround... I think there's been a spillover effect from Italy, Spain and now Germany, and France has followed suit."
So Is It Recession, and Will We See Rate Cuts From the ECB


Gross domestic product fell 0.2 percent in the second quarter from the first, when it grew 0.7 percent, according to the data released ny Eurostat (the European Union's statistics offic) last week, and it now seems clear that this contraction may well pass over into the third quarter. In fact Germany's Economy Ministry said only yesterday that the economic outlook in Germany has worsened even beyond the second quarter, when gross domestic product shrank for the first time in four years.

European consumers are not getting much relief from falling oil prices either, since while oil prices have fallen 20 percent from a record $147.27 a barrel on July 11 the euro has dropped 7 percent ($1.4780 today) from its peak of $1.6038 hit on July 15, taking a lot of the edge off the drop. The fall in the euro will however make exporting outside the zone easier, the difficulty is that the demand for exports is slowing generally as the global economy slows.

The European Central Bank, which raised its benchmark rate by a quarter point to 4.25 percent in July, currently predicts growth will slow to about 1.8 percent this year from 2.7 percent in 2007, but today's PMI data would seem to confirm that the ECB's growth projections are no longer realistic and that the time to move over into rate cuts mode is fast approaching.

The Rain In Spain Falls Mainly On.... The Construction Companies

Well, as they say "it never rains but it pours", and while on the Spanish beaches millions may be idly languishing in the sun doing their best not to think about what awaits them on their return to reality in September, on the Spanish plain the rain never ceases to fall, and torrentially so. On Monday it was Caja Madrid, on Tuesday Metrovacesa, on Wednesday Cortefiel, and today it is the turn of Ferrovial, since Ferrovial, which is Spain’s number 2 construction group, was yesterday faced with the serious possibility it may have to sell three of its British airports over the next year, following a damning report by UK competition authorities which attacked its dominance of the industry and its inefficiency.

In its findings the UK Competition Commission provisionally concluded that Ferrovial’s subsidiary, BAA, should be forced to sell two of its three London airports – Heathrow, Gatwick and Stansted – and either Glasgow or Edinburgh in Scotland. The most likely candidates for sale appear to be Gatwick, Stansted and Glasgow.

The commission’s findings – which will now be put out for consultation – raise serious questions about the wisdom of Ferrovial’s purchase of BAA for more than £16bn (€20bn), including debt, in 2006. Ferrovial, which had net debt of €30.2bn in December 2007, may well find it difficult in the present cilmate to sell assets. On top of which buying dear and selling cheap is hardly a sound commercial strategy, especially for a company heavily in debt. Ferrovial's original 8.75-billion-pound ($16 billion) hostile bid was originally rejected by BAA in May 2006. Ferrovial then raised its bid to 9.73 billion pounds ($18.1 billion) but BAA said it was still too low. The final price was eventually over 10 billion pounds, to which must be added the 3 billion pounds for new investment included in the refinancing of 13.3 billion pound ($24.8 billion) completed only 3 days ago (August 18). Not only do many Spanish companies seem to have made a serious error of judgement in getting so involved in a UK market which was also heavily inflated by its own property bubble (I mean really they couldn't have chosen a worse venue on on this count, except, perhaps, for all those ventures out in boom-bust countries to the East, which we will look into in more detail on another occasion). And in addition, as the pound sterling difts down and down, there are those little details of relative currency values to think about here.

Ferrovial shares are down 46 percent since the it closed the purchase of BAA on Aug. 15, 2006. The deal was funded by debt loaded onto the airport operator, forcing it to focus on what is the world's largest-ever refinancing amid an ongoing global credit crunch. BAA, which runs seven U.K. airports, completed a 13.3 billion- pound reorganization only two days ago. BAA stock has lost 31 percent this year amid steadily increasing speculation about its future and about its ability to carry out its function effectively following the cancellation of 600 flights on the opening of Terminal 5 in March.

And those of us who live in Spain, and are "aficcionados" for the finer details of these things, may like to notice how earlier this month, and while half of corporate Spain was starting to fall apart, the Spanish media had a major campaign whose main objective seemed to be to tell us just what "bad people" Ryan Air were. Looking at the situation of almost all out war which exists between Ryan Air and Ferrovial at the moment, this intense media pressure becomes a little more intelligible. Ryanair Holdings Plc, which is Europe's biggest discount carrier and the largest airline at Stansted, issued a statement today calling BAA an "abusive monopoly'' and declaring that a breakup would bring better facilities and lower prices. This, of course, is not the version the Spanish public are getting. And Ryanair’s David O’Brien, chairman of the airlines consultative committee at Stansted, is quoted as saying that the report confirmed the company’s near-monopoly was “bad for consumers and bad for Britain”. Clearly there is little love lost between Ferrovial and Ryan Air at this point in time.

"We are delighted by the decision, which we have been calling for years,"
Ryanair director of legal and regulatory affairs Jim Callaghan told Reuters.



Spanish Bank Lending Slows Again in June

We also now have the June bank lending data from the Bank of Spain. Surprisingly, month on month the lending was up over May, at a provisional 8.4 billion euros versus 4.8 billion euros in May (net increases month on month), and 6 billion in April. In fact the net lending increase in June is the highest figure we have seen since November 2007.

So things are getting better? Well not exactly, since the details matter, and looking at the fine print we find that the mortage component is only up by something under 1 billion euros of that total (850,000 euros approx) while other lending (which is mainly personal, car and home improvement type unsecured lending) was up by slightly over 7 billion euros, a huge increase over the 1.5 billion euro increases in April and May. And the reason for this is obvious: these loans carry a higher interest rate, and thus they are easier for the banks to intermediate since they themselves can afford to pay more to borrow the money (you know, the 7% they are offering on time deposits etc). The thing is all this money does still have to be paid back, even if it goes up in thin air rather down in cement, something which those lying on the beach in Cancun or having a restful month in Japan might care to think about at this point.

Anyway, whatever the distribution of the lending, the year on year rate of increase continues to trend steadily down, reaching 8.5% in June.






And do remember, it isn't only household lending which is being hit by the credit squeeze on the Spanish banks. As we are now seeing day in and day out, corporates are also being badly affected, and of course the interannual rate of credit increase to corporates is also steadily trending down, hitting an inter-annual 7.2% in June.





And the Number Of Tourists Continues To Fall

The number of foreign tourists visiting Spain in July fell 8 percent from the same month a year earlier, the government said on Thursday. A total of 7.1 million tourists from abroad visited Spain in July, the Industry, Tourism and Trade Ministry said in a news release today, adding that the number of French tourists had tumbled 21.6 percent compared to July 2007.

Credit Recovery Swaps

Reuters has an article today about how trading in recovery swaps kicked off in Europe this month. Recovery swaps are a credit derivative instrument which analysts think are likely to gain popularity as Europe's economy slows and more companies (as we are seeing in Spain) start to come under stress.

Recovery swaps are bets on the expected percentage bondholders will get of the amount they are owed in the event that a company defaults. No money changes hands unless there is a default and the swap expires unused if the company does not default.

According to Reuters the market in recovery swaps in Europe involves only three or four big dealers and 10 names at the present time - NXP, Hellas Telecommunications, ONO, Ineos, LyondellBassell, Seat, Truvo Subsidiary which is also known as WDAC, M-real, Thomson SA and Norske Skog.

In a recovery swap with a strike price of, say, 30 percent, the buyer agrees to buy bonds at a recovery rate of 30 percent if there is a default. When the default occurs, he benefits if the actual recovery rate turns out to be higher than the level he agreed to pay. The seller profits if the recovery rate is lower than 30 percent.

Reuters cite Mikhail Foux, a New York-based Citigroup director in credit strategy.
a saying that there are a variety of U.S. investors trading in European recovery swaps including hedge funds, investors in synthetic collateralised debt obligations (CDOs) and capital structure arbitrage players, who seek to profit from dislocations between credit and equity markets.

They also cite University of Texas Professor Henry T.C. Hu as making the evident point that holders of CDS could sabotage a company and other debtholders, because they stand to profit more if it fails than if it survives.





The Cobrador Del Frac


Reuters also has a piece on one of those ever so uniquely Spanish phenomena, the Cobrador del Frac. "El Cobrador del Frac", is the name of a company which specializes in sending men dressed like extras from a 1930s Fred Astaire movie to humiliate debtors into paying up. And according to Reuters business is booming.




Well, at least employment is rising in one sector of the Spanish economy. Maybe they'll be sending people to meet the holiday merrymakers off their planes as they arrive.

Wednesday, August 20, 2008

Cortefiel: The Vultures Circle

As the economy slows, Spain's retail sector is having a more and more difficult time, and as they do the vultures are starting to hover. The "vultures" in this case are what are known as vulture funds who specialise in buying-up the debt of ailing companies on the cheap. According to press reports today some of these funds are starting to take the view that debt from Spanish retailer Cortefiel may now be cheap enough to buy, after waiting months for prices of the struggling company's debt to fall further. Such funds, which have allegedly raised billions of dollars to invest on the hopes that a worsening global economy will depress debt prices, have been rumoured to be closely monitoring the Spanish group, whose debt trades currently at about 42 percent of its face value.

Cortafiel debt is well below the value of average bids on Europe's top 40 leveraged loans. which stood at 87.5 percent of face value on August 8, according to data from Reuters Loan Pricing Corp.

Grupo Cortefiel is the second largest apparel retailer in Spain through Cortefiel (traditional clothing), Springfield (contemporary and cosmopolitan look) and Women's Secret (underwear retailer). The Iberian Peninsula accounts for more than 85% of the revenues of the group. The company operates approximately 1,100 stores and is present outside Iberia through international retail formats and franchise operations (Douglas, Milano, Pedro del Hierro). In September 2005, PAI Partners acquired, jointly with CVC Capital Partners and Permira, a 86.8% shareholding in Cortefiel, following a joint take-over bid launched in July 2005.

Cortefiel - like most other Spanish retail groups is struggling in the face of the recent dramatic slowdown in retail sales - this is how effectively the real economy slowdown operates as a positive feedback mechanism on the financial sector crisis, and why the whole thing is crashing down much more rapidly than most conventional analysts (or, needless to say, Spain's government) seem to understand.






Cortefiel borrowed 1.3 billion euros in June last year in a recapitalization of its 2005 buy-out debt, acquired when the three private equity firms bought the company. Cortefiel's debt is now estimated to be about 1.080 billion euros. The trading company holds 650 million euros of debt, while another 450 million euros were borrowed by a holding company in Luxembourg, which own 85 percent of Cortefiel through another holding company according to reuters reports, with the debt held by the Luxembourg vehicle having been use to pay out to the private equity owners.

Cortefiel forecast between 180 and 190 million in annual earnings before interest, taxes, depreciation and amortization (EBITDA), but with the current slowdown it is well behind on meeting those targets.

Distressed funds buy parts of corporate loans hoping that the price will go up following a market improvement. Another strategy, known as loan-to-own, is to buy the debt and wait for a covenant breach, hoping that a debt-for-equity swap will land the funds an equity stake in the company. Cortefiel's net debt-to-EBITDA ratio was 6.2 times in early July, still well below a cap in bank covenants of 7.6 times, a source said in July. But at about 2 times, the EBITDA-to-interest cover ratio was nearer a covenant mark of 1.9 times, the source said.



Housing Output Continues To Rise

But even as retail sales plummet and demand to by property in Spain may collapses the supply of new homes seems to just keep on rising and rising. Construction completions increased by 2.8% - to 269,954 - in the first 5 months of the year when compared with the same period in 2007 according to figures released by the Ministry of Development yesterday.

Indeed construction completions are likely to carry on increasing for at least another quarter, perhaps longer, as new developments started at the peak of the boom are finished off. This swansong building boom (with no purchasers in sight) will however be short lived, since the number of new homes started is now in its turn collapsing - falling by around 60% in the first 5 months of the year.

People may well find it hard to understand why the number of new homes finished in Spain in 2008 will beat all previous records, simply adding insult to injury over the already existing glut of newly built homes languishing idlyon the market. But this was the information provided recently by non other than Jose Luis Malo de Molina, director general of the Bank of Spain, who declared to an astonished audience “The number of new homes this year will hit an all time high, more than in 2007,” at a recent conference in Valencia.

The logic behind this otherwise bizarre behaviour on the part of the Spanish construction industry was provided for us by Benjamín Muñoz, general secretary of the Valencian Region’s developer association. Speaking to the regional daily ‘Las Provincias’, Muñoz explained that “the real estate sector can’t turn around quickly, it works in the medium and long term, so this year the properties started at the end of 2005 and beginning of 2006 will be completed, which means the number of new properties on the market will hit an all time high.” In other words this industry has no on-off switch to press, the new houses simply keep getting churned out until one of the key components in the machinery finally breaks.


Services Sector Contracts In June

Spains services sector contracted again in June. Month on month it was down 0.2% on May, and year on year it was down 4.8% on June 2007.



If we look at the seasonally unadjusted index provided by the national statistics office, we can see that, despite the fact there is some cyclical seasonal variation, the idex readings are now well down from their previous highs.




Construction Output Drops Again In June

And of course Spain's construction output continues on its downward path. In fact at this point in time the slowdown in construction appears to be eurozone wide, and Eurostat reported today that construction output in the euro zone shrank by 0.6 percent in June from May as slowing economies and a bursting of housing bubbles in countries like Spain hit the whole sector. The European Union's statistical unit Eurostat said that compared with June 2007, construction output in the same month this year sank by 2.4 percent. Slovenia and Spain saw the biggest drops in the single currency area, with month-on-month falls in June of 5.8 percent and 3.1 percent respectively.

Spanish construction was down 15.9% year on year.






And if you are wondering how this reduction in activity squares with the earlier news that more houses were being finished in Spain in 2008 than ever, remember that this data referes to completions, and the reduction in activity is due to the steady slowdown in new building starts, which suggests I think that activity in 2009 will be on a very low level indeed, with few houses started this year, and probably even less in 2009 itself.

Tuesday, August 19, 2008

Caja Madrid Mortgage-Backed Bond Default Risk Soars




Well, it's been a quiet week, but bit by bit all the pieces are trickling into place. The latest little hiccup in the system comes from today's news that the cost of default protection on mortgage-backed securities sold by Caja Madrid - Spain's second-biggest savings bank - has soared to a record amid speculation the ongoing property crash may worsen. Credit-default swaps on a top ranking portion of Caja Madrid's Madrid RMBS III FTA transaction have jumped to 500 basis points from 310 at the end of July (RMBS's are Residential Mortgage Backed Securities), according to BNP Paribas prices. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.

The Madrid RMBS III FTA bonds are part of a 3 billion-euro transaction Caja Madrid sold in July 2007 - pooling mortgages with a loan-to-value ratio of an estimated 92 percent. The notes are among portions of debt from 13 separate transactions that Moody's Investors Service said last month it was reviewing for downgrade after a change in the way it assesses house price declines and risks of default for some Spanish mortgage bonds. Caja Madrid's loan default rate more than tripled to 1.89 percent of its total loans by the end of the second quarter from a year earlier.

Caja Madrid also had 262 million euros of mortgage-backed bonds downgraded by Fitch Ratings in June after the default rate on the underlying home loans doubled in a year. Caja Madrid also hit the headlines in July for its exposure to failed property developer Martinsa Fadesa. The bank's exposure to the firm - which is now in administration - was estimated to be1 billion euros, for which it had earmarked a provision of 250 million. Also we could note that Spain's national flagship airline Iberia had something of a shotgun wedding with the UK's British Airways last month, and Caja Madrid was the major sharholder with 22.9% of the equity. The Iberia decision was in marked contrast to the Italian government's support for the troubled carrier Al Italia, and there seem to be good reasons for assuming that the difference is not simply a question of the Spanish government having a greater disposition towards market-driven solutions.

Also last Thursday Gas Natural raised its potential stake in power generator Union Fenosa to over 50 percent after agreeing to buy a 5.15 percent stake from savings bank Caja de Ahorros Del Mediterraneo (CAM) The two entities have agreed to an equity swap through UBS in which Gas Natural agreed to pay CAM 18.33 euros a share, the same price it is paying hard-hit builder ACS for a 45.3 percent stake in Union Fenosa. CAM will receive an immediate 827 million euros (17.57 euros a share) and the remainder at the end of April, assuming the ACS-Fenosa deal goes through, raising the total to 862.8 million euros and CAM's capital gains to 556 million. This obviously provides Alicante-based CAM with much-needed liquidity as its traditional sources of funding steadily dry up in the wake of the developing housing crisis.

In order to do all this buying-up Gas Natural has itself had to float a 17 billion euro loan, a decision which has lead ratings agency Standard and Poor's say that it may in turn cut its credit ratings outlook on Gas Natural.

"It (the buyout) would result in a material weakening of Gas Natural's financial profile due to the size of the bid and the consolidation of Union Fenosa's approximate 6.9 billion euros of adjusted debt (at end-2007)," Standard and Poor's said.


So while this game may go round and round in circles, there are limits, and these limits are near to being reached. Somone somewhere is simply going to go one bridge too far with the implicit risk that this brings the whole edifice tumbling down like a pack of cards. And just one last "musical chairs" type detail. Guess which bank was on the list of guarantors for Gas Natural's 17 billion euro syndicated loan? You've got it: Caja Madrid.

Gas Natural announced on Thursday that it has mandated Barclays, BNP Paribas, Caja Madrid, Citigroup, ING, La Caixa, Royal Bank of Scotland, Santander, Societe Generale and UBS to lead the loan backing its purchase."The banks are committed to providing the financing for the whole transaction which will be around 17 billion euros," a company spokesman told Reuters Loan Pricing Corp.



According To The IMF Spain Has Comparatively Little Ficsal Room For Manoeuvre


According to Alessandro Leipold, acting director of the IMF's European Department, the Spanish government now has little room left to add fiscal stimulus to boost Spain's slowing economy - beyond that is standing back and allowing the economy to undergo its own natural correction process. Leipold also stressed in an inteview that to avoid a protracted economic slowdown, Spain should as a matter of urgency introduce reforms that would reallocate resources toward high-growth sectors. He also stressed the wage competitiveness issue given the need to start exporting more.

'Wage restraint will also be essential to protect employment and to prevent that higher inflation further damages external competitiveness,'


What Leipold is getting at is not that fiscal support is, in and of itself - undesireable, but rather there is not permanent room for 20 billion euro packages (around 2% of Spanish GDP) - like the one we saw last week - which mainly aim to prop up construction activity, and hope that at some early point everything will return to where it was. Leipold is simply making the point that what are called "automatic stabilisers" will naturally come into play as unemployment rises and tax returns fall, so the deficit will rise of its own accord. At the end of the first half of 2008 we were already running at a 1% annual deficit rate (from a 1% surplus rate a year earlier), so by this time next year Spain will be up against the EU 3% deficit limit without any additional packages being introduced.

Now the point is not that Spain should, at the end of the day be hamstrung by the 3% deficit limit - clearly the position is far more serious than that. But to be able to go beyond the 3% the Spanish government will need first to reconise the gravity of the situation, and then in the second place start to accept that it cannot possibly handle the financial implications of all that is happening hitting the banking sector alone. Brussels will need to be involved (as I am arguing, and as Wolfgang Munchau also argues - and please note that the latest flurry of activity on the FannyMae FreddyMac front on the US is precisely to do with specualtion that it is the US Treasury, not the Federal Reserve, which will have to step up to the plate and inject the cash which will save the failing mortgage providers. See this reuters report today for what ex-IMF chief economist Ken Rogoff thinks about the US outlook).


Of course in all this siren voices do abound. Ambrose Evans Pritchard quotes Bernard Connolly, global strategist at Banque AIG, who apparently said:

the eurozone faces possible disintegration unless there is a fiscal bail-out from Germany that matches - in sheer scale - Berlin's Versailles reparations payments after the First World War. "The bursting of the EMU credit bubble seems imminent, and will reveal current account imbalances among euro area countries as extremely dangerous. The medium-term feasibility of the euro area in its current form must be open to very considerable doubt,''


The comparison with Versailles may seem rather emotive, but we are talking about what are potentially very large amounts of money indeed here (between 300 and 500 billion euros, on my estimation, or between 30% and 50% of Spain's annual GDP). In fact the EMU's credit bubble has already burst on its Southern perimiter (Spain and Greece) even if we still can't see the full extent of the damage, and yes, EMU is not in danger at this point, but continued fudging and failure to act could well mean that it may be in the future.


Talking of fudging, Spain's economy Minister Pedro Solbes told the Spanish news agancy EFE over the weekend that Spain's unemployment could end the year above the government's 10.4 percent forecast (how much above he discretely failed to mention - and not unnaturally he was already warning of widespread government budget cuts next year. Solbes told news agency EFE in the interview that, "at the end of the year we could be above that (10.4 percent forecast)". Unemployment in Spain hit a 10-year high of 2.43 million people in July, with nearly two of every three layoffs coming from the construction sector.


It is also important to remember that even Solbes's negative budget forecasts are still based on his belief that quarterly growth from July to September will be "somewhat better" than in the second quarter when quarter-on-quarter growth slowed to 0.1 percent.


This is extremely unrealistic in my view. Solbes argues that Spanish GDP will benefit from lower oil prices (and declining domestic consumption which will ironically give a boost to GDP via an improved net export position), a good harvest and tax credits including the return of 400 euros to all income tax payers. I have discussed the oil price situation in my analysis of the May balance of payments data, but in the short term the Spanish GDP will get some statistical uptick from changes in the trade dynamic (although since this implies reduced consumption of imports, Spanish consumers will hardly feel this to be a benefit), but I think the sharpness of the downturn will mean we will soon see GDP growth in negative territory, and, of course, as an when oil prices start to pick up again this positive effect will turn into a negative one.


Metrovacesa

Metrovacesa SA have announced they are going to have to sell more assets than originally planned as their Spanish real estate holdings don't stop losing value, according to a report in El Economista yesterday. In addition to the steady attrition against the asset quality on their balance sheet income is falling steadily, and the Spanish press has been reporting that Metrovacesa’s sales rate has fallen from 8 properties per working day last year, to just one a day now. Metrovacesa’s income collapsed 76% in H1 as a consequence, to 45.4 million Euros. Metrovacesa is one of the biggest residential property developers in Spain, and is listed on the Madrid stock exchange.

Incidentally, when people ask me why Martinsa Fadesa was the first of the big ones to be let go by the banks, I normally answer "look at the land silly" (M-F had 29 million square metres of land inside and outside Spain, half of it not zoned for building). Land prices are normally the first to take the big hit in these situations. And "lo and behold", the details of Metrovacesa's revised business plan, named Phoenix, show that the company is to quadruple the sale of assets to 2 billion euros ($3 billion). And the reason they have had to revise Phoenix - "When we first presented Plan Phoenix, conditions were not as bad as they are now. Because it is difficult to sell land at the moment, we will increase in property,". Difficult to sell land, we ain't seen nothin yet!

Metrovacesa say they now plan to sell 1.53 billion euros worth of commercial assets such as shopping centres and offices in addition to the 486 million euros worth of land originally earmarked for sale in the first draft of Phoenix back in February. Obviously it has been hard to sell land in Spain's near-paralysed market.

Metrovacesa need liquidity urgently since they borrowed 810 million pounds ($1.5 billion) from HSBC to buy the bank's skyscraper headquarters in London before leasing it back to the bank, and it only has until Nov. 27 to pay back the loan. Metrovacesa also owes 240 million pounds which it used to buy the Walbrook Square office site in the City of London, and this loan is due on Oct 31.

Screws Turning Everywhere

And even those properties the developers manage to get an initial sale on don't always work out as planned. El Pais reported yesterday that the number of buyers backing out of purchases on new developments - and losing their deposits in the process - is starting to create a new headache for developers: with up to 15% of sales unravelling according to experts.

The problem of buyers backing out after signing a private-sale contract and paying a deposit is illustrated by the latest half-year results published by Acciona, a large listed Spanish developer. Acciona booked more deposits – 16 million Euros – in the first quarter of the year than it did in the first half of the year, which it closed with deposits of just 13 million Euros. The reason being that many of the sales made in the first quarter of the year subsequently unravelled, with Acciona having to return deposits.


Oh, and just to sum it all up for today, Spanish builder Acciona SA have agreed to sell a 75 percent stake in its funeral-service company, Memora Inversiones Funerarias SL, to 3i Group Plc in a transaction that values the company at 330 million euros ($486 million) including debt. Acciona shares fell 30 cents, or 0.2 percent, to 135.35 euros on the news. Obviously they feel they won't be needing Memora's services, since they can obviously get buried in their own rubble - and at a far lower cost.

Saturday, August 16, 2008

Spain's Current Account Deficit Continues To Rise in May 2008

Spain had a current account deficit in May 2008 of 9.423 billion euros, up 11% on the 8.492 billion euros registered in May 2007. According to the Bank of Spain this deterioration is due to three factors, an increase in the goods trade deficit (oil, since in general imports are falling), and a growing deficit on the income account (payments of dividends on equities and interest on loans, structurally not good news, but if you will borrow so much money, what can you expect?) and an increased deficit in the current transfers heading (migrant remittances). As far as the trend in the current account deficit goes, during the January to May period the total deficit was 50.144 billion euros, while in the same months of 2007 the total was 43.738 billion euros. This is a year on year increase of approximately 15%. Below you will see a chart for the deterioration in the income flow, which has been substantial, and is unlikely to improve anytime soon:



This rate of increase in the CA deficit is considerably down on the 26.3% increase registered over January to March 2008 quarter, but is still significant. With Spanish GDP likely to be near stationary in 2008 the % of Current Account deficit to GDP is set to rise significantly.



On the other hand since the economy is now slowing and the cost of oil falling, it is reasonable to assume the Spainsh current account (and trade) deficit will shrink going forward. In the absence of much stronger export growth, which looks highly unlikely given Spain’s lack of competitiveness and softening global demand, for the deficit to start to correct, imports will have to decline as a result of weak domestic demand.

This correction in the trade deficit has already been happening, but it has been obscured by the rise in the oil price. The non-energy trade deficit improved by an annualised EUR15bn, or over 1.0% of GDP, in Q1. However, the energy deficit increased by almost as much, leaving the total trade deficit little changed. Some of the improvement in the non-energy deficit was undoubtedly seasonal since the deficit normally improves in Q1. However, in EUR terms the improvement this year was three times that seen in Q1 during the last four years.

The impact of a change in the underlying import dynamic may well be important in the future. Imports amount to around a third of Spanish GDP. Therefore every one percentage point off import growth adds around one third of a percentage point to GDP growth. Alternatively, consider that net trade has subtracted on average 1.25pp from annual GDP growth from 2004-2007. Basically withoutout oil Spain's trade and current account situation would now start to improve. However the oil price is likely to limit the reduction in Spain’s external balance. In 2007, the total trade deficit equalled 9.4% of GDP. Of this, 6.2% was the ex-energy deficit and 3.2% came from energy. Now assume that the ex-energy trade balance improves to a deficit of only 4.0% of GDP in 2009. If on the other hand the oil price means the energy trade deficit rises, lets say to 5.4% of GDP from 3.2%, then this would leave the total trade balance (and similarly, the current account deficit) broadly unchanged. That is to say a good deal of Spain's future in the medium term depends on the price of oil, and even though oil is falling back from the previously very high levels as global growth slows it is hard to be very optimistic that we won't see prices surge back up again should growth once more accelerate.

Other items worthy of note in this month's data are the fact that foreign banks sent funds into Spanish deposits again in May, which enabled Spanish banks to also transfer funds back out of Spain. More importantly perhaps, the liabilities of the Spanish banking system with the eurosystem were up again in May, and sharply, by 15.869 billion euros.

The Trade Deficit

To get some idea where we are here, it is perhaps worth mentioning that the goods trade deficit was 7.202 billion euros in May (that is to say only slightly up from 7.131 billion euros in May 2007). Oil represents roughly 50% of this deficit. Goods exports were up by an annual 3.8% in May, and imports by an annual 3%. The services surplus was 2.283 billion euros (up from 2.002 billion in May 2007). Over the January to May period the goods deficit was 38.855 billion euros (up from 33.919 billion euros in January to May 2007), while the aggregate services surplus was 7.131 billion euros (up from 6.033 billion euros in the same period last year).


The negative income balance was up in May, to 3.817 billion euros, compared with 2.776 billion in May 2007. The balance on current transfers (which contains of course remittances from migrants) was a negative 687.9 millon euros, a deficit which was up around 17% on the 587.8 millon euros registered in May 2007. Again, as the Spanish economy slows it will be interesting to see how the remittances are affected.

The capital account had a positive balance of 963.7 millon euros, down from the 238.1 millon positive balance registered in May 2007.


The Financial Account


This large deficit in the Spanish current account - which resulted in a net financing requirement of 8.460 billion euros (up from 8.255 billion in May 2007) was basically covered by an increase of 12.885 billion euros in funds enetering Spain from the exterior (up from 7.032 billion euros in May 2007). This essentially meant that the liabilities of the Bank of Spain with the Eurosystem reduced by 3.443 billion euros compared with an increase in liabilities of 3.622 billion euros in May 2007.




Spain's net external financial balance with the rest of the world improved at least on paper in May due to a net inflow of funds to the tune of 12.885 billion euros (as compared with a net entry of funds of 7.032 billion euros in April 2007). This increase in the inflow of external funds is very large indeed (and we will look in detail at some of the ingredients below), but the end result is that the net indebtedness of the Bank of Spain vis-a-vis the rest of the world was down by 2.487 billion euros in May (as compared with the net reduction of indebtedness of 1.836 billion euros in May 2007). The inflow of funds was due to a considerable extent to an increase in portfolio investments in Spain in May, and to a lesser extent to an increase in loans to the Spanish banking system.


Direct investments saw a net outflow of 1.896 billion euros, which was down on the net outflow of 11.072 billion euros in May 2007. Portfolio investments saw a net inflow of 15.898 billion euros (compared to 10.194 billion euros in May 2007). This was mainly due to a very large inflow of funds into Spain from the exterior to the tune of 14.400 billion euros (15.618 billion euros in May 2007).


If we now come to repos, loans and deposits, the importance of these flows declined in May over April, and there were net inflows in May of 2.749 billion euros - while in May 2007 there were net inflows of 8.713 billon euros. Flows in and out of deposits at banks and other financial instutions are far and away the most important item here (about two thirds of the total, loans constituting most of the rest, while repos are pretty insignificant at this level).

The bottom line is that in May there was a movement of funds by Spanish financial institutions into deposits outside Spain to the tune of 8.893 billon euros while, on the other hand foreign investors moved funds into Spanish deposits and lent funds to the tune of 11.642 billion euros. As a result the lines on the chart below spike up again in April, although much less sharply than in January/February. Now let's see what happens in May.



Thursday, August 14, 2008

Spains Economy Grinds To A Halt in Q2 2008

As suggested in the recent bank of Spain report, Spain's economy virtually gtound to a halt in the three months between April and June, with the economy growing quarter-on-quarter on a seasonally corrected basis by just 0.1%.





This was the slowest second quarter growth since the 1993 recession, and marks the latest stage in the steady downward march in the Spanish GDP growth rate. As negative growth in Q3 now seems all but assured it seems clear that at the latest, the Spanish recession will have started on 1 July 2008 - of course there is always the possibility that this preliminary figure will be subsequently revised downwards, and we may yet actually open our papers one fine morning to discover that the recession actually started on 1st April.

The 0.1 percent growth followed a 0.3 percent expansion in the first quarter, according to the National Statistics Institute last Thursday. From a year earlier the economy grew 1.8 percent, the slowest since 1996. We will now have to wait till August 27 to see the detailed breakdown of the data.



Inflation At 16 Year High

The National Statistics Office have also confirmed thius week that Spain's year-on-year inflation rate hit a 16-year-high of 5.3 percent in July.



However as the economy starts to contract, and oil prices fall back from their July peak (they were down today at $111 a barrel, or 24% off the July 11 record of $147) then this current high level of year on year inflation may well become a very short-lived phenomenon. It is important to note that on a month-on-month basis the July CPI dropped by 0.5 percent from June, pushed downwards mainly by a summer sales fall of 11.3 percent in clothing and footwear. With cheaper oil costs on the horizon, and housing costs about to fall significantly, as overcapacity extends across the economy it is quite possible that 1 year to 18 months from now falling rather than rising prices will be the principal tendency, and should this possibility be confirmed it will then present the ECB with a whole new set of monetary policy headaches.

More Money From The ECB To Help The Spanish Banks

The European Central Bank lent a record 49.4 billion euros ($73.6 billion) to Spain's banks in July, with lending to Spain rising from 47.1 billion euros in June and 18 billion euros a year ago, according to the most recent data from the Bank of Spain. Investors currently demand higher rewards to buy bonds backed by Spanish mortgages than for any other home loan bonds in Europe - with the spread for Spanish banks now being at 2.5 percentage points over interbank rates for AAA notes, according to data from UniCredit.

Government Measures


The Spanish government this week also announced further measures to combat the economic decline, eliminating Spain's wealth tax and approving 20 billion euros ($29 billion, around 2% of GDP) of financing for businesses and consumers.

The measures, which follows the 18 billion-euro ($27 billion) stimulus package approved in April, have the objective of reducing bureaucracy, increasing competition and speeding-up public works projects. The plan's objective is proclaimed to be returning economic growth to a 3 percent rate by 2010, an objective which may well be laudible but not very realistic, especially since the plan does nothing substantial to address the root causes of the current crisis, which is the structural financing problem in the banking sector, together with the consequent looming banruptcies in the construction sector.

Full of good intentions is possibly the best that could be said of the present plan, although even this tag might have to be withdrawn from the proposal to loosen environmental criteria to enable more rapid implementation of public works. Spain is currently suffering from too much construction, and not too little. Basically much of this money would be a lot better spent closing down builders who are now no longer going to be needed, and retraining their workforces for other activities. Basically Spain urgently need a national construction industry "downsizing" plan, and the current proposals seem to be living under the really naieve illusion that what we have is simply a slowdown in the construction sector, and that things will return to normal by 2010.

As part of the plan, the government will also make an additional 20 billion euros in financing available in 2009-2010 for small businesses and families trying to buy public housing.

Another question I am asking myself in the face of all these numbers is what the fiscal deficit implications of them all are. If the government are working with the kind of unrealistic forecasts as they seem to be, many of their calculations may be way out of line. We need to remember that as the economy slows, VAT receipts reduce and unemployment payments rise accordingly.

Now we have already learned that Spain had a first half fiscal deficit running at 1% of GDP annual rate between January and June 2008, and as I suggest each 20 billion euros being spent is another 2% or so of GDP, so we are very soon going to hit the EUs 3% deficit limit at this pace. And while I certainly wouldn't be going out of my way to complain about that given the gravity of the situation, getting up to the limit without doing anything useful to resolve the underlying structural issues seems rather foolish to me. Indeed this would seem to be an exact repetition of the sorts of errors the Japanese were making during the early 1990s when they were also in denial about the full extent of their crsis. And to close all this I will just drop in one more strange coincidence in all this. Spanish corporates currently are indebted up to the level of around 120% of GDP. Households are indebted up to another 80% or so of GDP, and the Spanish government has an accumulated debt (not counting not-covered future outsanding liabilities in the social security system) of around 50% of GDP. Add all this up and we get total national indebtedness as a % of GDP in Spain of 250% of GDP. And what was the level of total national indebtedness in Japan when the property bubble burst in 1992 - yes you got it, 250% of GDP.

And Japan's misjudgement has cost them very dear indeed, apart from the years and years of price deflation which have followed, government debt was (according to OECD data) only 68.6% of GDP in 1992. By 1998 it had risen to 114.3% of GDP (these were the years of maximum denial) and by 2006 it had risen to a whopping 179.6% of GDP (again OECD numbers): all that cement and concrete comes at a very high price at the end of the day, as does all the dithering and failing to face up to reality.



Thursday, August 07, 2008

Planning Approvals Down January - May 57% Year on Year

This is hardly shocking news, since it was obviously coming, but it is nonetheless important. According to the latest data from the Spanish Development Ministry planning approvals fell by 57% in the period January - May , to 144,000, as compared with 336,000 in the same period last year. This is the lowest level of planning approvals since 2000. Approvals for apartment blocks were down by 60%, compared to a 43% fall in detached homes.

And the drop in planning approvals appears to be gathering pace as the year progresses, since the numbers for May were 30% down on April.




Planning approvals rose rapidly from 2000, reaching 687,000 in 2004, 730,000 in 2005, peaking at 866,000 in 2006, before falling back to 651,000 in 2007. It is hard to say what the final number for this year will be, but it now seems unlikely that it will exceed 300,000, meaning that housing construction will be running in 2009 and 2010 at something like 30% of the pace attained in 2007/08.




I think at this point we should remember the words of Jose Luis Malo de Molina, director general at the Bank of Spain who (speaking at a recent conference in Valencia) recently informed the world that the number of new homes which will be completed in Spain in 2008 will beat all previous records (that is we are building more houses than ever this year, many of them doomed to simply lie empty). Muñoz's explanation for this phenomenon is simply that “the real estate sector can’t turn around quickly, it works in the medium and long term, so this year the properties started at the end of 2005 and beginning of 2006 will be completed, which means the number of new properties on the market will hit an all time high.”


Migrants Starting To Return?


Also today we learn that the number of immigrants seeking government aid to leave Spain has doubled in 2008. The government received 2,100 requests up to July from immigrants who say they cannot afford to return home, compared with 1,184 during all of last year, and this year's funds for the subsidy scheme are exhausted, according to a spokeswoman for immigration and emigration department.

At least 4 million immigrants, mostly from Latin America and eastern Europe, have arrived in Spain since the start of the century, many of them looking for work in construction and jobs like cleaning and child care.




A total of 457,000 workers have lost their jobs over the last 12 months, giving Spain the highest unemployment rate in the European Union. Spain something over 5 million immigrants, about 11 percent of the population, and unemployment is rising three times faster among immigrants than in the wider workforce, increasing 69 percent in the past year to 266,458 registered jobless, government data show.

Bolivians, Argentines, Colombians and Ecuadoreans are leaving Spain in the greatest numbers, according to the spokeswoman. The travel subsidy scheme is operated by Spanish non-profit groups and gives each immigrant between 50 and 400 euros ($77.50 and $620) to journey home, plus 400 to 1400 euros per family. Groups such as the International Organization for Migration, the Spanish Red Cross and the Spanish Catholic Commission Association for Immigration say they have more than 2,000 immigrants on waiting lists seeking funds to return home.



The travel subsidy scheme, which has a 1.7 million euro budget, is only one leg of the current government programme to encourage immigrants to leave Spain. A further 100,000 plus immigrants are expected to leave Spain from September onwards, taking advantage of a separate programme to pay jobless immigrants anything up to two years unemployment benefit (depending on their earlier contributions) if they go home.




While I think it is essential to do as much as possible to help relieve the situation of poor migrants who are now, for no fault of their own, in distress, I cannot help feeling that this approach of simply encouraging the immigrants to leave is a big mistake. In the short term it may help ease some difficult situations, but if what is now only a trickle should turn into a flood in 2009, then Spain will be many, many years recovering from the negative GDP growth and extended property overhang which will result. Remember, all the migrants who are leaving either own or rent homes.

Wednesday, August 06, 2008

Spain's Industrial Output Slumps By An Annual 9% In June

Spain's General Industrial Production Index (IPI) was down by 9.5% in June 2008, in comparison with June 2007, according to data out from the National Statistics Office this morning. Adjusting for calendar effects the inter-annual rate of the IPI was estimated at a drop of 9.0%. The variation rates with respect to June 2007 was -9.6% for consumer goods (-21.1% for durable consumer goods and -7.4% for non-durable consumer goods), -10.8% for capital goods, -12.6% for intermediate goods and 1.8% for energy. After adjusting for calendar effects, these inter-annual rates were estimated at -8.9% for consumer goods (-20.2% for durable consumer goods and -6.7% for non-durable consumer goods), -10.2% for capital goods, -11.9% for intermediate goods and 2.1% for energy.




And if we take the purchasing managers survey seriously (which I think the balance of evidence suggests we should), then Spain's manufacturing sector continued to shrink in July, and at the fastest rate ever seen in any European Union survey of the sector. The Purchasing Managers Index for Spain slipped to its lowest level since the survey began in February 1998, the organizers of the survey, Markit economics, said. The Markit Research Manufacturing PMI index contracted for the eighth consecutive month to 39.2, down from 40.6 in June. Any PMI figure below 50.0 shows contraction while figures over 50.0 show growth.

CAM Downgraded By Moody's

Reuters are reporting that Moody's yesterday downgraded five more Spanish savings banks because of their exposure to real estate and construction. Ratings were cut (no details provided yet) on the listed bank Caja de Ahorros del Mediterraneo (CAM), as well as on unlisted Caixa Cataluna, Caixa Tarragona, Caixa Terrasa and Bancaja.

In its statement Moody said it continued to believe Spain would undergo an orderly correction in its housing market at the end of the housing boom. However, Moody's did say the correction, coupled with the global credit crunch "is translating into a more severe downturn in the credit cycle for Spain's banking system than initially anticipated".

"The request by Martinsa-Fadesa (Spain's largest real estate developer) to be placed under court-supervised administration has once more highlighted the significant difficulties this sector is going through as well as the vulnerability of Spanish banks to the underperformance of the real estate developers and the risks arising from these exposures," said Moody.

Tuesday, August 05, 2008

On Pedro Solbes

Although we could see this explosion coming, I don’t think even the biggest pessimists thought that the crisis would get this bad,” he writes. “But the blame can’t be pinned on the banks and property companies alone. Nor on the different governments that have been in power. At the end of the day we have all helped to created the bubble by paying exorbitant prices for flats and houses, using impossible mortgages, and ignoring our own resources. I remember friends and colleagues saying “property prices have never fallen”, taking it for granted that if they have never fallen in the past, they will never fall in future, and that “there is no safer investment than the real estate sector”. In fact, any time you hear comments like that about any type of investment, you can be sure that a bubble is in preparation.
Anonymous Comment in an El Pais readers forum on the property bubble


It isn't only Artemio Cruz (or if you like José Lluis Rodriguez Zapatero) who needs to get up and take a long hard look at himself in the mirror at the present time. Let each and every Spaniard who said "property prices will never fall" take a good look at themselves too, and before being too free and easy with their criticisms of others say to themselves "there but for the grace of god go I".


Ambrose Evans Pritchard (hello Ambrose, I'm a great fan of your dad's work) had a piece on Spain and on Pedro Solbes this morning. He closes the article as follows:

The vultures are starting to circle around the hapless Mr Solbes. Critics are calling for his head, accusing him of covering up the true scale of the downturn before the re-election of the Socialists in March. This seems unfair. Mr Solbes continued to dismiss warnings of a crisis as "enormously exaggerated" long afterwards. He appears to be genuinely astounded by what has occurred.
Now I think Ambrose, in his way, makes a very valid point here: I am sure that Pedro Solbes is absolutely astounded by what he is seeing in the way of data coming across his desk day-in and day-out at the moment. He could never in his wildest dreams have imagined what he finds in front of him, I think arguably no-one could. I seem to be playing Cassandra here, and while I always imagined we would see some sort of blow-out, it is the magnitude of what is happening that is truly unexpected, and indeed awe inspiring.

Even Ben Bernanke - to take just one example of a macroeconomist who I truly admire for his technical and theoretical skills (I would put him in my global top five) could not be said to have seen it coming, since in his speech - the euro at five - to mark the fifth anniversary of the introduction of the common currency, he simply limits himself to saying that the euro is a great monetary experiment - prudently he doesn't commit himself one way or the other about whether or not the experiment will work - but he certainly doesn't issue any kind of warning either, about the dangers of creating single country property bubbles via the "one size fits all monetary policy". Nor does he discuss what might be done in the event that such bubbles should develop.

Of course, what people are complaining about isn't so much the fact that Solbes couldn't forsee that there might be structural problems managing a common currency regime, but that his short term forecasts since last August haven't been all they might have been. But which national economics minister is getting it right at this point in time? And the point is that back in August 2007 I am sure that Pedro Solbes had no way of knowing that the looming credit crunch was going to give us all the worst set of financial headaches we have seen since 1929.

So what I am saying is that Pedro Solbes is only human, just like the rest of us he is a mere mortal. And he is a mortal who is evidently out of his depth with the problem which is confronting him, but then, I ask you, who isn't at this point. It is time for the fire brigade to go to work, the only problem is we don't have a fire department, because NO ONE saw the need, because NO ONE saw this coming, at least not clearly they didn't.

Now I am saying all this, and in a way writing this blog post, to defend Solbes name and reputation since I think there is a big danger in the way people in Spain are generally reacting to this problem at the present time. I think people here have a tendency to put far too much confidence in the knowledge and abilities of their leaders, and this becomes a problem when such confidence is misplaced, not because these leaders are bad people, but simply because they are, just like everyone else, only human.

I think there is far too great a tendency in Spain to think of politicians as dishonest ("son uns lladres", "no hi ha ni un pam de net") but astute (llestos), and they may be both or neither of these, since this is not my concern, but what they most certainly are not are macroeconomists, and thus they are in no real position to better appreciate the extent of what is happening than is the woman on the proverbial Madrid omnibus (you know, the one at the start of Almodovar's Carne Tremula, "malnacido, y sin padre). They are simply in shock, that is all.

But it is time to come out of shock, and put on our firemen's suits, or the whole house is simply going to burn down around us. We need a plan of action, we need the help of Brussels, and we need it now, and not after everyone comes back from holiday or whenever. If we don't do something soon many of those now idling away their days on the beach may not have a job to come back to when they return.

Now to touch on one or to of the other points which Ambrose raises:

The root cause of the bubble was the extremely lax monetary policy imported by Spain after it joined Europe's monetary union. Interest rates were slashed on EMU entry, and then fell to 2pc until late 2005 - far below Spain's inflation rate.
In other words the whole problem is a result of structural failings in the design of monetary union. This is a real problem, and it is one which needs more or less urgent responses, and not platitudes about Harrod-Samuelson-Balassa effects. These interest rates were "lax" in Spain, but not in Germany, and that is the problem.



Secondly we have the issue of the way in which the Spanish banks are now becoming the centre of global attention. The issue here is a recent report from Morgan Stanley (which I mentioned yesterday) and which Ambrose cites extensively:

"A momentous economic slowdown is now under way. We believe the deterioration in Spain is just in the beginning stages. The bulk of the pain will be suffered in 2009," said the report, by Eva Hernandez and Carlos Caceres. "The probability of a crisis scenario similar to the early 1990s is increasing. If the ERM (Exchange Rate Mechanism) scenario were to become reality the main concern would not be earnings, but capital....We estimate that a non-performing loan ratio of 10pc to 15pc for developers' loans would fully erase earnings in 2009 and would represent between 20pc to 30pc of the current tangible capital base of Banco Popular, Sabadell and Banesto," they said."

This attention is now here, and it is simply not going to go away (and indeed the latest example of such attention is the post "Construction Correction Driving Economy Down" on the Morgan Stanley Global Economic Forum). There is a further point in Ambrose's article which is worthy of comment:

The banks certainly dodged the US sub-prime debacle, thanks to restrictions by Bank of Spain on the use of off-books investment vehicles. Home equity withdrawals and "piggy back loans" are rare. Mortgages were mostly limited to 80pc of house prices, at least in theory.


This is not quite right. The only real sense in which Spain didn't have sub-Prime was in not making use of extensive off-balance-sheet SIVs. In theory this means that banks are inclined to be less risky in their lending, since if things go wrong their own balance sheets are directly affected - or as Morgan Stanley so nicely put it "the main concern becomes not earnings, but capital". So the main issue with the SIVs may well be that the leveraging induced causes everything to fold quickly like a pack of cards, whereas doing effectively the same thing on balance sheet may well prove to be virtually fatal, even if the unwind is a bit slower.

As I argue in my "No sub-Prime in Spain, but is Spain itself sub-Prime" post, bar the SIVs almost every other phenomenon associated with sub-Prime is here. Of course piggy backs and refi's were commonplace, even if the Spanish borrowed not to spend, but to do what they thought was saving, ie modernising and upgrading their home. And with LtV ratios of 110% commonplace for young people (who often didn't even have the savings for notarial fees and furniture - you know, the mil-euristes) there was not so much need for the piggy-back (since you were already up on the shoulders of a giant), but they were certainly there if ever you needed them. Basically, easy lending and over-leveraged households became commonplace here, and now the whole thing is unfolding, and if no one does anything to stop it the whole issue will steadily work its way back upstream to the bank balance sheets.

Which brings me back to Pedro Solbes.

As I say, I wouldn't want to falsely accuse him of attempting to mislead in the past. I have a good deal of respect for him, and for everything he tried to do, almost single handedly, to enforce the Stability and Growth Pact against the mighty forces of the French and German States when he was Economics Commissioner in Brussels. His successor isn't even fit to don the shoes he wore in this area. But that was then, and this is now. And statements like this (given in an interview to El Pais over the weekend) are much harder to forgive and forget:

"Spanish Economy Minister Pedro Solbes on Sunday said in a newspaper interview that he expected the European Central Bank to keep interest rates on hold..... If oil doesn't bring us any more surprises, if there are no other variables with a negative impact, we think there will be very low or flat growth in the coming quarters, but we are not thinking of a recession."

I'm sorry, this is inexcusable. It is clear that Spain is heading rapidly into recession, and the only real issue is how long and how deep it is going to be. So while Pedro Solbes can, for his past "omissions" reasonably take recourse in the defence that he has, like everyone else, simply been overwhelmed by events, this no longer applies to what is happening now, and I would recall here the old Greek adage from Sophocles' Antigone: "call no man happy until the day he dies". Pedro, don't undo a whole life's work for the sake of avoiding conflict and confusion in the short term. The Spanish people have the right to know the full extent of the drama which awaits them, and they have the right to know it now!