There Is No Sub-Prime in Spain, But Has Spain Itself Now Become One Huge Sub-Prime?

``Subprime lending, meaning poorly documented, very long- term, increasing-interest mortgage loans where repayment by the debtor depends sometimes critically on the ability to refinance, simply does not exist in Spain,''
Deputy Finance Minister David Vegara, Oct. 24 2007.

Bloomberg once more goes on the attack over Spanish mortgage backed securities situation this morning. They make the following, in my opinion, reasonably valid points:



1/. The Spanish issue is now a matter of international concern since mortgage backed securities issued in Spain are extensively held by global fund managers - like Pacific Investment Management Company LLC and Pioneer Investments (the two mentioned by Bloomberg). Josep Prats, a fund manager at Ahorro Corporacion in Madrid, is quoted as saying that property appraisal firms, working in the interests of the banks who controlled them, regularly inflated home values, and that such inflated assets are backing for as much as 320 billion euros of mortgage-backed paper sold to savers worldwide. This point seems a fair and reasonable one to me.

``Valuations aren't realistic,'' says Prats, who heads a team managing about 11 billion euros. ``Valuation companies issue reports for whatever amount the bank managers are prepared to lend.''

2/ Caja de Ahorros de Gipuzkoa y San Sebastian SA, a savings bank in northern Spain known as La Kutxa, has sold 2.5 billion euros of mortgage-backed bonds since the end of 2005. Pimco, based in Newport Beach, California, and Pioneer Investments bought Kutxa bonds for funds sold to investors around the world.

Pimco's Euro Bond Fund, sold to savers in Hong Kong, is the biggest investor in Kutxa's 2007 issue with a 20.6 million-euro holding, according to a March 31 regulatory filing. Pioneer Investments' CIM Euro Fixed Income Fund, which is sold to Italian savers, holds 11 million euros of the bonds. Pimco, majority-owned by Munich-based Allianz SE, runs the world's largest bond fund and has $829.5 billion under management on behalf of corporate pension plans, public retirement funds and foundations. Pioneer Investments is the fund-management arm of Italy's largest bank, Milan-based UniCredit SpA, which oversees 190.5 billion euros for 40 million customers in 23 countries. Kutxa's 2007 bond has lost 8 percent since it was issued in February last year. That contributed to the Pioneer fund underperforming the JPMorgan EMU Bond Index by 2.7 percentage points over the past 12 months.

One concern is that the real worth of many Spanish homes is far below official values, meaning the so-called loan-to-value ratio.... understates the risk, according to Prats of Ahorro Corporacion.

2/ In 2006 and 2007 many banks allowed three or four people to sign for mortgages when the buyers didn't qualify on their own, and Bloomberg cite a spokesman for Banco Bilbao Vizcaya Argentaria SA, Spain's second-biggest bank. I think this is already an "open secret" on the streets of Barcerlona.

Banks also granted variable-rate loans to families at the financial limit when interest rates were close to the lowest in a generation. Kutxa itself even offered a 50-year mortgage in 2007.

Concerns about the way valuation companies operate aren't new. In 2006, the Bank of Spain cautioned four home valuers against making baseless appraisals, or using a methodology for their calculations that didn't meet legal requirements. The bank didn't identify the companies involved.

"The tricks of a seasoned valuer include constant visits, models - any method is valid........In the end it's about imagination and knowledge. It's not a question, as it is in some other countries, of passing information from a public office to the statisticians.''
Luis Leirado, managing director of the biggest home valuer, Tasaciones Inmobiliarias SA, known as Tinsa.

3/ In recent years, existing safety measures failed to rein in the appraisers. Under Spanish law, valuers are obliged to provide a so-called mortgage valuation -- at a discount to the market price - when there is a significant risk a property will cost less within the next three years. In 2005, less than 1 percent of estimates applied such a discount, according to a report by the Bank of Spain. The central bank was already warning that housing was overvalued by as much as 30 percent then.

Many home-valuation companies are owned by banks. Kutxa gives most of its business to Servatas, in which it holds a 35 percent stake. Tinsa is owned by 36 savings banks and the Spanish Savings Banks' Confederation.

"During the credit boom, valuers understood that clients would welcome inflated estimates"
Ramon Lobo, former BBVA branch auditor.

Between 2005 and 2007 it was ``very common'' for valuations to exceed the transaction price by 25 percent, Lobo says. That allowed banks to treat loans for 100 percent of a property as if they were closer to the 80 percent limit for regular mortgages when they sold them to investors. In December 2007, the government passed a mortgage law limiting the amount of business appraisers can take from clients with ownership stakes.


4/. Spanish AAA-rated mortgage debt is now judged to be the riskiest on the continent. Investors demand as much as 240 basis points more than Euribor, the benchmark for interbank lending in the euro zone, up from 85 basis points at the end of last year, according to Dresdner Kleinwort prices. That means it costs borrowers an extra 15.5 million euros in annual payments for every billion euros of bonds.

Caja Madrid, Spain's second-largest savings bank, 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.


Company Profit Reports

Antena 3 Television SA, Spain's second-largest commercial TV station, cut its interim dividend by a fifth after first-half profit fell 31 percent as advertising sales dried up. Net income dropped to 80 million euros ($125 million) from 115.7 million euros a year earlier, the company said today in a regulatory filing. Sales slumped to 476.9 million euros from 538.8 million euros.

Telefonica SA, Europe's second- largest telephone company, said second-quarter profit dropped 20 percent after a gain from the sale of Airwave O2 Ltd. boosted earnings a year earlier. Net income fell to 2.06 billion euros ($3.21 billion) from 2.57 billion euros a year earlier, Telefonica said today in a regulatory filing. Sales rose to 14.25 billion euros from 14.08 billion euros. The company reiterated its 2008forecasts for all regions.

Spanish GDP Q2 2008

Bloomberg this morning are reporting the following:

Spain's economy expanded the least in 15 years in the second quarter as record oil prices and the collapse in homebuilding destroyed jobs and sapped spending, the central bank said. The economy grew 0.1 percent compared with a 0.3 percent pace in the first quarter, the Bank of Spain said in its quarterly bulletin today. From a year earlier, the economy expanded 1.8 percent.

Now I think we need to be very careful here, what the BoE actually say is:

The economic indicators for 2008 Q2 point to a more pronounced adjustment, and one particularly sharp in private consumption and in employment, against a background in which the extension of the bout of fi nancial turbulence and the climb in crude oil prices are heightening uncertainty over economic developments, with significant effects on agents’ confidence. The Spanish economy’s high dependence on external saving along with the importance of oil and oil derivatives in its productive structure are contributing to spreading the effect of the shocks assailing it. In this setting, the estimates made drawing on the available conjunctural information suggest that the year-on-year growth rate of GDP in Q2 was 1.8% (0.1% in terms of its quarter-on-quarter rate), as a result of a signifi cant cut in the growth rates of the different components of national demand — which overall are expected to have increased at a rate of 1.9% (2.8% in the previous quarter) — and of a 0.2 pp improvement in the contribution of net external demand, which is estimated to stand at -0.1 pp. On the supply side, the correction in the residential sector has become more acute in recent months and is exerting a marked impact on employment, which would be acting as the main transmission channel of the real estate adjustment to the rest of the economy. The EPA data for Q2 show a strong cut in job creation, the growth rate of which was 0.3% on a yearly basis. The unemployment rate rose to 10.4%. As to prices, the deterioration in infl ation continued in Q2, and the increase in oil prices was quickly refl ected. As a consequence, the HICP rose in June to a year-on-year growth rate of 5.1%, which placed the differential with the euro area at 1.1 pp, the average level since the start of Monetary Union.

Now basically I think we should be very careful with this data, since as the BoE say it is made using "available conjunctural information", and thus is a guess, even if it is a very educated one. Most of the data which is available is still liable to revision at the INE (which is the source of the stats and not the bank) and thus growth of only 0.1% is well within a margin of error which could mean (at this level)that growth could just as easily be -0.1% as 0.1%. And in a sense all of this is academic, since if we are not in negative growth this quarter, we will be in the next one. Which is why, for the life of me, I can't understand this from Pedro Solbes:

``We're working on the basis that there will be no recession,'' Solbes said today in an interview with Cadena Ser radio. ``But we're also working on the assumption that growth will be very close to zero in the next few quarters.''

I mean where the hell does he derive this assumption from? Let's imagine the BoE data is more or less accurate and look at the charts. First GDP growth year on year:



and now here is the chart for quarterly change:



Now in both cases the line is down. And why should we not expect this downward line to continue? I cannot think of a single reason. Unemployment is going to get worse not better, less houses - a lot less - are going to be built in 2009 than in 2008, the eurozone itself is now slowing sharply, and Germany may even be entering recession, etc, etc.

So let's be clear. It is technically just possible (though I won't be convinced till we see the flash estimate on August 14th and even not then if growth is only 0.1% and within the error margin for subsequent downward revision) that Spain hasn't entered recession in Q2. But even if it hasn't it will, and in Q3 2008.

Spain's Retail Sales Down 7.9% in June, Building Permits Plummet

Well, this is now becoming more and more of a nightmare by the day. According to the national statistics office this morning, Spain's inflation adjusted retail sales were down 9.8% year on year in June. In working day adjusted terms this represented a 7.9 percent fall, making it the largest drop on record in Spain, following seven consecutive months of decline.

And there is clearly worse to come, at least till we get nearer to October/November and the low base effect kicks in.




Building Permit Applications Plummet

We also learn today that permits issued for building new houses in Spain plummeted 57 percent over the first five months of the year when compared to the equivalent period in 2007, according to data from Spain's College of Architects. In what is only now one additional confirmation that Spain's decade-long construction boom is now well and truly over, the College said 143,918 permits were granted in the first five months of 2008, down from 336,263 in the same period of 2007.


Basically Spain's economy is like a car cruising down the motorway without any oil in the engine, and one of the pistons about to seize-up. And as of the time of writing no one - in either Brussles or Madrid - seems to have the presence of mind to try to alter the course of destiny.

Spanish Corporates Sell Whatever They Can In the Great Liquidity Race

The real point to get hold of at the present moment is that it is Spain's non-construction corporate sector which is really feeling the pain of the fact that the cash strapped banks can't help them with liquidity. Yesterday it was Iberia who had to look for a swift marriage, and today we learn that media entity Promotora de Informaciones SA (aka Grupo Prisa) - the publisher of newspaper El Pais - have just completed the sale of three buildings for 300 million euros ($467 million). The sale of the poperties to Longshore is expected to generate a capital gain of 227 million euros, the Madrid-based company said in a regulatory filing. Prisa said it will use the funds to reduce debt. Basically, in the present property market, if you are forced to sell to reduce debt, then you really are in trouble.

As can be seen from the chart below, the indebtedness of Spanish corporates is even more important than the indebtedness of Spanish households, and is way above the average for the other eurozone countries.


And today it was also the turn of Gas Natural and Fenosa to stop the trading in their shares, not because either of these utilities companies is in trouble, but because Actividades de Construccion & Servicios, Spain's biggest construction company has a 45 percent stake in Union Fenosa, and it badly needs to sell. ACS is scheduled to post earnings after the close of trading in Spain today, and obviously the outlook is not good, hence the rush to cut a deal before closing today.


Spain's Gas Natural have announced that their board will meet at 14:00 CET today to study a possible bid for ACS's stake in Spanish utility Union Fenosa. Spanish media had been suggesting that Gas Natural would make an offer today for the 45 percent stake at a price of up to 18 euros per share, which values the utility at around 16 billion euros ($25.17 billion). Under Spanish law, the stake buy must be followed by an obligatory full bid.

A widely quoted bank analyst bank has requested not to be named is sayinh: "An 18 euros offer would be 13 percent up on the 15-16 euros mooted up to now, but Gas Natural could stretch to that...But it would have to be a mix of 60 percent in cash and 40 percent via a capital hike...That would take the gearing of the new Gas Natural-Fenosa to about 56 percent, which would be just about at the permissible limit."

Electric Glyde In Blue?

Also today Spanish Industry Minister Miguel Sebastian has announced that the Spanish government aims to have 1 million electric cars on the roads by 2014 as part of a plan to cut energy consumption and dependence on expensive imports

"Electric vehicles are the future and the driver of the industrial revolution," Sebastian said in testimony to a congressional panel.

Now frankly I don't know whether this is sheer science fiction, or a realistic policy. Having a million electric cars on the road would be positive (depending on how you are going to generate the electricity, and how efficient they are), but first you need one million people willing to buy them, and Spain is likely to be in the midst of a deep slump, at least during the first half of this period. So is this real, or isn't it? At this point I don't have the technical expertise to decide.


Santiago Baena, president of the API real estate agents association (Colegios Oficiales de Agentes de la Propiedad Inmobiliaria) estimates that Spanish property prices have fallen by 30% since Spain’s economic downturn began last year. Baena argued this at a recent conference on Spain’s property crisis as reported in the Spanish press. He describes the price correction which is currently underway as “brutal”, and says that the situation this year is “radically different” to last year, when the sector was already “absolutely paralysed”.

Further the Spanish daily ‘Levante’ is reporting that in July and August occupancy rates of rental apartments on the Valencian coast, which includes the Costa Blanca, have fallen from 100% last year to as low as 50% in some cases this year. The real estate agents Eurosol, in Perelló, Sueca, told ‘Levante’ they had only managed to sell 2 apartments on the coast this year, and that holiday rental enquiries have fallen substantially. With 50% of all holiday rental apartments on the Valencian coast still in search of bookings as of the start of July, the number of ‘for rent’ and ‘for sale’ signs on properties along the coast is evidently multiplying.

Mortgage Lending Down Sharply In May, Bank Credit Ratings Under Review

Spanish house sales dropped sharply again in May for the fourth month running, official figures showed on Monday, and talk of price declines is now becoming much more general. House sales fell by 34 percent year-on-year in May and mortgage borrowing was down by 40.4 percent from a year earlier, according to the latest data from Spain's National Statistics Institute. The result is rather a shocker since many had obviously been clutching at straws following April's better-than-expected year on year decline in new mortgages of only 7.8%. Reality is, unfortunately, now starting to sink in.




Sales of resale properties appear to be suffering the most, down 44% to 25,280, compared to the 21% fall (to 24,890) in the number of newly built properties sold by developers. This figure is misleading, however, as the INE’s figures are based on property transactions inscribed in Spain’s property register, not new sales achieved by developers, which are down by between 40% and 60%.

To add insult to injury Barcleona property consultant Aguirre Newman have said Spain's real estate market is depressed by anything up to 1.5 million unsold new homes (ie the estimate is now moving up from the earlier estimate of Spanish builder OHL who suggested there were between 500,000 to 1 million new homes in Spain sitting empty and waiting to be sold after overbuilding.). Aguirre Newman also report that the average time needed to sell a residential property in Barcelona has now gone up to 27 months (from 17 months one year ago).

Mortgage Security Credit Downgrades

Last week it was also announced that Moody's Investors Service has put about 16.9 billion euros of Spanish residential mortgage-backed securities under review for possible downgrades after adjusting for rising default rates and slowing house price growth. Moody's say they are in the process of reviewing 68 tranches of 13 deals after updating their model.This issue of downgrades is an important one, since if the securities are downgraded then, one way or another, they will become more difficult for the banks to finance and re-finance.

"Moody's believes that many Spanish mortgage borrowers have now debt-to-income ratios above the 40 percent benchmark observed in 2005,"

Deals singled out for review tend to have higher loan-to-value ratios and higher-risk products and have been performing below expectations, Moody's said. Riskier features are thought to include involving borrowers who are not Spanish residents (such clients account for as much as 10 percent of some deals), loans to multiple borrowers, loans as part of debt consolidation and interest-only loans.

Current ratings on the different tranches of the 13 deals from issuers including BBVA and Santander vary from triple-A to junk levels as low as Ca. The review over the next three to six months is likely to produce one-notch downgrades and some two-notch downgrades.

Standard and Poor's also said on July 10 that they were considering cutting the ratings on 298 million euros of bonds backed by subordinated debt issued by nine Spanish savings banks, including the top-ranking triple-A bonds.

Standard and Poor's said its decision to review its ratings on the bonds, a deal called AyT Deuda Subordinada I that was issued in November 2006, was due to a deterioration in the underlying debt. Both these actions constitute a further sign of the problems in the Spanish financial sector and illustrate very clearly how one problem can add to another in a cycle of progressively deteriorating headaches.


Standard also Poor's also downgraded two Spanish banks and changed the outlook on three others to negative, citing "the sharp deterioration in economic conditions and increasingly difficult operating environment in Spain." According to a pre-sale report they issued in 2006, the nine banks that issued the debt backing the deal are Caja de Ahorros y Monte de Piedad de Cordoba, Caja de Ahorro Provincial de Guadalajara, Caja Provincial de Ahorros de Jaen, Caja General de Ahorros de Granada, Caja de Ahorros y Monte de Piedad de las Baleares, Caixa d'Estalvis de Girona, Caja Insular de Ahorros de Canarias, Caixad'Estalvis Comarcal de Manlleu, and Caja de Ahorros y Monte de Piedad de Madrid. The agency only rates the last of these publicly, at AA- and it was the outlook on that rating which was modified to negative.

Of the nine banks, just four account for 78.9 percent of the debt which underlies the deal under review: Cordoba, Girona, Granada and Baleares, according to S&P.

Meanwhile Bloomberg this morning report that Banco Santander - Spain's biggest lender - have a group of bonds - which form part of an issue called Santander Hipotecario 4 - that are backed by mortgages that exceed property values by as much as 24 percent. Now Santander assert that they have not made any extensive use of the ECB liquidity facility involving collateral of mortgage backed securities, and there is no suggesting that Hipotecario 4 bonds - which presumeably still carry investment grade rating - have been used, but all of this does put the ECB in a very difficult position, since in principle (as with Italian government paper) they are willing to accept them. It is only the exercise of due discretion by Santander itself which means they are not already vaulted-up in Frankfurt.

Spanish lenders have, however, almost tripled borrowings from the ECB in the past year to 47 billion euros. Most ECB loans mature in one week or three months, but the bank have been providing some six month loans since the start of the credit crunch last August. Spanish banks increased their use of three- and six-month ECB loans to 27.5 billion euros as of June 30 - thus accountsing for for some 10 percent of the ECB's three- and six- month lending - up from from 2.4 billion euros a year earlier, according to Bank of Spain data. Of course the 10% level is completely in line with the level of Spain's participation in the eurosystem, so there is nothing necessarily preoccupying here, but the speed of the rise in borrowing is noteworthy.

Spanish loan defaults rose in May to 27.76 billion euros or 1.5 percent, from 12.05 billion euros or 0.77 percent a year earlier, according to the latest Bank of Spain data. Obviously the level of defaults varies from bank to bank. Banco Popular Espanol, Spain's third-biggest listed bank, scrapped its earnings forecast last week as bad loans more than tripled to 1.15 billion euros, or 1.89 percent of total debt.

Spanish AAA rated mortgage debt is now judged to be the riskiest on the continent, with investors demanding as much as 240 basis points above Euribor, up from 85 basis points at the end of 2007, according to Dresdner Kleinwort prices. That's more than twice the interest margin on equivalent securities in the Netherlands. Only bonds secured by home loans to U.K. borrowers with poor credit histories trade at higher spreads, according to Dresdner data.


Iberia To Join British Airways

And to cap a very busy day, British Airways and Spain's Iberia have announced they are in merger talks as airline industry participants seek to consolidate to compensate for rising oil costs that have been hitting both their top- and bottom-lines. As the level of economic activity has deteriorated in Spain and the UK, both airlines have struggled to keep their planes full. In the year to June, Iberia's passenger load factor, a measure of passengers to available seats, fell by 0.6 of a percentage point, to 79.6%. The same measure for British Airways dropped to 76.8% from April to June, down 3.4 percentage points.

And well-well-well, the main shareholder in Iberia is guess who, savings bank Caja Madrid, you know, the one who had an estimated one billion euro exposure to failed builder Martinsa-Fadesa, is very supportive of the Spanish airline's plan to merge with British Airways. "Caja Madrid is happy," according to reports. They would be, they have a 23 percent stake in Iberia, they had three Aaa rated bonds backed by mortgages placed on review for possible downgrade by Moody's only last week, and clearly they can't afford to have any more "lame duck bailouts" knocking around on their books at this point.

The Pateras

Thanks to Charles Butler at Ibexsalad blog, in the world of ever more giddily rising prices, I have discovered one thing - apart that is frpm property and land - whose price is coming down: the cost of a boat ride from Senegal to Tenerife. Evidently the transport supply has gone up, but the demand is obviously down, and sharply:

"This boat came up from Casamance full of illegal immigrants trying to get to Spain," said our boat driver as we sped past. "The boat ran into difficulties and came in here. The police jumped on it and arrested 25 people. The rest ran away." The price for getting to Spain on a canoe has gone down. It used to cost almost £1000, but in 2006 went down to £450. Now it is possible to buy a passage for £350. It must be the only thing in Senegal which has gone down in price. A loaf of bread has gone up by a third since I last bought one.

Unemployment In Spain Up Sharply In Q2 2008

Unemployment in Spain, the source of half the euro region's new jobs between 2001 and 2006, was up sharply in the second quarter as the credit crunch in the financial sector gradually extended its reach across the whole economy..

Spain's unemployment rate was up at 10.4 percent (from 9.6 percent in Q1) according to data from the National Statistics Office (INE) this morning. The number of people in employment increased 0.1 percent from the previous quarter and stood at 20.4 million, as compared with a 0.4 percent decline in the first quarter, but we need to consider seasonal factors here, since employment should normally be rising sharply in the second quarter.

The number of jobs in construction fell 4.5 percent to 2.55 million, while manufacturing jobs declined 2.1 percent and agricultural jobs were down 5 percent. Service jobs increased 1.9 percent to 13.81 million.

This data is compiled by the INE on a quarterly basis using a different methodology (survey based) than that used by INEM, which gives the monthly data. At this point it is hard to estimate the actual July increase which we should get to see next week, but it is likely to have been considerable. Meantime here is the last monthly chart based on the INEM data.

New Bank Lending To Households and Corporates Continued To Slow In May

Well, here I am presenting two of what I consider to be the most important charts in understanding the mechanics of the current Spanish crisis. The rate of growth in lending to households and the rate of growth in lending to corporates.

We now have the May 2008 data from the Bank of Spain, and as we will see, in each case they continue to slow. But first, why do I say "the most important charts". Well simply because they sum up the core of what the problem is in a very simply nutshell. The Spanish banks are struggling to find liquidity, and as a result they are unable to maintain the pace of lending expansion to individuals and to households that they previously could. This is what is provoking the severity of the problem, and in comparison with this everything else is a mere detail (although of course some of the details will soon be becoming big problems in and of themselves). Basically, as we know, more houses are still being built this year than ever. So construction at this point hasn't slowed that much. The thing is though the builders are accumulating unsold homes (which will soon be passed on to the banks as the builders go bust one by one), since individuals don't have acces to sufficient mortgage finance to buy them.

Thus the rate of new lending to households has been dropping steadily:




And then we see that corporate Spain is having the same problem, which is why so many people are busy out there trying to sell subsidiaries, and such like, since they are having problems borrowing sufficient money, and of course sales and profits are now steadily going down.



Now if we look at the next chart, you will see that Spanish companies and households are much more indebted than their average eurozone neighbours, and companies especially - at around 120% of GDP.





Now you might say, well isn't it a good thing that all this is slowing, since so much lending and debt was hardly healthy? And I would have to agree with you. But nothing is so simple, since after so many years of debt indulgence the economy is badly structurally distorted, and relative prices are way out of line with most competitors, so as domestic consumption drops exports can't take over and down the whole edifice comes.

Those of you who can speak Spanish can probably read Italian too, and I just found this comment from one of the readers of this blog on an Italian financial forum:

"L'euro ha ucciso (finanziariamente parlando) la Spagna: una moneta troppo forte, ed un tasso di interesse troppo basso, hanno distorto il mercato del credito, provocato una colossale bolla immobiliare, finanziata con capitali esteri che adesso non arrivano più o peggio stanno tornando da dove sono venuti. Inoltre, visto che la politica monetaria si fa decide a Francoforte, e non a Madrid, la BC spagnola è totalmente priva di mezzi macroeconomici per fronteggiare la crisi bancaria:"

I don't know about the idea of hiring people to give economics classes to Zapatero, but if they are looking for someone, this guy gives effectively a master class in one short paragraph. What he is really saying is that the absence of independent monetary policy meant you had no way to stop yourselves going up, you were simply shot out of the cannon, and now you have no way to stop yourselves coming down just as quickly as you went up. I remind everyone: interest rates at the ECB just went up, not down, and deflation - and possibly a very whopping dose - not inflation, is about to become Spain's problem.

Spain's Producer Price Index Hits 23 Year High

Well everything here simply seems to be going from bad to worse, at the very moment you need to export more than ever before, your cost prices start shooting through the roof.

The price of goods leaving Spain's factories, farms and mines rose 9 percent from the year-earlier period after a 7.9 percent increase in May, according to the latest data from the National Statistics Institute (INE). Prices rose 1.1 percent on the month.

Tourism Declines in Spain In June

Well, as they say, it never rains but it pours, even if "the rain in Spain does mainly fall on the plane". Now we find that foreign visitors to Spain are down, and tourism is taking a hit. This is what it means when we say that the "external conditions are going to be difficult", nowhere else in the rest of the Europe is going to be as badly hit as Spain by the credit crunch (the UK will probably come nearest) but Europe in general is heading for slowdown and probably recession as we enter 2009 (my guess is that in Q2 2008 the eurzone as a whole contracted - we will soon see), so increasing exports, or attracting tourists is going to be hard work (especially with air travel costs rising so much).

Data out today showed hotel stays dropped 2.3 percent year-on-year in June, down from growth of 6.6 percent in May. Tourism. which had been after construction the second-largest driver of the Spanish economy had held up so far but the effects are obviously now starting to seep through.

Spain is the world's second most popular holiday destination, attracting some 60 million tourists last year. On Monday, the government said foreign tourist arrivals dropped 0.7 percent in June and today the national statistics office (INE) said 57.7 percent of hotel rooms were full in June, 5.4 points lower than in the same month a year earlier. Even at the weekends, occupancy was 63.9 percent, down 3.1 percent year-on-year. Hotel prices rose by 1.6 percent year-on-year in June, below the overall inflation rate of around 5 percent. In May, prices rose 1.3 percent. So margins are being crimped, since price leverage really doesn't exist given the level of excess capacity.

Spain Posts Fiscal Deficit In The First Half of 2008

The Spanish government posted a budget deficit in the first half of 2008 as the housing collapse continued to hit tax revenue. The Spanish administration posted a deficit of 4.7 billion euros ($7.5 billion) compared with a 5.2 billion-euro surplus a year earlier, according to the Finance Ministry. The deficit was equivalent to 0.42 percent of annual GDP (which is something just over 1,000 billion euros). So we have gone from a surplus running at an annualised rate of 1% to a roughly similar deficit in the space of a year, and of course the economy continues to down in freefall.

Wolfgang Munchau Proposes The EU Organise An IMF-type Rescue For Spain

Well some times I agree with Wolfgang Munchau, and sometimes I don't. This is one of the occasions when I do, especially the following passage which can be found in his Financial Times op-ed this morning:

"Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own..........So what actions would be needed? In the very short run, a transfer mechanism to provide help for countries in severe distress. Of course, any transfers would have to come with IMF-style conditions attached."

Basically this is broadly in line with what I was suggesting in my RGE Europe EconMonitor piece - What Is The Risk Of A Serious Melt-Down In The Spanish Economy? - last Friday. Essentially the ECB has now gone about as far as it can, and the EU Commission in some yet to be determined way needs to play the role of the US Treasury (we lack the appropriate architecture at this point, but still), and inject cash - rather a lot of it. This is an EU problem and not simply a Spanish one since the source of the bubble lies very clearly in earlier monetary policy over at the ECB (or in deficiencies in the way in which the "one size fits all policy has been administered, see in particular "How to prick local housing bubbles in a monetary union: regulation and countercyclical taxes" by Alan Ahearne , Juan Delgado and Jakob von Weizsäcker - also on RGE last Friday).

It appears the Spanish cabinet is now divided between one group - lead by Industry Minister Miguel Sebastian - who favours intervention to rescue ailing builders - and another - lead by Economy Minister Pedro Solbes - who do not favour intervention.

My view is that a substantial, but as of yet indeterminate quantity of money (possibly in the region of 300 - 500 billion euros) needs to be injected urgently into the Spanish banking system, either directly (by buying cedulas hipotecarias outright) or indirectly by buying up and closing down builders as part of a "restructuring programme", and this needs to be done by the EU equivalent of the US Treasury (whatever we decide that that actually is) and not by the ECB. Thus I am neither with Sebastian (who would, I suspect like to save the builders) or with Solbes. Of course, as Munchau indicates, any such intervention would need to come with all manner of conditions attached (a restructuring of the whole Spanish mortgage situation, to put the banks back on a sound footing, being just one of these), and this would mean that the Spanish government would to some considerable extent lose control of its own internal affairs. But this possibility was already implicit in the creation of the eurozone in the first place, so I suppose you could say that one day or another this situation had to arise. And now it has. So let's get on with things and take some decisions.

You can find the relevant part of Munchau's editorial below:

But what about intra-eurozone divergences? I was struck the other day by a statistic from the ECB that shows Spain losing competitiveness relative to Germany, even now. We knew this happened during the years of high economic growth in Spain and low growth in Germany. But the trend continued even when the relative positions of the two countries were reversing. One explanation is that Spanish wages are directly linked to inflation, while German real wages are still declining.

Worse, Spain’s slippage comes amid the prospect of a serious downturn in its economy. Last week’s collapse of Martinsa-Fadesa, a large property developer, has been a reminder, if any were needed, of the massive scale of the Spanish property crash. Serious financial and economic distress is almost inevitable. Do not be fooled by the fact that Spanish banks had virtually no exposure to US subprime mortgages. Being exposed to Spanish mortgages is probably worse.

Spain is in a more delicate position than the US or the UK because, as a member of a monetary union, the country has fewer macroeconomic adjustment tools at its disposal. The dollar and the pound have devalued in real effective terms, while Spain has one of the hardest currencies in the world. Spanish interest rates have gone up while US rates have gone down.

The good news is that Spain has some room for manoeuvre in fiscal policy, given its low debt-to-GDP ratio. But the whole structural and legal setup of the eurozone requires that, in any adjustment, most of the heavy lifting is done via the real economy. Spain is thus in danger of entering a decade of misery, with falling real wages.

The problem is that even if Spain were to try to pull itself up through competitive adjustment, it is not at all clear that this would work. I am not even sure whether it works all that well for Germany in the long run, but that is another story. Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own.

Yet the eurozone’s system of economic governance is not designed to produce this type of response. There are no cyclical transfer schemes, only structural funds. No common rules exist on bank bail-outs. Small-minded national banking regulators even refuse to countenance the very obvious necessity of a central banking regulator for cross-border banks. The eurozone does not even have single representation at the International Monetary Fund. The economic shocks to be experienced by Spain, and by Ireland, will seriously test the eurozone’s see-no-evil-hear-no-evil approach to economic governance.

I have long thought that the only way the current set-up will be changed is not through debate about future eventualities but as a result of being plunged into crisis. Eurozone finance ministers – the so-called eurogroup – are a complacent bunch. They never do anything until it is absolutely necessary. But they will act eventually. I am relatively optimistic that they will always be able to ward off the worst-case scenario, one that still excites some commentators: the threat of a eurozone break-up.

So what actions would be needed? In the very short run, a transfer mechanism to provide help for countries in severe distress. Of course, any transfers would have to come with IMF-style conditions attached. As a price for an increase in intra-eurozone solidarity, the other member states would almost certainly demand that the beneficiaries end the silly policies that got them into the mess in the first place. Spain, for example, should end the automatic link between inflation and wages. It should also end the monopoly of the one-month euro interbank offered rate mortgage, which has had a hugely pro-cyclical effect on mortgage lending and the housing market.

The one institution that cannot help Spain is the ECB. Its role is to run an optimal policy for the eurozone as a whole. Dealing with this hugely asymmetric shock is primarily a matter for politicians, not central bankers. Anybody who claims to be serious about economic policy co-ordination, such as President Nicolas Sarkozy of France or the European parliament’s economic and monetary affairs committee, should therefore stop bashing the ECB for a few months and focus attention on the storm that is building up on the eurozone’s western front.

What Is The Risk Of A Serious Melt-Down In The Spanish Economy?

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again
John Maynard Keynes

'As far as I am concerned, this is ... the most complex crisis we've ever seen due to the number of factors in play'
Spanish Economy Minister Pedro Solbes speaking this week to Spanish radio station Punto Radio

Jose Luis Borges tells a story about two rascally villains, eternal rivals, who - under sentence of death - are offered one last bet: rather than accepting a conventional execution they can agree to have their throats slit simultaneously, just to see who is a able to run the farthest. Immortality, rather than fame, in an instant. Now I mention this since tale I can readily anticipate the immediate feelings many will have on reading what follows (I am at the end of the day going to argue that it is necessary to inject money - and I do mean rather a lot of money - into a banking and construction system which many will want to argue is largely responsible for Spain's present distress, and indeed, that having made a good deal of money out of the operation, these are the very people who should now be forced to don that sackcloth and ashes costume which so behoves them (actually the way things stand they are much more likely to find themselves reduced to a sporting a loincloth, but still). I understand why many ordinary Spanish people may have such feeling, but I do think this is a time for cool heads, and that what is most needed here is an extreme dose of pragmatism coupled with a lot of emotional intelligence. There is no point in agreeing to have your own throat slit just to see people you don't like have their's slit first.

Martinsa Fadesa The First To Go

This week's filing by the Spanish property developer Martinsa-Fadesa for protection from its creditors has brought Spain's ongoing economic agony back to the headlines. The decision follows a request from Martinsa Fadesa last Friday to its creditor banks for a postponement of the deadline on their requirement that the company obtain a 150 million euro ($235.7 million) loan. The banks refused the request and the rest is now, as they say, history. The failure of Martinsa - Fadesa whose debts are in the region of 5 billion euros - is not only the largest corporate bankruptcy in Spanish history, it is also a reflection of the pain which must now be being felt in Spain's troubled banking and construction sectors, and a harbinger of what is, in all probability, going to be much worse to come.

Spain At Risk

So to come directly to the matter which has provided me with the header to this post, just what is the risk that the present recession in Spain is something a bit more than a mere recession? What is the risk of a real and serious economic melt down just across France's Southern border, a mere stone's throw away (by plane) from Brussels or Frankfurt, yet still on the other side of that intellectual and cultural divide which seems to be formed by that ever so picturesque natural barrier known as the Pyrennees? Well it is a non-negligable one, in my view. Let me explain a bit.

First, as background it would be worth reading my Artemio Cruz Syndrome post, since all the main macroeconomic arguments are presented there (and those who seriously want to know what is going on should definitely read the excellent "Spain:Bubble Bursting - We now expect a full-blown recession" desknote from PNB Paribas).

Secondly, we need a bit of vocabulary clarification, since the terminology being used has become somewhat confusing of late. We could reasonably break things down as follows I think:

i) Soft Landing
ii) Hard Landing
iii) Melt Down

Now, in terms of the available semantic space, why don't we allow that "soft landing" means a recession of the more or less garden variety (as Portugal or Italy have at this moment, or as say France may anticipate, or Denmark) and not consider this to mean avoiding recession completely, which is how some seem to have used the term in recent times (I think it is hard to imagine any EU 15 economy avoiding recession completely between now and Q2 2009). Possibly Hungary up to this point could also be said to have had a comparatively soft landing.

"Hard Landing", on the other hand would be what they are currently experiencing over in the Baltics, what they may well soon experience in Romania, Bulgaria, the UK, and Ireland, and what is now most certainly taking place in Spain. Thus by "hard landing" I mean a very sharp slowdown in growth, a medium sized contraction in consumption, financial distress and bankruptcy in some areas, and a recession which drags itself on for more than a mere two quarters (in and out of negative growth) and probably results in annualised negative growth for a period of at least 12 consecutive months. What happened in Turkey in 2000 was certainly a hard landing in this sense.

iii) "Melt Down", following such definitions, would then be a Hard Landing plus, a Hard Landing plus a shock (or in Hungary's case, where the shock would be a run on the forint, you could imagine what initially is only a Soft Landing being converted into a melt down, but arguably Hungary's case is very special given the very high level of exposure of household balance sheets to CHF denominated forex loans).

Such a shock could be a banking crisis, a run on the currency, a sovereign default (this is where Italy's series of perpetual soft landings could move decisively into meltdown mode one of these fine days if something isn't done to correct the low growth/high sovereign debt to GDP dynamic while there is still time).

Now in this sense, Spain's economy is at some significant level in danger of having a melt down - lets define this as more than two years of negative GDP growth with a magnitude of more than one percentage point, coupled with (in the case of countries which have their own currency) very sharp devaluations, and in the case of those that don't severe and extended price deflation (ie a mini version of what happened in the USA in 1930).

Now the recession in Spain is, I think, more or less most certainly already served. The Spanish press were talking earlier in the week about a quarter on quarter contraction of 0.3% in Q2, and it is hard to see any acceleration of the economy in Q3. Pedro Solbes, when questioned explicitly by Punto Radio on the possibility that whole year growth for 2008 could turn negative replied diplomatically "It's not my feeling at the moment", which means basically that it might well turn out to be the case.

If this expectation if fulfilled then Paribas may have to revise their latest forecast slightly (see above link) since - in what is really an excellent general analysis - they pencil-in the recession to start in Q3 2008 and then move on to anticipate a contraction in the Spanish economy of 0.75% in 2009 (although as they freely admit all the risks here are skewed to the downside). My own personal call at this point is that the recession may well have started in Q2 (we will soon know) and that the contraction in whole year 2009 will be over 1 percentage point. Further than that I am not willing to go at this stage, since it all depends, and in particular it depends on whether or not we get a nasty "event" or series of events which send the economy hurtling out of the "hard landing" bracket and into the "melt down" one. It is because I strongly believe we be should doing everything we possibly can to avoid that eventuality that (and not continue to languish under our blankets with a heavy dose of the Artemio Cruz syndrome) that I am writing this post now.

Before continuing, however, I should point out that even the Paribas idea of negative growth in 2009 is still very nonconsensual, despite the widespread pessimism which currently surrounds the Spanish economy. The consensus economic survey for June gives a median 2009 growth forecast of 1.5%. The lowest forecast in the survey is 0.4% but most are grouped in the range 1.0-1.8%. Maybe the consensus will catch up with the curve in due course.

Structural Unwind

So what would be my justification for making such an apparently gloomy forecast? Well as I argue in my Artemio Cruz piece, and as Paribas re-iterate in their study, this is no ordinary crisis. It is taking place against a background of a severe credit crunch which affects the entire financial sector, in a country with an enormous external deficit (CA deficit over 1o% of GDP and rising), which has a strong external energy dependence, and at a time when food and energy prices have been rising sharply. All of this is bound to exert a very strong downward pressure on internal consumer demand, and as a knock-on impact on investment spending. At the same time slowing growth globally, and in the EU and eurozone economies in particular, makes for a very difficult external environment where increasing exports (even assuming Spanish export prices were currently competitive, which they aren't) becomes difficult, if not well nigh impossible.

Serious Structural Distortions

So let's take a quick look at some of the underlying structural issues. In the first place both Spanish households and corporates are extremely highly leveraged at this point in terms of their outstanding debt obligations. The levels of debt to GDP are really extraordinarily high when compared with their eurozone peers.



So how did Spain get into this rather precarious situation? Well I don't think you need to look too far to discover the answer. As can be seen in the chart below, Spain effectively had negative interest rates throughout the entire period between the start of 2002 and the autumn of 2006. That this state of affairs was produced in the very earliest years of the history of the eurozone was indeed, in my opinion, truly unfortunate, since it meant that inflation expectations had not had time to be "steered down" by a central bank track record. Thus a very widespread reaction on the part of ordinary Spaniards to what were generally perceived to be derisory interest rates for savers was to withdraw money from longer term deposit accounts and to place it in what was considered to be the safest of safe inflation hedges: property. Thus began what may well turn out to have been one of the most serious property bubbles in recent history.

The situation was also doubly unfortunate, since the ECB along with other central banks had lowered interest rates in an attempt to support economic weakness produced by a drop in stock market values following the collapse of the internet boom. In Spain's case however, the excesses caused by the internet boom never really had the opportunity to unwind, since as one boom ended, another one simply got going in its place. This effect can be clearly seen in the chart for long term quarterly GDP growth produced below, where we can see that following the 1992/93 recession (and up to Q2 2008) Spain simply hasn't had one single quarter of negative growth - that is during 15 years. Hence the legend of the Spanish economic miracle was born. But as with all legends, we should also really be asking ourselves what the reality was which lay behind it, since as we can now see, the absence of recession - and in particular the absence of recession in 2002/03 - simply means that we now have a lot of extra "distortion" lying out there and waiting to be "corrected" (the waste-pipes were effectively never flushed, which is why we are now faced with such a peculiar smell emmanating from the sewage system). This would be the main reason why I would argue that what we cannot now expect is a relatively smooth "return to trend" in 12 to 18 months time, since Spain has effectively been "off trend" for some six or seven years now, and the magnitude of the excesses (10%+ CA deficit, 5 million immigrants in eight years, corporate indebtedness pushing the 120% of GDP mark etc etc) is prima facie evidence for this. So even in the best of cases we are almost certainly now facing a significant period of negative and then very low headline GDP growth. But we may not be lucky enough to get away from all this with a simple best case scenario.



The last piece of structural evidence I would offer in this post refers to the CA deficit situation. Since I deal with that reasonably exhaustively in the Artemio Cruz piece, I will only refer to one item here: the deteriorating balance on the income account.

Now this is important in my opinion. It is important since obviously any of the remedies to Spain's short term financing problems imply borrowing money (in some way, shape or form via the support which is offered by belonging to the eurosystem). Spain needs one of those proverbial "bailouts", even though since Spain does not have its own idependent currency this position is somewhat masked by the fact that everything is denominated in euros. But debts incur interest, and the more you borrow, the more you effectively have to pay, not only in capital, but also in interest. And if Spain country risk rises sharply in any way - as some analysts are suggesting it may have to - well then what is already a serious problem is only going to become a more serious one.

Land Prices


So where are the risks? Well I think it is no simple accident that Martinsa-Fadesa has been the first major developer to go, since a very large part of their portfolio is composed of land. According to press reports Martinsa Fadesa had land totalling 28.67 million square metres, 41 percent of which is outside Spain (and 50% of which is not "zoned", that is it is without the necessary premission to build). They also have a stock of more than 173,000 newly-built and unsold properties (again by no means all of these are in Spain). Now land is going to be a very important component in this whole "correction", since a lot of land (as we can see) has been accumulated with intent to build, and much of this land may now become virtually worthless. And land prices are already falling faster than house prices. Data from the Ministry of Housing shows that land for building fell to 251 Euros/m2 in March, a 7.7% drop when compared with March 2007. Land prices had fallen for 3 consecutive months by March with the average cost of land in Spain now being back somewhere around where it was at the end of 2004.

So I would say this is one of the first issues the Spanish government needs to tackle, and quite urgently. Frankly I can see little alternative to having the government intervene and take this land off the books of those who are holding it - not at market prices, they can handle some sort of "haircut" - but I don't think the government should be sitting idly back and watch one developer after another simply fold, since the end result of this is that the problem then moves over into an already overstretched banking sector.

Which brings me to my exhibit one: Japan land prices.

One of the key features in Japan's ongoing battle against deflation has been the way in which land prices were simply allowed to fall after the property bubble burst in 1991. The above chart shows the sharp rise in Japanese land prices from 1986 to 1990 - a period during which they more than doubled - and how they subsequently fell - albeit more gradually — by roughly two thirds from 1990-91 to 2005. Although urban land prices started to turn up slightly post 2006, land prices still continue to fall elsewhere, and of course we still haven't seen how the latest construction "bust" in Japan is going to leave things. Unsurprisingly, residential construction has remained virtually dormant in Japan over this entire deflationary period.So the question is, what is to stop this happening in Spain. I would be grateful to anyone who can present me with a reasoned argument as to why what happened in Japan won't happen here. Meanwhile the risk is evidently there.

The Builders In General

Obviously even if the most immediate and pressing problem in Spain is arising in the area of land prices, the rest of the housing related construction sector will not be far behind. This is a problem that is simply waiting to happen. According to the latest data from the Spanish housing ministry, average Spanish property prices fell by 0.3% in the 3 months to the end of June, but they were still 2% up on prices in Q2 2007, a factor which is leading many to question the reliability of the Spanish data (one more time Artemio Cruz strikes, since Spanish institutions are far from swift in responding to problems, and would seem to prefer denying that they exist). One explanation for the present situation may be that prices are being measured in terms of the initial asking price and not the final selling price. Whatever the explanation prices are certainly set to tumble, and even the the G-14 developers’ association, traditionally a staunch upholder of the immobility of property values, has had to admit that new-build prices have fallen by 15% in the last 6 months alone, while Cue Mariano Miguel, ex-president and present board member of the much troubled developer Colonial, is already predicting a fall in the region of 25% to 30% over the next two years. And new property in Barcelona (which is where I live) is now taking ten times longer to sell than it was only a year ago, according to real estate consultancy Aguirre Newman.

Meanwhile we learn from Jose Luis Malo de Molina, director general at the Bank of Spain (speaking at a recent conference in Valencia) that the number of new homes which will be completed in Spain in 2008 will beat all previous records (I said this was a system which was slow to react), simply piling one more house after another in order to add to that glut of newly completed homes that is already idly languishing and casting its long shadow over the Spanish property market. 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.” As I say, "just in time" may be an idea that has entered the heads of the more agile companies like the textile consortium Inditex, but most of Spain is a very, very long way from being able to offer an agile response. On the anecdotal front, a friend of mine recently went to visit family homes in the North West of Spain. In Vigo he spoke to the owner of a brick factory, and in Leon someone who had a quarry. In both cases production was continuing (there is simply no on/off switch here) but the inventory already had piled up to the extent of being now prepared to satisfy normal requirements for the whole of 2009 (in both cases), and of course, in 2009 requirements will not be normal, since housing starts in 2008 have collapsed to a forecast of below 200,000 (down from 600,000 plus in 2007).

At this point estimating the volume of unsold housing in Spain is really a question of "its anyone's guess" rather than a matter of scientific fact. The number 1 million is popular, but I suspect this is more a question of serving up an easily managed factoid than one of accurately measuring empty houses one by one. The same applies to the estimates for the size of the likely fall in property values. All we can safely say at this point, I think, is that the number in both cases is large.

The big question for our current concerns is who is exposed to the risk on all this, and the answer to that question is a lot simpler: Spain's already cash-strapped banking system.

One common estimate of the exposure of the banks to the builders would be somthing of the order of 300 billion euros - this is the opinion of Spanish analyst Inigo Vega at Iberian Securities (and it is one I more or less share). So we could say we have something in the region of 20% to 25% (or more) of Spanish annual GDP in play here.

Bank Exposure Through Mortgage Backed Securites

To this second order exposure of the banking system to the construction sector alone (and remember, through the negative impact of all this on the real economy, we should never lose sight of those non-construction corporates, you remember, the ones who had all that indebtedness we saw in the first chart) we need to add the exposure of the banks to the cedulas hipotecarias, which alone run to something in the 250 to 300 billion euro range (to which we need to add, of course, other classes of more conventional mortgage backed-securities ). If we add these two together - the builders and the cedulas - then we are obviously talking about a potential injection into something of over half of one years GDP in Spain.

According to Celine Choulet of PNB Paribas mortgage-backed securities in the broader sense of the term (ie including cedulas and MBS) now add up to around 37% of outstanding mortgage loans in Spain. She also estimates that asset backed securities held by non-residents may amount to as much as 81% of the total securities issued.

Outstanding home loans (for purchases and refis) represent a substantial percentage of the Spanish banking institutions’ balance sheets (21.5% of total assets and 35.6% of total loans to the non-financial private sector in the second quarter of 2007). In the second quarter of 2007, outstanding home loans amounted to 589 billion euros, 56.4% of which were distributed by cajas (29.8% of their assets), 37.2% by commercial banks (15.4%) and 6.4% by mutual institutions (30.9%).

If we add together home loans and the financing of real estate sector (construction and property services), the overall exposure of Spanish credit institutions has increased significantly over the last decade (37% of assets in the second quarter of 2007, 61.5% of total loans to the non-financial private sector). Exposure of Spanish banks to the real estate sector has exceeded, both in level and in growth rate, that of US, Japanese and British banks. In total, in the second quarter of 2007, cajas (49.7% of assets, 70.5% of loans) and mutual institutions (46% and 56.3% respectively) were almost twice as exposed as commercial banks (28% and 55.2% respectively).

According to Choulet - and just to take one example - in 2006 total new funding to the Spanish mortgage market reached 201.3 billion euros, of which 88.3 billion took the form of covered bonds (representing 43.9% of the total of mortgage securities market) and 113 billion was in mortgage-backed securities (56.1%).

And remember the cedulas all need to be "rolled over" in the next few years (with a big chunk coming up between now and 2012). And the problem starts this autumn. According to an article in the Spanish daily El Pais at the end of June the Spanish banking sector needs to raise 62 billion Euros before the end of this year just to rollover what they have coming up on the immediate horizon.

So what does all this add up to? Well, to do some simple rule of thumb arithmetic, just to soak up the builders debts and handle the cedulas mess, we are talking of quantities in the region of 500 to 600 billion euros, or more than half of one years Spanish GDP. Of course, not every builder is going to go bust, and not every cedula cannot be refinanced, but the weight of all this on the Spanish banking system is going to be enormous. Banco Popular is the most visible sign of the pressure, and their shares have already dropped by 44% this year, and by 7.9% on Tuesday alone (they were the listed bank which was most exposed to Mrtinsa Fadesa).

So it is either inject a lot of money now - more than Spain itslelf can afford alone - or have several percentage points of GDP contraction over several years and very large price deflation - ie a rather big slump - in my very humble opinion. And it is just at this point that we hit a major structural, and hitherto I think, unforeseen problem in the eurosystem (although Marty Feldstein was scratching around in the right area from the start). The question really we need an answer to is this one: if there is to be a massive cash injection into Spain's economy, who is going to do the injecting? Spain alone will surely simply crumble under the weight, and it is evident that the problem has arisen not as the result of bad decisions on the part of the Spanish government, but as a result of institutional policies administered in Brussels and monetary policy formulated over at the ECB. And yet, the Commission and the ECB are not the United States Treasury and the Federal Reserve, no amount of talk about European countries being similar to Florida and Nebraska is going to get us out of this one: and it is going to be step up to the plate and put your money where your mouth is time soon enough. Yet, cor blimey, we are still busying ourselves arguing about the small print on the Lisbon Treaty.



Demographics and Construction


The third major area of risk I would like to highlight today relates to the problem of demographics and their impact on the construction outlook. PNB Paribas (see initial link) see demography as one of the principal downside risks to their forecast. They put it like this:

"With United Nations population projections pointing to growth of only 300k per year on a ‘high-population’ variant for 2010-15, housing starts could fall considerably further. Hence the risks to our central forecast of 30% off housing investment by end-2009 are to the downside. The correction could be more rapid than expected. If not, it is likely to persist into 2010. ...........Our forecast has housing investment converging to levels consistent with relatively strong population growth. A weaker population assumption or some undershoot of the ‘equilibrium’ level would lead to a worse outcome."

Basically, I think the big topic in this context is the coming rate of new household formation. And here it is worth remembering that while the countries most affected by the property-driven credit crunch in the EU would appear to be Spain, Ireland and the UK, the UK is rather different from the other two, since while housebuilding grew by 187% in Spain between 1996 and 2006 (and by 177% in Ireland), the equivalent increase in the UK was just 12%. Planning restrictions in Britain meant fewer homes were built and the resulting relative scarcity may provide one part of the explanation for why house prices have almost doubled, in real terms, in the UK since 1999 despite the comparatively low percentage of new builds (this would bring us back to the huge zoned and un-zoned lang overhang in Spain, and what the dynamics are that produced it). That is, while the UK can to some extent offset the impact of the crisis in the longer term by increasing homebuilding (to house, for example, all those extra people from Poland and other parts of Eastern Europe), in Spain and Ireland the problem is going to be very different, since they both have to sharply reduce housebuilding capacity.

So what are the main sources of new household formation in Spain? Well basically they are threefold: natural population development, migration, and second homeowners from the north of Europe. Now if we start with the question of natural population evolution in Spain, ex-migration the Spanish population is virtually stationary at this point - with an average annual increase of a mere 30,000. But what matters in housing terms is not so much the size of the population as its age structure, and here we don't need to go to the level of refinement involved in looking at longer term UN population projections (high, median or otherwise) because in terms of Spanish property from now to 2020 (at least in terms of natural population drift) the deal is now done (or rather the goose is now cooked), and a quick glance at the US Census Bureau IDB population pyramid for 2000 should make this abundantly clear (see below).

What we can effectively see is that in 2000 (and please click on the image if you want a better look) Spain's three historically largest 5 year cohorts constituted the 25 to 40 age group. But if we mentally fast forward as far as 2015 we will see that the aggregate size of the cohorts in this age range is very significantly smaller, and if we fast forward again to 2020, we will see that what we have are the three smallest cohorts in the last forty years. And from here on in we only go down and down - talk about absence of sustainability!

So we are left with North Europeans is search of second homes and migrants to offer some support to Spain's rapidly crumbling housing sector in the coming years. Well on the North Europeans front the picture doesn't look exactly promising either, since the bulk of the buyers in recent years have been British (Britons own an estimated 500,000 to 700,000 properties in Spain), and they are already having their own problems, plus the fact that changes in the value of the GBP and interest rates mean that affordability is becoming an issue, an issue to which you have to add the drop in attraction of properties whose prices may now be set to seriously deflate, and over a significant number of years.

Indeed, according to Manuel Gandarias, president of the ‘Live in Spain’ holiday-home developers’ association, sales of holiday homes in Spain are now down by 50% from the peak “In recent years between 120,000 and 125,000 holiday homes were sold each year, this year it will be half that,” he is quoted as saying. And of course it isn't only the cost of buying the home that has been going up, it is also the cost of servicing the debt that buying the home brings with it. Josep Suárez, director at Solbank in London estimates that the combined impact of rising Euribor rates and the appreciation of the Euro against the pound (15% in the last 9 months) means that mortgage payments for Britons with mortgages in Spain are now 25% higher than they were a year ago.

So the outlook on the North European second home market doesn't exactly look bright either, which leaves us with the migrants. As is now generally well known, Spain's population has increased dramatically in recent years - from around 40 million in 2000 to around 45 million in 2008 - and this increase has been almost exclusively (natural increase is no more than a quarter of a million) the result of huge inward migration.



Basically the future of all these migrants is now deeply uncertain. I would even say that losing the migrants constitutes the most important of all the downside risks to the Spanish economic crisis for the impact it will have on urban rents and mortgage delinquency in the short term (since many of the migrants have bought flats), and for the consequences for Spain's housing market and pensions system in the mid term. Evidently, since most of the migrants are economic migrants the inward flow must surely be about to dry up (since there are few if any jobs for them) and thus our attention should be focused on the need to hold onto those we already have.

Is There A Rescue Plan Available?

Basically, and on the basis of all the above, I would like to now put forward a five point "rescue" plan for the Spanish economy. It would look something like this:

1/ Set up a national land agency, to buy up land and to irrevocably convert it to other uses (agriculture wouldn't be a bad bet where possible given present food prices). This to include the proviso that such land could never again be zoned.
2/ Buy out and close down the bankrupt builders as part of a general restructuring programme such as the one which was developed for the shipyards and the mines.
3/ Buy up and burn immediately ALL outstanding cedulas hipotecarias. Well, I'm exaggerating here, but something very decisive needs to be done to take these things out of circulation in the longer term, or we will never ease Spain out from under this.
4/ Establish a programme to help immigrants in difficult circumstances, and offer training etc to prepare for the future. Abasic focus of policy needs to be on trying to persuade migrants to stay.
5/ Restructure all existing mortgage contracts - which will involve every one paying more - in order to put mortgage financing in Spain back on a sound footing. This will obviously require legislative intervention, and will equally obviously involve breaking the direct tie with one year euribor. It has been following euribor up and down which has gotten the Spanish mortgage market into this mess in the first place.

OK, I warned you. I said none of this was going to be popular. And none of these propsals should be consider as carved in stone. Better ones could well, I am sure, be put forward, but in the absence of anything credible in the way of alternatives I am putting them forward now. As I said at the start, there is no point in agreeing to have your own throat slit just to see people you don't like have their's slit first.

It is very, very important that some form of "corta fuegos" (fire break) is put in place, and put in place now, otherwise the whole of Spain could very easily burn down in just the same way the Liceu opera house did here in Barcelona, simply because some chump decided to do on-stage soldering repairs with the safety curtain up! Risk sir, there's no risk here. It's all as safe as houses.

Spanish Builder Martinsa Fadesa Suspends Trading (Updating Daily 10)

Please Note That This Post Is Presently Being Updated On A Daily Basis As The Crisis Develops. The latest news is at the bottom.


Reuters are reporting that the listed Spanish property company Martinsa Fadesa have been suspended from trading this morning following the request from the Spanish property firm last week for extra time from the banks to obtain additional credit in order to maintain its refinancing obligations. Martinsa Fadesa said on Friday it had asked creditor banks to waive a requirement that it obtain a 150 million euro ($235.7 million) loan - to make scheduled interest repayments - until August 7 after the deadline for obtaining it expired. (For fuller explanation on the background see this post of mine from yesterday).


The company is scheduled to hold a board meeting at 14:30.

Shares fell 25 percent to 7.30 euros this morning before the Spanish stock exchange regulator suspended trading. On Friday, they fell almost 34 percent after the company said it had asked creditor banks to give it until Aug. 7 to obtain a loan the loan it needed as part of a refinancing agreement reached in May. In a regulatory filing, the company added that it had asked for the waiver because the deadline for obtaining the loan had expired.

Update 1

According to the Spanish paper Expansion Martinsa-Fadesa creditors expect the Spanish developer to initiate bankruptcy proceedings later this week.

La Caja de Ahorros y Pensiones de Barcelona and Caja Madrid, Spain's two largest savings banks, are said to have lent more than 1 billion euros ($1.6 billion) each to Martinsa, while Banco Popular Espanol, Spain's third-biggest publicly traded bank, may have lent 400 million euros, again according to Expansion. Banco Popular's shares closed down 2.74 percent today.


One of the big areas of interest about the Martinsa portfolio is the quantity of land it contains. At the end of March 2008, Martinsa Fadesa had land totalling 28.67 million square metres, 41 percent of which is outside Spain. They also have a stock of more than 173,000 newly-built and unsold properties. Their net assets were worth 1.693 billion. In the first quarter, the company made net losses of 85 million euros and an EBITDA (earnings before interest, tax, depreciation and amortisation) loss of 85. Further, more than 40 percent of Martinsa Fadesa's land in Spain is not zoned, which means it could have problems getting building authorisation, particularly as the government tightens development rules.

Update 2 - Tuesday 15 July 2008

Well, it's happened. History is now in the making. Martinsa-Fadesa SA yesterday became the first publicly traded Spanish developer to seek protection from creditors following the closing of the wholesale money markets to Spanish banks in the wake of last August's sub-prime crisis in the United States. Martinsa sought bankruptcy protection after failing to secure a loan that banks had demanded from them as part of a debt refinancing process. Martinsa has a current market value of 680 million euros ($1.1 billion), less than half of the peak reached in March 2007.

Sixty-five developers and real-estate brokers based in Spain have now sought bankruptcy protection this year, according to Credito y Caucion, a Spanish credit insurer.

So now it is simply a question of waiting and see who is going to be next. This is very frustrating, sitting here and watch the government sitting back with virtually folded arms, as if we were attending a typical European Cup final play off, just waiting to see when the Spanish team get sent home. There is lot's that could be done. This is all such a pity.

In very active trading on the Spanish Bolsa this morning Banco Popular and the country's leading real estate shares opened down over 6 percent as the market weighed news of Martinsa Fadesa's bankruptcy. This is already one of the largest and most significant corporate failures in Spain's history.

Property firms Colonial and Renta also opened down more than 6 percent. Popular, a major creditor to Martinsa - Expansion suggested yesterday that they were into Martinsa for 400 million euros, but they are much more vulnerable (and possibly generally exposed) than the larger La Caixa and Caja de Madrid - suffered the heaviest fall of any Spanish blue-chip stock.

At 2:12 Banco Popular shares had fallen 56 cents, or 7.9 percent on the day, at 6.54 euros, thus extending their loss so far this year to 44 percent.

Update 3 - Wednesday 16 July 2008

Well, El Economista is reporting that Spanish Prime Minister Jose Luis Rodriguez
Zapatero actually went back on a promise to provide loans to Martinsa, effectively forcing the company to seek protection from its creditors. According to the paper Zapatero promised Martinsa Chairman Fernando Martin he would provide the company with a 150 million-euro ($239 million) loan from the Official Credit Institute at a meeting in his official Madrid residence - La Montcloa - last December.

This is fascinating. Who really knows if ZP did make any such promise, or if this is simply the Spanish rumour mill hard at work - although presumeably ZP did meet with Martin - but either way a lot of scandal is surely now about to be served (incidentally there is now quite a lot of opinion and observation in comments if you are interested).

Also Martinsa-Fadesa SA formally asked a court for protection from creditors late last night, in the largest bankruptcy filing yet among traded property companies in Spain. The company said in a securities filing dated July 15 that it delivered the request to the Mercantile Court of La Coruna, in northwestern Spain, where the real estate company is based.


According to Reuters writer Elena Moya, the demise of Martinsa is a sign hedge funds are pushing hard to profit from the plight of ailing companies and this may lead the insolvency proces in Spain to speed up.

Hedge funds bought Martinsa Fadesa debt at discounts of as much as 50 percent of its value, and may now profit from the forthcoming administration process, since the expected sale of assets in the longer term may pay them back at a price closer to face value. The problem is that the Spanish banks and builders simply don't now have the liquidity to sit back and wait in this way.

Basically this is modern globalised capitalism, and there is no need for such funds to care whether or not a company goes bust, and this may teach many Spanish companies - used to cosy long-term relationships with regional savings banks such as La Caixa, and Caja Madrid - a very painful lesson in modern global finance. Essentially the process doesn't come in parts. You can't have the parts you like, and then reject the bits you don't like. No one was complaining when these people were buying cedulas, well now.....

Moya quotes Mark Fennessy as follows:

"There will be more of these companies. Spain is completely unprepared for what's going to hit them," said Mark Fennessy, a restructuring partner at Orrick, a London law firm. "There are a number of funds, large private equity funds, that are already in discussions with Spanish banks to take out their debt and equity positions in distressed companies. We will see an increase in this activity."

I completely agree, the whole deabte here is way behind the curve. Basically such funds tend to be patient investors who sit back and wait for months (or years) before acting - and they are now reputedly eyeing Spanish companies such as retailer Cortefiel, or natural stone producer Levantina, who are both rumoured to be suffering as Spain's economy crumbles. (Claus Vistesen had a useful summary of the debate about the so called "vulture funds" - more correctly termed distressed hedge funds on his Alpha Sources blog earlier last year).

Spanish banks had been trying to exclude foreign banks and investors in distressed companies from the restructuring agreements, in an attempt to prevent them influencing debt deals, however with the position deteriorating rapidly this is no longer realistic. Property companies such as Detinsa and Diursa did recently manage to reach debt restructuring agreements without international banks, but it will now be hard to keep international investors out, especially after the collapse of Martinsa Fadesa has increased the profile of opportunities in Spain.

Indeed, earlier this year, Martinsa Fadesa itself had to battle hedge funds in London as it needed a unanimous creditor agreement to approve its 4 billion euro refinancing. Using their deal-blocking power, some hedge funds managed to win repayment deals within one year, while some Spanish banks had to wait as much as seven years.

Perhaps the most ominous quote of the day comes from this (anonymous distressed hedge fund manager):

"Before, prices discounted the fact that the biggest companies wouldn't go bust, now maybe there will be a change, maybe now people will see the seriousness of the matter and will start working with more realistic expectations,"

On a not altogether related front, we learn today that Spanish car sales fell even further through the floor in June. Car sales fell 31 percent (year on year), compared with only a 14 percent decline for January-May. New car registrations for the whole of Europe were down 7.9% year on year, falling to 1,427,008 units from 1,549,574 in June 2007, according to data from the Brussels-based European Automobile Manufacturers Association. European sales for the first half of the year slid 2.2 percent, accelerating the 0.7 percent contraction recorded in the first five months.

So car sales are falling everywhere, but Spanish car sales are falling by a considerable order of magnitude above the rest, and the problem is accelerating rapidly, as financial jitters send builders out of business, and the combination of these two sends the real economy swiftly down, which of course only adds to the problems in the financial sector, etc, etc, etc......

Meanwhile Spanish Economy Minister Pedro Solbes in an interview on PuntoRadio today that the financial trouble of property group Martinsa Fadesa is an isolated case and not a sign of systematic failure. He also said the government would not bail out Martinsa Fadesa.

``We always said to Martinsa that we would help in whatever way we could,'' Solbes said in an interview on Punto Radio. Still ``the Official Credit Institute's credit lines aren't for working capital or real estate investment'' so ``we couldn't agree that there were projects that would allow us to offer'' financing.

Solbes also confirmed that Spain's economic growth will be "close to zero in some quarters" this year. Economic growth slowed to 0.3 percent in the first quarter, less than half the 0.8 percent rate of the previous three months and the government has predicted the expansion will cool further this year. When asked "Could growth turn negative?" Solbes replied "It's not my feeling at the Moment".

However the daily El Pais reported today that 12,500 families have begun paying for homes that were still under construction in Spain, Portugal, France, Morocco and eastern Europe, and Solbes also said that the government had an interest in guaranteeing that the company preserved the maximum amount of jobs - 234 people are apparently already about to lose their jobs - and that houses under construction were finished, so it is not quite clear at this point how all the circles are going to be squared here.

'It is true that other countries have acted to help companies, but it's normally when the problems are systemic and could filter through to other sectors...but this has nothing to do with the Spanish case, which is isolated,'

I really fail to see how he can say that this is an isolated case and keep a straight face. Maybe the magnitude of the land portfolio made Martinsa a bit special, but the issue is going to be far from an isolated one.

However he did admit that Spain's economy is going through an exceptionally complex economic crisis, this is the firts time, I think, that he has spoken so frankly.

'For me, this is ... the most complex crisis we've ever seen due to the number of factors at play,'

Would sombody kindly like to do something to try and extinguish the fire! (see comments)


Update 4 Thursday 17 July 2008


Prime Minister Jose Luis Rodriguez Zapatero has denied Martinsa loans he had promised the company before Spain's March 9 election when he wanted to prop up the company to avoid damaging consumer confidence, according to the newspaper El Economista.

Reuter's Elena Moya is now reporting that Martinsa Fadesa may not need to sell assets during its administration process if a new debt refinancing agreement is reached with creditors, citing "a source involved in the situation".

Moya says that "under Spanish administration law, a deal now needs only 50 percent consensus to be reached, facilitating an agreement amongst creditors". It's the now in this phrase which attracts my attention. Does this mean that the law has recently been changed, since this clearly wasn't the position before, or they wouldn't have gone bust so quickly. Or is this just rumourology to "buy time"?

According to Moya:

The international banks and hedge funds that imposed tough conditions on the company's failed restructuring agreement will now be left out -as the board will only need 50 percent approval on any deal- making a solution more likely, the source said.

But this takes us back to the hedge funds as the source of the problem - the so-called "vulture fund" thesis - and while they are part of the picture, they are not the main part, so something still has to be faced up to somewhere, someday. And protecected as unlisted savings banks like La Caixa and Caja Madrid are, there are limits to their potential "generosity".

Meantime Spanish real estate company Renta Corporacion said today it had booked net losses of between 25 and 27 million euros ($42.8 million) for the first half of the 2008 financial year. Sales were between 173 and 176 million euros, the firm said, without giving a comparative figure for the same period last year.

Friday 18 July 2008

Not too much on the general bankruptcies front today. The only vaguely related topic is the news that Banco Popular after coming back from last Tuesday's low of 6.54 retreated again for the first time in three days today, declining by 10 cents, or 1.5 percent, to 6.80 euros.

Spanish loan defaults climbed by 3 billion euros in May, according to data from Spain's central bank. Defaulted loans climbed to 27.76 billion euros from 24.75 billion euros in April and 12.05 billion euros a year ago. Loan defaults as a proportion of total loans reached 1.53 percent from 1.37 percent in April and 0.77 percent a year ago, according to the Bank of Spain data.

Spain's stock of mortgage loans rose an annualized 10 percent in May, the slowest growth rate in at least 15 years. Mortgage growth in May halved from 20.5 percent a year earlier, the Spanish mortgage association said today. That is the slowest growth rate since at least 1993, when the association began recording the data. Growth in Spain's stock of mortgages may slow to the 6 percent to 9 percent range this year from 14.9 percent in 2007, the association said. Mortgage defaults are now at about 1.1 percent of home loans and may rise to 2 percent by year-end.

Spanish construction sector output fell by 10.8% in May compared to May last year, according to the EU statistics office Eurostat. This was the biggest fall in the EU, and came after a 19% drop in April, when Spain also lead EU countries with construction sectors in retreat.




On a monthly basis, however, Spanish construction activity actually rose in May, with output 2.9% higher than in April. This is the first time since December that Spanish construction activity has risen from one month to the next, and was the second biggest monthly rise in the EU, behind only the UK (+3.4%). However, we need to remember that building is one thing and selling another (see mortgage data above), that Spain has to complete a record number of house and flats this year, and that the government is also increasing spending on civil engineering works which also figure in the data.


On another front altogether Promotora de Informaciones SA, aka as PRISA, and which is Spain's largest publicly traded media company, extended the maturity on 1.95 billion euros ($3.1 billion) of loans used to fund its increased stake in pay TV operator Sogecable SA on Friday.

Prisa extended the debt's maturity to March 2009, the company said in a regulatory filing today. Prisa owes about 5 billion euros after borrowing last year to buy the 48 percent of the Spanish TV company it didn't already own. The publisher of Spain's El Pais daily newspaper will raise another 500 million euros in the capital markets to reduce debt, the regulatory filing said, without providing details. Banks that supplied other loans to Prisa approved the extension, according to the filing. Looks like some people are struggling to find cash.




Update 6 Monday 21 July 2008

Well as noted at the end of last week, Prisa have been looking for cash, news today may help us understand why. Gestevision Telecinco SA and Antena 3 de Television SA, Spain's largest broadcasters, may well have to cut their dividends as a slowdown in advertising growth erodes earnings. Telecinco, who have raised their dividend for the past three years, have alreadt lost 48 percent in Madrid trading this year. The television company reports earnings on July 31. Antena 3, which has paid annual dividends since 2005 and is down 43 percent this year, posts results the same day. Both broadcasters will say profit declined, according to analysts' estimates.

Spain's 2008 ad revenue is forecast to grow at about half of last year's pace, if they are lucky. The slowdown in ad revenue has prompted Morgan Stanley to cut its profit estimates on the broadcasters for 2008 through 2010. As Spanish economic growth falters, the companies' outlook is worse than their European peers, and this is giving us another clear sugn how what started out as a problem with cedulas hipotecarias in the wholesale money markets is now ripping its way through the entire Spanish economy.

Shares of Fomento de Construcciones y Contratas SA, Spain's third-biggest construction company, are falling this morning, and were down as much as 4.4 percent in Madrid trading following a decision by Morgan Stanley to cut its price target, citing Spain's building slowdown.

FCC dropped as much as 1.62 euros to 35.29 euros and traded at 35.70 euros as of 10:32 a.m., giving the Barcelona-based company a market value of 4.66 billion euros ($7.4 billion).

Also Spanish construction company ACS is going to put its 45 percent stake in electricity group Union Fenosa on sale this week and hopes to close the deal by mid-September. Media had previously reported that ACS was going auction its stake in Spain's third largest utility - worth about 2 billion euros at current market prices - today, and wanted to close the deal by August. So everyone is having a hard time finding cash at the moment.

ACS says it is selling becuase it wants to "consolidate" its position in rival utility Iberdrola where it owns 7.2 percent directly and a further 5.2 percent via equity swaps, but some of the cash raised could well go towards cutting its net debt, which stood at 16.6 billion euros at the end of 2007. Iberdrola's gearing at that point was 66.4 percent.

Update 7: Tuesday 22 July 2008


Well today it is the turn of the telephone companies. Basically we are in the period of company reports and outlook, and it is clear that the deteriorating real economy is going to affect virtually everyone. Telefonica fell the most in six months in Madrid trading after Vodafone's quarterly sales in Spain declined. Telefonica declined as much as 6.8 percent to 16.10 euros and traded at 16.22 euros as of 9:23 a.m. in the Spanish capital. Before today, the shares were down 22 percent this year. Vodafone, the world's largest mobile-phone company, posted a 2.5 percent service revenue drop in Spain in the three months through June. Spain was ``impacted by a decline in customer spending in a challenging macro economic and competitive environment,'' Vodafone said today in a statement.

Spain's benchmark stock index, the IBEX 35, fell 0.53 percent at 9:05 a.m.

Acciona: Enel will be forced to pay a premium should it wish to buy Spanish builder Acciona out of their partnership in power company Endesa, according to El Economista. Acciona shares retreated 60 cents, or 0.4 percent, to 141.05 euros on the news.

Fomento de Construcciones y Contratas SA (FCC SM): Merrill Lynch & Co. cut its recommendation for Spain's third-largest builder to ``underperform'' from ``neutral.'' The shares declined 41 cents, or 1.1 percent, to 36.50 euros.


Meanwhile cash-strapped savings bank Caja de Ahorros del Mediterraneo (CAM) yesterday set a final price for retail investors of 5.84 euros per share for a planned July 23 placement on the stock market, the first of its kind by a government-controlled savings bank. CAM had set 5.95 euros as the maximum price of the listing on July 15, but the final figure was at the bottom of its initial price range of 5.84-7.30 euros. CAM plans to allot retail investors 65 percent of 50 million "participation certificates" - similar to non-voting shares - on offer. The Alicante-based bank aims to raise up to 365 million euros ($582.3 million) by floating 7.5 percent of its "available surplus". We will see what happens on Wednesday.

Also the Spanish press has revealed that Fernando Martin, president of Martinsa-Fadesa, the company that left 12,500 clients with no home to show for their money, and hundreds of staff laid off, took 85 million Euros in cash out of the company last year in the form of dividends. That is more than the 70.4 million Euros paid in salaries to all Martinsa-Fadesa staff.

It has also emerged that Martinsa-Fadesa’s board of directors was paid a total of 6.8 million Euros last year, an average of 614,000 Euros per director. Despite running the company into bankruptcy, Martinsa-Fadesa’s board was paid more than larger builders like FCC, which is still in business.

The Spanish press reports that owners and managers of Spanish property developers are worried that Martinsa-Fadesa’s bankruptcy could set off a domino effect that engulfs the sector. Various sources in the Spanish property business have told the press that more bankruptcies are now inevitable.

Sources in the Spanish property sector warn that many more developers are experiencing liquidity problems. “Many other companies should be seeking voluntary protection from their creditors, but they aren’t doing so for image reasons,” Angel Serrano, director of the real estate consultancy Aguirre Newman, told the Spanish daily ‘El Pais’. “When they finally do so it might be too late.”

Martinsa-Fadesa’s bankruptcy has been front page news in the international business press, helping to reinforce negative investor sentiment towards Spain. “The principal repercussion is the damage done to the image of Spanish real estate sector in the eyes of national and international clients,” Serrano told ‘El Pais’.

With the Spanish banking system heavily dependent on foreign capital for liquidity, Martinsa-Fadesa’s bankruptcy will make it even more difficult for other Spanish developers to get credit, making further bankruptcies even more likely.

Now that Martinsa-Fadesa has gone into voluntary administration, investor attention has turned to Reyal Urbis, a quoted Spanish developer whose 6 billion Euros of debt makes it even more leveraged than Martinsa-Fadesa. Reyal Urbis chalked up first-quarter losses of 52.7 million euros ($81.9 million), which had quadrupled from 13.7 million a year earlier. Total Q1 revenue fell to 187.4 million euros from 314.5 million, with property development sales down to 129.5 million euros from 243.3 million a year earlier.

Both Colonial and Reyal Urbis, warned the CNMV stock market regulatory body last week that they have still not managed to refinance their substantial debt.

The Valencian developer Obradis was also forced at the weekend to seek protection from its creditors. With 5 developments partly sold and under construction, including its Balco de la Vila building in the popular resort town of Javea, Obradis has run out of the cash it needs to finish the projects and pay its debts. Obradis borrowed more than 50 million Euros in 2006 when credit was plentiful and cheap and had sales totalling 13.7 million euros in 2007. This is evidently pretty small beer compared with what is going on generally, but it is indicative of what is going to increasingly happen among the smaller developers.


Update 8: 23 July 2008

Not a lot of really "fresh" news today.

Sacyr Vallehermoso - Spain's fifth-biggest builder - has said it has extended by one year a 560 million-euro ($884 million) loan used to buy its stake in Europistas Concesionaria Espanola SA. Their shares declined 10 cents, or 0.7 percent, to 14.24 euros. Everyone is absolutely strapped for cash now.

El Confidencial is reporting that Sacyr has also put its services division Valoriza on sale to raise cash. Shares declined 10 cents, or 0.7 percent, yesterday to 14.24 euros.

Exceltur, a lobby group for Spanish tourism companies, has halved its estimate for growth in the industry as the economy slumps, according to El Pais. Exceltur now predicts the industry will grow 0.8 percent this year, down from its previous prediction of 1.6 percent growth.

Banco Santander: Sovereign Bancorp Inc., the U.S. lender in which the Spanish bank owns a 24 percent stake, is scheduled to release its quarterly earnings today. Santander shares declined 12 cents, or 1 percent, to 11.58 euros yesterday.

Caja de Ahorros del Mediterraneo (CAM SM): Shares of the Spanish lender are due to begin trading at midday today on the Madrid exchange.

ABC is reporting that as many as five groups that may be interested in buying Actividades de Construccion y Servicios's 45 percent stake in Fenosa, and that they will receive sale documents on July 28. The shares were up 31 cents, or 2.2 percent, to 14.16 euros. ACS also need to raise cash. First you sell the household silverware and crockery.....

Housing Minister Beatriz Corredor announced a small plan to buy some land from the builders today. The Spanish government is planning to buy some 300 million euros ($478 million) worth of land for state-subsidised housing over four years. At the same time she insisted the move was not to bail out ailing construction firms, although it obviously is. She said the government needed extra land to meet its promise to increase production of state-subsidised homes to 150,000 a year from 100,000. The government will start a search for land to buy in October, asking companies to present plots for sale.

A few things are obvious here and needs saying. In the first place this is quite a small quantity compared to the size of the problem, and it is an attempt to do what badly needs to be done, but by the back door. The fact the plan isn't going to be put into effect until October also suggests they are in no hurry, and hence have no real idea of the magnitude of the problem they are actually facing.

Also, why build more homes? If the government want 150,000 to 200,000 flats, why not simply buy them at bargain basement prices to try and help clear the huge backlog of unsold housing.

I am in favour of buying back land, but with a large "haircut" to the present owners, and only under condition that this land is reclassified and not used for future building. If you don't do this you are simply never going to clear the market given the long term downward adjustment in the number of houses which are going to be needed in Spain, given that people are now not likely to be buying them for investment purposes in any way which is remotely comparable to the quantities which were built 2000-2008.

Update 9: Thursday 24 July 2008

Well today Banco Popular is back in the news again. Banco Popular Espanol is Spain's third-biggest listed bank, and today they reported that second quarter profits rose less than analysts estimated as asset sales offset higher loan defaults.

Popular fell as much as 5.4 percent in Madrid trading after reporting net income increased 8.3 percent to 352.2 million euros ($552.5 million) from 325.3 million euros a year earlier. That missed five analysts' 392 million-euro median estimate. Popular may need to raise capital in the not too distant future should loan losses continue to mount. Popular fell 35 cents, or 4.4 percent, to 7.60 euros at 9:30 a.m. in Madrid, which was the most since July 15 and which puts this year's decline to 35 percent after the shares had recovered somewhat in recent days.

In May, the bank reported provisions of 39.3 million euros to cover loans to Inmobiliaria Colonial SA. On July 15, Popular said it set aside 100 million euros to cover loans to Martinsa-Fadesa SA, Spain's first traded developer to seek bankruptcy protection. Popular made 332 million euros in provisions in the quarter. It used gains of 200 million euros from the sale of real estate to cover part of the loan-loss provisions. Popular also booked 40 million euros in gains from the sale of its French banking unit.

Popular reported core capital, a measure of the underlying solvency backing its business, of 6.67 percent in June and said core capital could reach 7 percent by the end of 2008. The bank reported loan losses as a proportion of total loans of 1.42 percent, up from 0.98 percent in March and 0.72 percent a year ago.

The ratio of provisions to defaults has now plunged to 139 percent from 185 percent in March and 256 percent a year ago as new defaults surged 1.15 billion euros from 359.2 million euros a year ago. Losses from impairment of assets climbed 325 percent to 343.6 million euros from 80.8 million euros a year ago. Lending growth slowed to 8.1 percent from 11.7 percent in March and 16.7 percent in the same period last year. Client funds Net interest income rose 8.8 percent to 630.97 million euros.


Update 10: Monday 28 July 2008

Banco Bilbao Vizcaya Argentaria (BBVA), Spain's second-biggest bank, said quarterly profit declined in the second quarter of 2008 by a more-than-estimated 19 percent as loan defaults surged and it set aside money for early retirements.

Net income dropped to 1.16 billion euros ($1.82 billion) in the second quarter ended June 30 from 1.42 billion euros a year earlier. Profit missed targets as BBVA booked a 329 million-euro charge for early retirements.

BBVA is facing simultaneous slowdowns in the bank's three largest markets, Spain, Mexico and the U.S., which together account for more than 80 percent of profit. While BBVA avoided subprime mortgage assets, the U.S. economy started to deteriorate after it bought Compass Bancshares Inc. for $9.1 billion last year. Loan defaults in Spain and Portugal rose to 1.22 percent in June from 0.64 percent a year ago.

BBVA's loan growth in Iberia (ie Spain and Portugal) fell by half to 7 percent in the first six months of 2008. The increase in Mexico declined to 15 percent in constant currency terms from 26 percent a year ago, when Mexico and the U.S. reported as a single division.

Worldwide defaults at BBVA climbed to 1.15 percent of total loans from 0.99 percent in March and 0.86 percent a year ago. Consolidated losses from impairment of assets rose to 618 million euros in the quarter from 509 million euros a year ago.

And this piece is very interesting. Spanish bank Banesto announced on Friday it had set up a joint venture with Spain's third largest property firm Reyal Urbis to help it sell unsold property. A spokesman for the bank declined to confirm or deny a report by El Confidencial on Friday which said Banesto had bought assets worth 400 million euros from Reyal Urbis in the last few weeks to boost the firm financially. The spokesman only confirmed that Banesto had created the company Promodomus "to try to make the promotion of Reyal Urbis assets more efficient".


Promodomus is 51-percent controlled by Banesto and 49-percent controlled by Reyal Urbis. Banesto formerly owned a stake of slightly more than 50 percent of Inmobiliarius Urbis, but sold it in 2006 before the firm merged with Construcciones Reyal.

Meanwhile we learn that Martinsa-Fadesahas won a reprieve from its creditors (ie it will not go into bankruptcy, for the time being) after a judge in La Coruña accepted the company’s request for voluntary administration. However a recent article in the Spanish daily ‘El Pais’ reports that Martinsa-Fadesa sold properties without building licences, and failed to provide some buyers with bank guarantees to cover their stage payments, which is against the law. This may be illegal, but it is the buyers who will do all the suffering: They may be looking at big potential financial losses, whilst Martinsa-Fadesa only has to worry about a slap on the wrist for an ‘administrative infraction’.

“Voluntary administration helps companies in distress, but does nothing to protect the interests of citizens,” the notary José Ignacio Navas Olóriz told ‘El Pais’.