The past week has seen a flurry of merger announcements from various cajas, the Spanish mutually owned regional savings institutions. Confirmation that three new groups, each centred on a relatively large caja (Caja del Mediterraneo (CAM), Caja Madrid and La Caixa; see article), have put forward merger proposals to the Bank of Spain. These actions have most recently been followed by reports in the Spanish press that four smaller institutions – Cajamurcia, Caixa Penedes, Caja Sa Nostra and Caja Granada – are also planning to merge. In short, what we have witnessed over the past ten days is nothing short of a full-scale restructuring of the entire caja sector. What brought on this flurry of activity? And what are its effects likely to be?

The longer-term causes of distress among the cajas are well known. Unlike the more diversified commercial banks, the cajas’ loan books were concentrated on their home regions and, specifically, on the troubled property and construction sectors. The latest data from the Bank of Spain show that mortgage loans made up 37.7% of cajas’ total loans at end-2009 (commercial banks: 29.0%), at which time NPLs made up 3.1% of mortgage loans (commercial banks: 2.4%). The NPL number, which appears manageable, is deceptive, as property prices have not fallen uniformly across Spain, causing the regional cajas to experience varying levels of difficulty. For example, CajaSur (recently seized by the Bank of Spain) had an NPL ratio of 10.2% at end-2009, while that of La Caixa stood at just 3.4%. The loan losses caused by the housing crash depleted the cajas’ stock of provisions and capital until it became clear that a sector-wide response was necessary.

In the short term, the Bank of Spain has been the catalyst for action. It has long seen the need for restructuring – indeed, the government last year set up a €99bn leveraged fund for orderly bank restructuring (FROB) to help facilitate consolidation among the cajas. But the cajas – often heavily influenced by local politics or other considerations (CajaSur, for instance, was controlled by the Catholic Church) – have been dragging their feet. However, as negative sentiment against Spain and its banking sector increased to the point where CDS levels approached or exceeded those seen when Lehman Brothers collapsed (see chart), the Bank of Spain finally lost patience. On 22 May, it took over CajaSur, which had – for no discernible reason – failed to reach a merger agreement with neighbouring Unicaja. A few days later, the Bank changed the provisioning rules. From now on, all banks operating in Spain will have to provision for 100% of a bad loan within a year of it being listed as doubtful, compared with the current period of between two and six years. However, banks will now be able to offset collateral (usually property or land) against the provisions, but only after sharp writedowns in the collateral's value, ranging from 20% for the main residence of the borrower to 50% for undeveloped land. The final proposed change will oblige banks to increase their writedowns on assets acquired in payment of debts, which has been a favoured tactic during the crisis. Assets bought through debt-for-property swaps must generally be written down immediately by at least 10%, rising to 30% over the next two years. The Bank of Spain said that the new rules would, on average, cut pre-tax profits on Spanish operations by around 10%, hitting the domestically-focused cajas harder than their more diversified banking counterparts. Most importantly, they are specifically designed to force the weaker cajas to choose rapidly between restructuring and insolvency.

Selected Spanish banking institutions’ 5Y CDS

Source: Markit

The Bank of Spain’s move – and the knowledge that the FROB is due to expire at end-June 2010 – galvanised the cajas. Within ten days, the four mergers discussed above had been proposed to the Bank, and more are being discussed. While CDS spreads, driven by sovereign concerns, currently show few signs of tightening, we believe that this spate of consolidation is positive for the Spanish banking sector. The structure chosen by most cajas – known as Sistema Institucional de Proteccion (SIP) –falls short of a full merger but overcomes the regional objections to restructuring by merging cajas’ central functions while allowing them to retain their local brands and operations. The resulting entity gains critical mass (CAM’s group of cajas will become Spain’s fifth largest banking institution with around €135bn of assets) and increased capital levels (CAM’s group will have a Tier 1 ratio of around 9.4%, as opposed to the 8.6% posted by Caja Cantabria, a member of the new group, at end 2009). Some synergies should also be possible in most cases, although questions have been raised over some proposed mergers whose individual entities are located in different parts of the country, providing little scope for cutting branches. All this should help to stabilise the Spanish banking sector and raise most cajas’ credit profiles and ratings (although the capital and liquidity resources of the stronger cajas around which the new entities are being formed will inevitably decrease in the short term). And the reduced number of institutions should make it easier for the Bank of Spain to supervise the sector.

These measures should, therefore, improve the cajas’ prospects. But there is one key proposal over which some uncertainty remains. The cajas’ mutual structure means that they have found it difficult to raise capital, and the IMF warned recently that there could still be a system-wide capital drain on the cajas if the economy performs significantly worse than expected (see previous blog). There are reports that both the Spanish government and the main opposition have agreed to push through a law allowing cajas to sell voting shares. That would allow them to raise capital and could dilute the obstructive influence of local interest groups. Such a move would be the icing on the cake, and we look forward to its implementation. But, for now, the coming together of the cajas should provide the sector with a welcome platform for rehabilitation.

Nick Smallwood - Credit Analyst

Disclaimer:

This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at http://www.us.daiwacm.com/.

Investment Banking Relationships; Daiwa Capital Markets Europe Limited or an affiliate has managed or co-managed a public offering of securities in the past 12 months, or has received compensation for investment banking services in the past 12 months: CAM Global Finance.

The statements in the preceding paragraphs are made as of May 2010.

For more details, please contact:

Nick Smallwood, Research Division
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX

+44 (0)20 7597 8383

nicholas.smallwood@uk.daiwacm.com

For up to date Research analysis, see our blog site here.

Sign up for news/events alerts