Sun, sea, sand and interest-rate derivatives.
So goes the sad tale of mortgage-swap victims in Fuertventura in the Canary Islands, according to a report by Spanish online newspaper ABC.es on Monday (via Google Translate, emphasis ours):
Living a nightmare since he signed with the People’s Bank a mortgage to finance your home and signed an insurance “to protect the mortgage to the vagaries of Euribor” which was a high risk financial product.
Now they are trapped by the bank that required each quarter an amount exceeding one thousand euros, for a drop of Euribor, which must be added the loan. Regina is the story of Vincent and Mary Lake.
Like them, more than two dozen people in the downtown area of Fuerteventura have become victims of insurance swap ‘clip’ or ‘swap insurance rate IRS’ directed primarily to large investors accustomed to dealing in the financial market.
Both recall having shown “a certain distrust” when the bank offered them safe and assured them they would receive “some fifty euros each quarter” if the Euribor was maintained between 4.7 and 6.8. Despite having asked for “the small print” they cautioned against anyone running if the benchmark index fell, as it were.
Which means products designed to offer mortgage holders helpful cash payments, are instead — due to a low-interest rate environment — forcing additional payments out of overstretched borrowers instead.
—————
A derivative-focused tale of a different sort, meanwhile, came our way from Alicante in mainland Spain via Laverdad.es. This time, though, it was connected to freshly arranged ICO loans.
According to the Google translation, lenders administering the agency’s loans have been forcing borrowers into expensive swap arrangements that hedge against interest-rate rises in order to get the deals done.
As the Laverdad report stated on Tuesday, emphasis FT Alphaville’s and via Google Translate:
Banks and savings and settled in the province and managing the various strands of the Instituto de Credito Oficial (ICO) to confront the crisis with liquidity operations and working capital to undertake investments are requiring companies and entrepreneurs who hire Alicante a ‘swap’ or shield insurance against possible spikes in the price of money.
Businesses are unhappy because ICO won’t cover the swap costs, which are significant, and in many cases eat heavily into the face value of the original loan.
The report cited an example of a well-known businessman in the construction sector, who having been granted an ICO loan of €150,000 loan was told a ‘swap’ arrangement based on an underlying value of €500,000 would be needed for the loan to go through with the bank.
————–
It’s worth reminding readers at this point of the trouble caused back in 2009 by FX options and other currency derivatives dealt to businesses and private clients in Eastern Europe.
Before the financial crisis, businesses and individuals had assumed domestic currencies would only appreciate against the single currency as the countries drew closer to Eurozone entry.
These products were sold, therefore, on the premise that clients in would-be Eurozone-member countries would want protection against the appreciation of their own currencies in relation to the euro.
For instance, if you were a Polish exporter you could hedge some of the losses expected from the appreciation of your own currency with the helpful use of FX options. These options being sold by the client to the bank also provided the client with cash-flow, which was an added incentive for some.
All of which worked really well – until the region’s currencies began to sell-off due to the financial crisis and precisely the opposite of the anticipated scenario came to pass.
Eastern European companies which had bought into FX options — many of them state-owned — suddenly found themselves out of the money and presented with one of two choices: pay-up, or default.
And it got pretty bad.
Poland’s deputy treasury minister, for example, estimated in February 2009 that the Polish government alone had lost as much as $270m on unwise currency bets of this sort, via state-owned enterprises. The country’s overall exposure, meanwhile, was estimated at its peak to be worth around $1.3bn.
Controversially, the government attempted to pass legislation rendering the contracts unenforceable to mitigate losses. It failed to pass, however, on fears the move would set a bad precedent for Poland in international markets – and partly also because the zloty rebounded cutting the scale of losses.
Bearing all that in mind, you’ve got to wonder about the level of Spanish exposure to equally untested derivatives – and how it might play out in the event the economy worsens still.
Related links:
Eeek, ICO is getting riskier – FT Alphaville
The EE mortgage – FT Alphaville
Managing CEE’s FX addiction – FT Alphaville