ING’s Simon Goodfellow looks at the Spanish issue this week.
His main question — “What would happen to the banking system in Spain if the Spanish housing crisis turned Japanese?”
While the Japanese scenario is not ING’s central projection, Goodfellow explains it is worth examining the idea as a worst-case scenario.
The answer, unsurprisingly, is not pretty.
As Goodfellow notes:
The boom in Japanese house prices from 1981 to 1991 was 225% compared with 178% in Spain from 1998 to 2008. Then prices fell by 65% over the next 14 years. So far Spanish house prices have fallen 10%, based on official data.
Against that context, the Spanish banking industry is only provisioning for an average 13 per cent of the value of total loans to developers, says Goodfellow.
But the current inventory of homes for sale, meanwhile, is some three times annual demand — as noted in the following chart:
Which not only means property prices are unlikely to recover soon, but brings a certain Japan-esque parallel to the market. As ING notes:
After the peak, Japanese house prices fell for 14 years in a row, and bottomed some 65% below their peak. Official data suggests that Spanish house prices have fallen 10% from their peak, but anecdotal evidence suggests that some properties are being sold for 50% or less of their appraised value 3 years ago.
Hence:
If Spanish banks were to double their provisions for real estate developers this would amount to an incremental €53bn, which is equivalent to 23% of the capital of the Spanish banking system.
But even that might not be enough in a Japan-style collapse. ING notes that if the Spanish housing sector was to follow a similar trajectory to the Japanese market, then it would take five years to work through the inventory overhang, seeing house prices fall 48 per cent from the peak by 2013.
Of course, that’s based on the scenario of no new housing coming into the market in the next three years and no further foreclosures.
In ING’s worst case scenario:
• We think a worst-case scenario could involve the banks having to provide for 50% of 50% of their loans, ie, 25% of the total outstanding. This would involve another €53bn of provisions.
• To put this number in context it amounts to 23% of the total capital and reserves of the Spanish banking system or 135% of their annual net operating income before taxes and provisions.
A scenario that would definitely call for Bank of Spain or central government intervention and via that, have an impact on the Spanish government’s fiscal projections — with debt to GDP rising, instead of falling.
This is interesting in light of the fact that much of Spanish government’s defence has focused on the government’s current fiscal liabilities, rather than the country’s overall private debt exposure.
But even on Monday, there was news of the Bank of Spain seizing yet another ailing savings bank.
ING’s conclusion:
Much of this analysis is well understood by investors. The Spanish real estate crisis is hardly news. But the linkage with the crisis of confidence in the euro has the potential to add a new and unsettling dimension to a problem, which is already severe.
Full note available in the Long Room and really worth a read.
Related links:
The deflationary pain in Spain – FT Alphaville
Execution Noble: Santander & BBVA need €8bn extra capital each – FT Long Room
Seized: CajaSur, or, 0.6 per cent of Spanish banking assets – FT Alphaville