Impressions from Madrid

I have been in Madrid looking for the other side of the story on Spain. Is the situation really as bad as we and the markets think and if not, why? I met three large banks, a rating agency, a journalist and a housing market specialist.

I will do a more thorough update on the situation early next week, but here are the immediate impressions:

• I am surprised that the people I met were not more negative. There was a clear sense that if bond yields continued to increase then the politicians would have to step up to their responsibility and come up with a solution. Not that anyone sounded very optimistic regarding Spanish or European politicians, but more like Spain is too big to fail and hence someone will do something right eventually.

• The Spanish problems are a combination of lack of growth, recapitalisation needs in the banking sector and a large fiscal deficit. These problems are linked and exacerbate each other. Spain has done a lot of reforms on all areas, BUT this is not recognised abroad and by the markets due to lack of credibility of the political leadership! The general impression is that the Prime Minister has made a number of unfortunate remarks and has lost a lot of credibility both abroad and with the people. The unresolved situation around Bankia and the lack of details on the 100bn bailout underscores this credibility issue. Rajoy needs to step up to the job and show that he has a plan and knows what he is doing.

• Banks have been forced to provision massively on real estate loans. This was proven by yesterday’s reports by external consultants Berger and Wyman which concluded that in a baseline scenario the recapitalisation needs will be EUR 16-21bn. In a stressed scenario 52-62bn additional capital may be needed, but the three biggest banks will not need more capital. Thus, the 100bn rescue from the Eurosystem should be enough even in the case of more stress than what is already the case. The concern in the markets is that other loan portfolios (mortgages in particular) will turn worse as well. That is not at all a concern in Madrid. The banks said that only mortgages taken in 2007 and 2008 are in the danger zone and that the high share of unemployment is related mostly to young people and to construction workers with temporary contracts – two groups that do not have a lot of mortgages. The main concern in Madrid is that part of loans to small and medium sized enterprises are actually real-estate related, which means that the banks will have to increase provisions. Berger and Wyman have not looked at specific loans, but “only” stressed the portfolios with different scenarios. Four external auditors have until 31 July, or maybe to September, to go through a large share of the specific loans in all banks and see if they are classified correctly. This exercise could easily lead to more real estate-related loans and hence larger capital needs, according to the people I met.

As I said, I will dig into the details and come up with more next week.

Have a nice weekend when the time comes!

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