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Spain: Bad bank details emerge

October 24, 2012

Spain continues the process of restructuring its financial system. Although the asset management company designed to take on most of the banks' toxic real estate assets (the so-called "bad bank") created in August will not officially start operating until the end of November, details about the new entity are starting to emerge. The creation of a bad bank is one of the core conditions that Spain must satisfy before it can receive funds from the EUR 100 billion credit line agreed with European authorities. The bad bank fund will have a maximum size of EUR 90 billion, although government officials have already stated that the final figure will be smaller, probably ranging between EUR 60 and 70 billion. The entity will take on the banks' toxic assets and try to sell them over the next 15 years, with banks receiving capital or government bonds in exchange. Following on weeks of negotiations between the Spanish government and the EU-ECB-IMF Troika, the price of the real estate assets being transferred into the bad bank is based on the baseline scenario of the stress tests carried out by consulting firm Oliver Wyman in September and then applying an additional haircut. Under the final agreement, newly-built housing will be valued at a 52.2% discount to original book value, while second-hand housing will be valued at a 47.5% discount. Undeveloped land will suffer an 85% discount to book value. Determining the price of the toxic assets has been a key issue in designing the vehicle, as it should not be too low so they cripple banks that are already in a weak position, but low enough so they can be sold at a profit in the future. Housing prices have dropped approximately 25% from their peak in early 2008 and the establishment of the bad bank should accelerate the correction, with some analysts estimating real estate prices may fall an additional 20 to 30% in the coming years.


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