• The objective of the reform is to improve the confidence, credibility and strength of the financial system so that it can refinance economic growth and job creation
  • The sanitation process, valued at 50,000 million euros, will be the most intense in the entire EU
  • The provisioning effort is made at one time, affecting the income statement for a single year
  • Provisions for problematic assets increase to 80% depending on the case and a generic of 7% is created for the rest of the promoter credit

The Minister of Economy and Competitiveness, Luis de Guindos, explained today that the reform of the financial system aims to achieve a healthier and better dimensioned sector, with the aim of returning to exercise its main function: granting credit to families and companies to recover the economic growth and job creation.

The new financial sector consolidation and consolidation scheme, which is expected to be approved tomorrow by the Council of Ministers, is one of the basic axes – together with the budgetary and labor axis – of the Government's structural reform program, which is part of the commitments assumed for Spain with its community partners and is key to recovering the confidence of international financial markets.

The reform aims to dispel the doubts of the market about the valuation of the real estate assets (land, promotions and homes) that the entities have in their balance sheets, a process that will encourage the exit to the market of homes at more affordable prices.

The financial sector will emerge from this process more strengthened, with fewer but stronger entities, so that Spanish institutions are among the healthiest in the EU. No other country in the community environment has designed such a process to clean up assets, despite the fact that in some cases the financial crisis has affected them more intensely.

Unlike also what happened in other countries, in the Spanish case the reform will not have an impact on the public deficit; that is to say, it will not suppose any cost for the taxpayer, since the write-offs will be assumed by the entities themselves with charge to results or to capital, for which reasonable terms are enabled.

Real estate asset write-off

The real estate assets linked to the promoter credit of the Spanish financial system as a whole amount to 323,000 million euros (as of June 30, 2011), of which 175,000 million are classified in the problematic category (88,000 million in land and ongoing development and 87,000 million in finished development and foreclosed homes). The current average levels of coverage of entities on the set of problematic assets are between 31% (land), 27% (ongoing developments) and 25% (completed development and homes).

Uncertainty about the valuation of these assets is one of the factors that make it difficult for entities to access the wholesale financing markets, with the consequent withdrawal of credit to finance the private sector of the economy. For this reason, it is essential to clarify the outlook and place asset valuation in a position more in line with that of the market.

With this objective, additional write-downs will be established for a total value of 50,000 million euros through new provisions and capital buffers. Those entities that participate in merger (consolidation) processes will have more flexible conditions to adapt to the new framework. The objective is to achieve an adjustment in the excess capacity of the sector as a whole and to improve the efficiency of the new institutions. In short, fewer entities but more healthy.

A specific provision is established for problematic assets, with an extraordinary allocation charged to results, for an amount close to 25,000 million euros. In addition, a capital buffer of 20% on land and 15% is planned for ongoing promotion, which will be charged to undistributed benefits, capital increase or conversion of hybrids (preferred, convertible bonds, subordinated debt …), for an estimated amount of around 15,000 million euros.

In the case of non-problematic assets linked to real estate development, a generic provision of 7% is established, in anticipation of possible future deterioration, given that they represent a higher risk than the rest of the credit portfolio. This provision will be made against results and its estimated amount will be around 10,000 million euros. The deadline to make the specific provision, the generic provision and the capital endowment will be December 31, 2012.

After the reform, the specific provisions plus the capital buffer will cover 80% of the problematic assets (so far 31%) in the case of land; 65% in the case of ongoing promotions (before 27%) and 35% in finished development and housing (before 25%).

The total amount of sanitation, considering the provisions and the capital buffer, will amount to 50,000 million euros, a figure that is extraordinary and will therefore be required at one time. This is a very substantial recovery effort, given that the one carried out by the Spanish banking sector from 2008 to June 2011, with specific provisions, reached 66,000 million euros.

Concentration to gain efficiency

The merger regime provided for in the regulation to be approved tomorrow by the Council of Ministers establishes that the entities that choose this route must present a feasibility plan and corporate governance measures that make possible a quick and efficient integration. Likewise, the entities in the merger process must assume expansion commitments in the granting of credit.

The deadlines to resolve the concentration processes will be extremely short. The entities must present the merger projects before May 30 and the requests will be resolved within a month.

To promote this process of mergers and consolidation of the sector, the required write-downs will be carried out over two years. The required write-down of the assets may be made against the equity. In the event of resorting to financing from the Orderly Bank Restructuring Fund (FROB), they may do so through contingent convertible bonds. The equity endowment of the FROB will increase to 15,000 million euros, in such a way that its debt capacity is improved.

In short, this significant consolidation effort will achieve better access for credit institutions to capital markets, and an improvement in the flow of credit to the real economy, with a positive impact on production and employment. In addition, it will facilitate the release to the market of real estate assets held by banks, with the consequent reduction in housing prices.

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