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Savings banks find strength in numbers

28 Sep 2010

In one of the most tumultuous years on record for Spain’s financial institutions, the country’s savings banks are metamorphosing while funding markets have flicked open and closed. Katie Llanos-Small surveys the year of change and asks how the new system will withstand challenges to come.

This year has been one of upheaval for Spain’s financial institutions. Across Europe, the challenges of navigating volatile markets have complicated funding plans for banks, but Spanish institutions have had an even tougher ride as investors worry about sovereign risk. To add to the drama, the country’s savings banks are undergoing a complete transformation, consolidating from more than 40 local institutions into a handful of national ones.

If all goes as planned, in 2011 just 18 savings banks — cajas de ahorros — will remain after 40 of the country’s 45 separate entities merge or integrate.

The redesign of the savings banks was instigated by the Bank of Spain, which worried about the cajas’ excess capacity and increasing reliance on wholesale markets. The consolidation, it hoped, would strengthen solvency ratios and improve efficiency and productivity.

The country’s Fund for Orderly Bank Reconstruction — known as the Frob — is overseeing the process. It is injecting Eu10.2bn into seven groups of merging savings banks by way of preference shares. The money, which has to be paid back within five years, is conditional on the merging entities closing, on average, 25% of their branches and reducing staff headcount by 15%-18%.

Broadening the options

"Jupiter" is one such example. The amalgamation of seven savings banks is expected to become operational in early 2011, after getting final sign-off in September.

Jupiter is not a merger but an institutional protection system, or SIP. Integrating this way, rather than through a straight merger, the cajas will create an overarching entity that has the legal status of a bank. Crucially, this gives them the option to list publicly if they want to raise capital through the equity market in future.

The alliance of the seven banks — Bancaja, Caixa Laietana, La Caja de Canarias, Caja de Ávila, Caja Madrid, Caja Rioja and Caja Segovia — was dubbed Jupiter by the Bank of Spain for simplicity’s sake before the new entity is up and running. The combined bank will almost certainly have a new name and brand.

The resulting entity will be Spain’s third largest banking group, the country’s biggest domestic private sector deposit taker and its second biggest private sector lender.

For Caja Madrid, which will be the biggest partner in the new group with an expected 52% stake, the integration offers growth prospects that would be otherwise unattainable.

"Merging through a SIP will give us an opportunity to grow in Spain," says Carlos Stilianopoulos, deputy chief executive and head of treasury and capital markets at the savings bank. "Caja Madrid has had 7% market share for the last decade. It’s almost impossible to grow. We will become number one in terms of domestic market share of deposits and loans, so it is a good opportunity for us."

The savings bank reported market share of 7.4% for deposits and 6.9% for lending in its 2009 annual report.

Rollercoaster year

The overhaul of the savings banks came as Spain’s banking system found itself ostracised by debt markets in the second quarter of 2010. As worries over European sovereign debt escalated, financial institutions were hit by the knock-on effect.

At the same time, some international investors highlighted concerns over unknown levels of bad loans that may be sitting on Spanish bank books as a reason for being cautious on the sector.

In Madrid, the tone is considerably more bullish.

"Spain has a fantastic financial sector," says Jorge Estévez, managing director, debt capital markets, for Iberian financial institutions at Société Générale in Madrid. "There is a lot of expertise in retail banking and things have been done very professionally. It’s a shame everyone gets thrown in together.

"It’s mainly core markets where there have been huge losses in assets where there was no expertise and there’s been comprehensive state support. We haven’t seen any of those things in Spain. It may take people several months to realise we were never in such a bad position to start with."

Yet the spreads that Spanish banks pay, compared with similarly rated entities from other countries, show that investors remain unconvinced.

Many are worried about the banks’ exposures to bad real estate debt, and the effect it might have on their profitability in the future.

Indeed, non-performing loans have continued to rise and economists are split on whether this rate will continue upwards.

Frob help

Determined to prove the worth of Spanish banks during the shutdown of the debt markets in the second quarter, the government said it would make public the results of confidential stress tests conducted by European regulators. After Spain called for its tests to be published, the Committee of European Banking Supervisors agreed to reveal the results of all the tests across Europe.

The government made efforts to go beyond the necessary on the stress test, in a ploy to reinforce confidence in the country’s financial system. Just a handful of the country’s banks needed to be tested to conform to CEBS’s goal of covering at least 50% of Spain’s banking sector. Yet the Spanish published results for all the country’s savings banks and listed banks.

In the results released at the end of July, it was calculated that five of the 27 Spanish banks and cajas tested did not have sufficient capital to withstand a "worst-case scenario" — involving a GDP drop of 2.6% in 2010 and 2011 — and reach the end of 2011 with 6% core capital.

The Frob immediately offered assistance to those falling short of the pass level of capital. While CEBS was criticised for some of the methodology employed in the tests, overall they were positive for Spain’s banks.

"The stress tests were a missed opportunity in some sense because they weren’t as harsh as some would have liked," says Noelle Cajigas, head of debt capital markets for Portugal and Spain at BNP Paribas in Madrid.

"But they still demonstrated that regular borrowers in Spain are not worse off than their European peers, in many cases they are actually stronger. Really, they helped a lot."

IR work critical

It is likely that the wholesale funding needs for the cajas will drop as they cut costs through the restructuring. But when it is time to return to capital markets, extra efforts in investor relations will be a must, say bankers.

"They won’t just be able to say, ‘we’ve merged’ and for that to be enough," says BNP Paribas’ Cajigas. "Investors are very selective now. They will need to have a powerful message for the future. And I am sure many will have that message, but those who don’t will need to work on it to regain receptiveness in the market."

Jupiter has already taken this message on board. As the sovereign storm raged in the second quarter, the cajas in the SIP met investors in London in June to explain the forthcoming structure.

"In these times, investor relations work is even more important than it was," says Stilianopoulos of Caja Madrid. "The efforts we have put in with investors have increased in the last couple of years. The number of visits hasn’t changed but the information we provide has increased. Investors now demand much more transparency. We’re much more transparent now because the market needs that information."

Creating opportunities

The year has been an exceptionally busy one for those who follow the fortunes of Spain’s financial sector, with turmoil in the funding markets and an overhaul of the banking system’s structure.

Those developments are unlikely to wrap up any time soon either. Looking ahead, some say that this shake-up in Spain’s financial system may be just the beginning.

José Manuel Amor, partner at Analistas Financieros Internacionales, a consultancy in Madrid, says more mergers may be on the way in a couple of years. The next round could involve the country’s banks, as opposed to the savings banks.

"Looking at the business forecast for the banking sector, and credit and deposit growth, efficiency and cost of funding in the capital markets, we think there probably would be a second wave of merger activity within two to three years," says Amor.

"The cajas have merged or integrated through SIPs but only two banks have. We think the Spanish banking sector needs more consolidation. But we need these mergers to go through to see how they work, and probably within two to three years we’ll have a second wave."

For both the cajas and the banks, the months ahead are likely to continue to be tricky. This year started out in fine form for Spain’s bank borrowers in the flow markets but quickly degenerated as markets were shaken up by the European sovereign crisis.

Now the concerns have eased but remain in the background, says Iñigo García-Palencia, managing director, debt capital markets and financing at Bank of America Merrill Lynch in Madrid.

"The health of the banking system has been shown to be much better that some investors thought," he says. "During the second quarter, and even in March, investors were saying, ‘I don’t want to touch anything on Spain’. Now we’re in a second phase. The worries haven’t disappeared, but investors can see that measures to tackle the problems are in place. Now investors are prepared to consider credits, depending on the tenor and pricing."
28 Sep 2010