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Spain faces frightening parallels to Britain

Spanish officials have furiously denied reports that the country’s property market is heading for a crash or that a clutch of banks may be in the same boat as Northern Rock.

Miguel Angel Ordoñez, the Bank of Spain’s governor, told the Spanish parliament yesterday that the country’s financial system was “immensely solid” despite the dramatic fall in the share price of mid-sized banks and construction firms geared to the deflating property bubble.

“The current turbulence has highlighted the downside risks to growth but Spanish institutions face this episode from strength. Exposure to [sub-prime debt] is insignificant: the problem is we don’t know where the losses are, or who owns what,” he said. “The biggest favour the banks can do is to come clean on losses.”

The central bank also denied reports that its financial institutions had required “emergency liquidity” along the lines of Northern Rock, but the statement failed to end doubts since Spanish banks have been able to borrow unlimited sums cheaply from the European Central Bank’s window.

David Taguas, the prime minister’s chief economic adviser, said: “To talk about severe adjustments or a meltdown in prices is ridiculous. That sort of crisis is unthinkable. We have…one of the most efficient financial systems in the world. That’s insurance in times of turbulence.”

The reactions follow a scathing report on the Spanish banks by Citigroup that sent tremors through the Madrid bourse. The note downgraded Banco Popular, Banco Sabadell, Banesto and Bankinter, warning the credit crunch had changed the picture for Spanish lenders that rely on the wholesale capital markets. It was exactly this sort of funding that caused Northern Rock’s troubles. The Spanish banks’ shares have fallen almost 40pc since April.

“Spain’s mid-cap banks have some of Europe’s lowest core capital ratios (6.12pc) and the highest loan-to-deposit ratios (182pc). The freeze in credit markets reverses all the prior positives for investing in these cap banks,” said Kato Mukuru, the note’s author.

He added the debt-driven M&A deals that enriched these banks are likely to become rarer in the new climate, while a mismatch of maturities would eat into profit margins. The banks rely on three-month paper to raise funds, but their assets are on a 12-month cycle.

Adding to the woes, the spreads on Spanish AA mortgage bonds have leapt from 21 to 100 basis points over Euribor.

The banks are highly exposed to the Spanish housing market. After rising 270pc since 1995, house prices have begun to fall in parts of northern Spain, slipping 2.1pc in Barcelona and Madrid so far this year. Over 98pc of all mortgages are priced off floating Libor rates, causing mortgage payments to almost double in under two years. Construction has reached 18pc of GDP, more than Germany (15pc) at the height of the reunification boom.

David Owen, an economist at Dresdner Kleinwort, said Spain was in danger of a serious crisis. “House prices may fall, but what is even worse is that the corporate sector’s deficit has grown so large that it needs to find financing equivalent to 10pc of GDP every quarter just to stand still,” he said.

“In an environment of easy credit and low rates, these excesses are not an issue, but it can quickly unravel as the mood changes. The problem is that a country inside EMU can’t get itself out once it reaches tipping point: it can’t cut interest rates or let the currency fall.”

While the extreme levels of household debt in Spain are similar to those in Britain, the abilities of the two countries to act in a crisis are quite different. Spain may face a replay of Britain’s ERM crisis in 1992, but this time without the safety valve of easy exit.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/09/19/cnspain119.xml
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