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More bank bail-outs loom for new Spanish government

Source: Reuters - Fri 25th Nov 2011

A crippling squeeze on funding for Spain's banks has pushed them to the brink and the new centre-right government has nowhere to turn to finance more expensive bail-outs or the creation of a bad bank.

The Bank of Spain took over small bank Banco de Valencia on Monday, the day after an election in which the People's Party (PP) swept to power, to inject 1 billion euros of capital after the lender ran out of liquidity.

Money markets have long been shut to Spanish banks, and with short-term yields on sovereign debt higher than 5% other options such as corporate paper have become too costly.

Banks have increased their reliance on the ECB's liquidity window as Europe's debt crisis threatens to engulf France and Germany and leaders struggle to come up with a long-term solution.

The state intervention in Banco de Valencia, whose assets account for under 1% of Spain's banking system, raises the question of how many more lenders will crack as they fail to fund their everyday needs.

"Liquidity is getting sucked out of the room," said one London-based analyst. "If the Banco de Valencia needs 1 billion euros and it's just 1% of the sector, then the numbers only go up."

The PP government, which won't be sworn in until mid-December, has not detailed how it will tackle the problems facing Spanish banks, brought low by closed money markets, increased demands for capital and rising bad loans.

"The messages are very confused and contradictory," said one Spanish banker.

The PP is considering the creation of a bad bank to group together toxic real estates from a property crash, banking sources say, despite the fact incoming Prime Minister Mariano Rajoy said earlier this month he did not favour such a move.

"It's not clear what they want to do, they have discussed the possibility of a bad bank," said another Spanish banker. "The problem of a bad bank is it is very difficult to fund and you have to price the assets."

IRELAND SHOWS THE WAY ?

A top PP party official told Reuters in September the new government would force banks to write down real estate holdings to their true market value after a devastating property boom and bust to rekindle investors' faith in the sector.

But the government has nowhere to turn to fill in the resulting capital hole. The euro zone rescue vehicle, known as the EFSF, is unfunded and undefined. Private investors are nowhere to be seen and Treasury borrowing is too expensive.

"The EFSF is more dead than dead," said one economist who analyses Spain's bank sector.

Ireland's decision to create a bad bank by purging the banks of their risky land and development loans, shrinking the sector and putting a 70 billion euro price tag on a bail-out has persuaded investors there are no more nasty surprises lurking.

But applying a similar strategy to Spain at a time when the euro zone seems on the brink of collapse could be disastrous, analysts and bankers say, by unveiling a huge capital shortfall to a government already desperately trying to cut its deficit.

"Once you set up a bad bank, the government has to pay for the assets," said one London-based analyst. "I think the bad bank is going to cost them so much money they can't afford it."

The 90 billion euro rescue deal for failed Franco-Belgian lender Dexia is another example of how identifying huge capital losses creates headaches for Europe's governments.

Spain has put 18.6 billion euros of capital into its banking system up to now, some in the form of loans. The state-backed FROB fund has around 3.3 billion euros left in its coffers without going to fraught markets to raise another bond.

MERGER MILLSTONES

The state already owns around 7% of the nation's banking assets taking into account the five lenders it has on its balance sheet - Catalunya Caixa, NovaCaixaGalicia, Caja de Ahorros del Mediterraneo (CAM), Unnim and Banco de Valencia.

This makes the state among the top five banking groups in the country. The Bank of Spain is trying to sell failed lender CAM through auction, but potential buyers want the state to offer guarantees on future losses at the lender.

The PP has backed further consolidation in overbanked Spain. A wave of mergers under the previous government last year has already cut the number of regional savings banks to 15 from 45.

Banco de Valencia was part of an earlier merger which grouped seven regional savings banks, including Spain's biggest unlisted bank Caja Madrid and Valencia-based lender Bancaja, into BFA, the parent of recently-listed Bankia.

Mergers are preferred over simply shutting down small banks because many of the savings banks have strong political significance in fiercely regional Spain.

But grouping together weak lenders with funding difficulties loaded with unsellable land and rotten loans only creates future problems.

"Merging is taking a bank that is already shaky and putting a huge mill stone round its neck," said Pedro Schwartz, economics professor at San Pablo University in Madrid.

"You can't say they are systemically important banks. Banco de Valencia is not Lehman Brothers."

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