More Comedy From The Spanish Banking System

Going through the Variant Perception report on the parlous state of Spain’s banking system, I couldn’t help stopping and thinking hard about this point from the Spanish newspaper Expansion.

The valuation of the guarantees of the mortgage book of the cajas and banks and of its real estate gains importance. The thirteen companies tied to financial entities represented 47% of all real estate appraisals in 2007. The valuation of these real estate assets has taken on new importance for banks in the context of the current economic recession. The valuation of the mortgage guarantees and of the real estate assets they are taking on through the courts and debt for equity swaps is key to calibrate the solvency of the financial system. This situation has placed the focus once again on the links between banks and the real estate appraisers that goes beyond in many cases a mere commercial relationship.

And then scratching my head, and scratching my head.

Now to put all this in plain English, we are talking here about the valuation of properties that are repossesed by the banks, and that the banks then have as part of their asset side, as goods awaiting sale. Now, Expansion raises the question: “how can we know that these assets are being fairly valued (that is how can we assess the quality of part of the asset side in the bank balance sheet) when the banks themselves own (directly or indirectly) nearly half of the companies doing the valuing.

Well, this is an issue, but in fact the problem is much worse than the Expansion writer seems to realise, since there is a technical (matter of fact detail) that they seem to miss here, and that is how the valuation of property which is repossed by the bank actually takes place.

The issue is fairly complicated, but please bear with me, since if you follow me through to the end you will see why all the rigmorole is important. Basically Spanish “escrituras de hipoteca” (or mortgage agreements) require that the “valor de tasacion” as well as the amount secured is specified in the deed. The “valor de tasacion” is in effect the valuation of the property and it is put in the deed so that the amount of the debt can never actually exceed the value of the assets being mortgaged.

However since the bank don’t know when they might need to “exercise” (or recover) the mortgage, they don’t really want to compromise themselves in advance, and the typical way of handling the problem legally is to state in the “escritura” (or title deed) that it is agreed that the “valor de tasacion” for purposes of “exercising” the mortgage will be equal to the total amount of the debt outstanding plus the rolled-up interest.

This is a very convenient solution for the banks, since it gives outsiders the impression that there is what one might call a valuation in the UK or US sense, when what is really involved is simply a formula applied in order to structure legal documentation.

The same thing happens when it comes to the time to “ejecutar una hipoteca” by auction, there being no other way in Spain. Since judges tend to give banks a really hard time if the asset is valued below the amount of the mortgage debt (ie the individual who owes the money has a debt even after the auction) banks normally take the easy way out and value the property at the amount of the debt rather than have the judge cancel the auction. Banks then theoretically have to pay tax on the transfer price to the registry (assuming they end up “adjudicando” the asset to themselves, i.e. taking possession), and the tax office – Hacienda – won’t accept anything other than the price at which the asset has been “adjudicado”.

The whole point here is that it ends up being very difficult for a bank to transfer an asset to itself in settlement of a debt at a figure which is substantially different from the amount of the debt unless there is a real possibility of getting the borrower to pay the balance.

So…….. “valuations” in Spain effectively result from this complex and machine-like calculating process and are in no way comparable to what are known as valuations in – say – the UK market, nor does anyone involved in the process really think that such “values” really reflect what someone would pay for the property. Having got themselves into this position as a result of what is in the end for them a necessary procedure the banks basically just leave the figures exacty as they are. In simple Spanish a property valuation is an estimate of the property’s “value”, whatever that might mean!

Which brings us right back to the Expansion article, and this quote:

“The valuation of the mortgage guarantees and of the real estate assets they are taking on through the courts and debt for equity swaps is key to calibrate the solvency of the financial system.”

Well if this proces I have descibed above is the “key” to calibrating the solvency of the Spanish financial system, then the calibration process that results is going to be just as ad hoc and inadequate as the valuation process that gave rise to it. In a way all of this reminds me of the structured CDOs in the US case. Most of these got valued by computer programme simply because they were never traded. No-one ever really thought the valuations represented what they could be sold for even if that’s what hedge fund investors were told they were worth. Hence many were in the uncomfortable position of having them valued at 99.98 one minute and getting a bid at 30 the next.

Which again brings us back to Jonathan Tepper, and his Variant Perception report. As I undersand Jonathan, what he is arguing is that the situation in Spain now has certain structural similarities with the situation in the US before the sub-prime crisis broke out. The similarity is partly becuase there is little in the way of an early warning system available. The fact that the Bank of Spain’s foreign exchange reserves are merely academic means that many professional bank analysts lack the early warning signs of an imminent balance of payments type crisis, and the mechanical and artificial system for valuing the growing number of homes accumulating in the banks’ real estate portfolio means there may well be no small amber flashing light to watch for before all the dials suddenly luch over to red.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

10 thoughts on “More Comedy From The Spanish Banking System

  1. I guess it is implicit in your article, but I think it’s worth spelling out that not only do artificially high valuations of repossessed properties make the Banks look – temporarily – better, but repossessed properties then don’t exert such a severe downward pressure on the housing market in general.

    In my part of the US, CA, it is Bank-owned properties that are driving house prices down. A repossessed property on your street is very bad news.

  2. That accords with what I’m hearing from banks here in Portugal. Repossessed properties are sold by the bank for the money outstanding. Very difficult indeed for them to do a short sale, leaving the previous owner in negative equity.

    Here, it’s not so much of a problem, no boom so no slump. In Spain however….

  3. Hi Tim,

    But to be clear, here in Spain the banks aren’t selling the things – there are no customers, someone told me the total sales to non Spaniards in the first six months were only 478, which makes sense, but I cannot confirm – they are simply swapping property for debt, and valuing the asset in the balance sheet at an imaginary price, then telling the press the level of bad debt is going down.

    Incidentally, in Portugal, no boom no bust, but there do seem to be a very large number of empty properties built for tourists who never came. Half a million according to this article:


  4. Sure….but there’s very much a division between the “tourist” market and the local one.

    15 clicks away on the Algarve coast the stack a tourist flats are tough to sell. Here inland new apartment blocks (say, 8 flats in a four story) sell out before completion.

    Up in the north, Porto, Viseu, Braga, Coimbra, very different story, very depressed market. Just seen a 5 bedroom flat in Porto on the market for 80,000 €. Very tempting indeed.

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  6. Edward,
    As far as I understand it the Bank of Spain requires banks to classify assets according to risk, and that 80% LTV mortages are classified as low risk. Does the spurious valor de tascion refer only to the cases where the bank is swapping debt for the ownership of the property or can we not trust the stated LTV of the entire mortgage book of the spanish banking system.

  7. Haraldo,

    “Does the spurious valor de tascion refer only to the cases where the bank is swapping debt for the ownership of the property or can we not trust the stated LTV of the entire mortgage book of the spanish banking system.”

    Interesting question. The spurious “tasación” only refers to the properties acquired in debt for property swaps, since this formula is only applied when a property is “repossesed”.

    However, the other part, the real value of the properties underlying the mortgages in the loan book, well this brings us back to the Expansion point, about who was doing the valuing in the first place. If the banks controlled 47% of the valuation companies, well… these values cannot be assumed to be objective, can they?

  8. On the other hand, these valuations might previously have been below market value. Consider the point below made in a comment I received. I such cases 100% LtV would have been more like 75% LtV. Of course, even these are soon headed underwater.

    Spain has traditionally suffered from sellers not recording the full money received from the sale of the property, with the convention being an under declaration of approximately 30%. However, over the last three or four years there have been some very high-profile court cases involving corruption and money-laundering. Under declaration has been brought into the money-laundering field and as a result is much less prevalent. The result of this in a level market would be the Registries showing higher prices being paid for properties, which were in fact only being sold at the same total price. However, prices dropped substantially, in many cases by more than 30%. Accordingly, the net effect is that the registries are showing marginal drops in sale prices, when in fact the actual gross prices are dropping substantially.

  9. Here’s another very interesting comment I got:


    “I was chatting with an employee with a large bank-owned property site that are disposing of these repossesions. By law they have to ensure the properties are 100% compliant with local planning laws and taxes. They have to pay back taxes if they exist,etc…

    Anyway, this employee said they have 5000 on their books to sell now and another 12000 in the pipeline for the near future. But bear in mind the process takes between 4 months and 2 years before they get through their pre-sales processes.

    Its a huge logistical nightmare for the banks, they are becoming the largest estate agents in the world and also making a loss on everything they sell. The operational costs of running such an real estate organisation must be substantial.

    They are also enlisting the support of local estate agents for viewings, one had just told me the “minimum price” for a place – too high but I guess that his idea of the minimum based upon his slice of “action”. They are not going to move them quickly like this.”

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