Twenty Percent of Spanish Mortgages Now Considered To Be High Risk

According to an article which appeared in the Spanish newspaper Expansion this morning, one in five Spanish mortgages is now considered as being high risk and liable to become “non performing”.

The mortgages at greatest risk are naturally those contracted after 2005 where the loan to valuation was over 80% of the total. In 2006 and 2007, according to data from the bank of Spain, LtVs were over 80% in 17.7% of the mortgages granted, since prices are now heading back towards the 2005 level, we can easily conclude that something in the region of one in five Spanish mortgages are now high risk.

Prior to 2006, the main source of data comes from a study by Genworth Financial, who show that loans with +80% LtV rose from 12.2% in 1996 to 26.4% in 2005 (see chart below which comes from Expansion). These loans were especially popular between 2003 and 2006, but then started to decline as the decision of the ECB to raise interest rates made the likelihood of a price correction rise sharply.

The other key indicator for risk of mortgage default is, of course, the proportion of income devoted to servicing the loan. This has risen, according to Bank of Spain data for the second quarter of 2009 to an average of 38.6% of disposable income.

This figure is down sharply from the 46% reached between 2006 and 2008 largely as a result of the drop in interest rates. This is the plus side of over 90% of Spanish mortgages being variable interest. The boost to families with mortgages has been significant, and this is evident in the consumer confidence surveys.

But there is a downside here. Spanish households are now extraordinarily vulnerable to any rise in interest rates.

Secondly, people feel better because of the improved cash flow situation, but are probably not looking at the capital account side of their personal balance sheet. People with large mortgages and very high LtVs may well be better off by a few hundred euros a month, but the capital value of their investment may be sinking like a stone. In other words they are bleeding out money through the rear window. One day they will wake up to this, and find they are paying interest on a loan which is worth far more than the property they hold. Then, if there is no change in the bankruptcy law it is off to Australia, Canada or Brazil for many highly educated but heaviliy indebted young people, since as the Spanish law stands there is simply no way out from underneath this for them, ever. That is what those awkward little words “full recovery” mean.

Thirdly, Spain is now in deflation. This means that incomes will go down (over several year probably, if there is not one dramatic year of fall), and property values (which will remember correct against the general price index, that is they will also be further sucked down by the general level of prices) will also continue to fall. So the LtV will rise even as the proportion of income which needs to be paid to service a debt of which so many people were once so proud, but which they now find the be a millstone round their necks, will go up and up an up.

Meanwhile Bad loans as a proportion of total credit at Spanish lenders fell the first time in two years in June as savings banks reported a decline in defaults. The ratio fell to 4.6 percent from 4.66 percent in May and compared with a rate of 1.7 percent a year ago, the Bank of Spain said today on its Web site. Bad loans at Spain’s banks slipped to 85.6 billion euros in June from 86.7 billion euros in May and 31.2 billion euros a year earlier.

But to put this in perspective, the ratio of bad loans to the total has still tripled to 4.6% over the past 12 months. And the situation is worse than it seems, since according to a study by UBS Spanish commercial banks have clawed back about €10 billion in debt-for-property swaps. And this number does not include Spain’s savings banks who do not disclose the relevant figure. If the position is similar to their commercial peers and we reclassify all these property purchases as bad loans, then the non-performing loan ratio would be 5.7% (before making any further adjustments for the loan restructuring which has been going on thanks to the availability of generous government and ECB funding).

In addition the central bank recently circulated new guidance relaxing the provisioning rules on risky mortgages. Until now, banks had to make provision for the full value of high-risk loans – those above 80% of the property’s value—after two years of arrears. That was obviously far too demanding, since property values rarely fall to zero. However the timing of the change was far from inpeccable, and the new rules, which mean banks only have to allow for the difference between the value of the loan and 70% of the property’s market value, give the impression of massaging rend results.

Iñigo Vega, an analyst at Iberian Equities, estimates that the new rules would relieve banks of the need to make provisions of about €22 billion in coming months (assuming non-performing loans only reach 8% by the end of 2010). To put that into context, Spain’s savings banks, which are heavily exposed to developers, are expected to make profits of only €16 billion before provisions this year.

As the Economist said, deferring losses to mañana doesn’t change the extent of the difficulties facing Spain’s financial system.

And just to confirm that Spain really is different, surreal almost, this article (in Catalan) explains that the majority of the long term unemployed who have gone to the employment offices to claim the 420 euro monthly payment they thought they had been promised have discovered …… that they are not in fact entitled. Apparently, according to the small print, you need to have run out of benefit and been declared unemployed AFTER 1 August 2009. This is Monty Python stuff, isn’t it?

This entry was posted in A Fistful Of Euros, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

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".

29 thoughts on “Twenty Percent of Spanish Mortgages Now Considered To Be High Risk

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  2. I had to reread it, but yes, it is MP stuff. Is Spain really that much at the end of its rope that politicians can’t provide for hand outs anymore? Automatic stabilizers ‘n stuff.

  3. Hi If. The short answer: yes. They aren’t out of money yet, but we are getting there. Income is going down, and spending is being driven up, and the two lines can’t go in opposite directions for that long. My guess is push will come to shove back end of 2010, early 2011, give or take six months either way, Then we will see what gets to happen next. And of course, this wasn’t funny. People who have run out of benefit went to the offices to collect, only to be told they weren’t entitled. That sets a new low in cynicism I think, and makes the way the expression “solidarity” is being used in Spain an absolute joke.

  4. The problem is that there is a 12 month lag (at least) on all these figures. Many are paying far more than prevailing rates due to the Spanish 1 year fixed rate system.

    Those mortgage holders who manage to survive last years high rates are desperately hanging on for their annual “mortgage rate review” which should substantially decrease their monthly payments.

    But, this simply gives them 12 months at a more affordable rate whilst the Euribor creeps back up – I really think the turning point is here for the Euribor and from August 2009 the only way is up – lets hope it sits in this trough for a while because if it climbs as quickly as it fell, in 12 months time all these mortgage borrowers will be back where they started.

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  6. If the law on debt repayment were changed due to political pressure, which banks would be hit? Would these banks be forced to write off the money anyway?

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  13. I had always thought that the Spanish banks had comparatively tight criteria when lending, unlike the UK for example – so I’m surprised there are such a high level of bad mortgages.

  14. They do have tight criteria and always have. The problems are a result of a number of failures in their underwriting system.
    Too much authority was given to local branch managers who were able to sign off on large loans without authorisation from anyone else in the bank.
    This inevitably led to fraud and corruption.
    Valuation companies were paid to be generous with their reports – over valuing property leading to larger mortgages.
    Estate agents over declared prices – allowing them to raise higher mortgages against a property (in excess of the purchase price.) This encouraged lots of people to buy property as they didn’t have to put any money down – immediate negative equity.

    Mortgages were written based on the valuation – the purchase price was usually not taken into account – again, huge mortgages, no money down.

    As soon as prices began to fall, the party was over.
    All this fraudulent activity combined with a large percentage of earnings in Spain being undclared meant that as the economy began to falter and people lost their jobs, income support was based around their declared incomes and as such was far too little for people to have any chance of maintaining their huge mortgage payments until they could find work again.
    With little or no money of their own invested in the property they simply didn’t have an incentive to keep paying.

    Combined with all this, o many people in the real estate industry – which has all but collapsed, the tourism sector – which is on its knees and Spain has for the past 10 or 15 years been racing towards an economic brick wall.

  15. Bit off topic:

    Is anyone out there living in Spain (e.g. Edward) worried about a possible exit from the euro and the corresponding loss of store of value of the bank accounts they have there?

  16. Andy Ward and others. Over the time delay in the downard adjustment of the interest rate, I would just say that this is one of the principal reasons bank numbers have been looking a bit better of late, since the drop has been very sharp and very rapid, and the banks obviously benefit immediately, while their clients only get to notice the change at some time over the next twelve months. Things won’t be so easy for the banks next year.

    In fact, given the impact on household finances which would follow from any raising of interest rates at the ECB, Spain’s households are now in the ridiculous position that they can’t afford to have an economic recovery. A more Monty Pythonesque situation is impossible to imagine, and that is the mess we are in. Salaries down, house values down, mortgage service costs up, it just wouldn’t work. Like Japan, they now need bargain basement near zero interest rates in perpetuity.

  17. Mark

    On the euro. I would say Spain leaving the euro is the next best thing to impossible. Not because Spain might not like to do it at some point, but because the impact on the rest of the world would be enormous. Spain has the fifth largest absolute gross external debt in the world, and one of the largest external debt levels in net terms. In per capita terms Spanish debt only comes behind Iceland and Ireland.

    So now go back to last autumn, and think what happened when Lehman Brothers went. Spain defaulting on its external debt (which is what exiting the euro would mean) would have a massive effect on all those other countries (mainly European) exposed to counter party risk. This is what makes Spanish debt very different from say Italian government debt, since in Italy the majority of the debt is held by Italians. That is, Italian exit would be serious, but would have far fewer global repercussions.

    So Spain will be forced to stay in the Euro, which is why my bet is for the EU to float an IMF rescue idea, in just the same way they have for Latvia, Hungary and Romania.

    Of course, I say Spanish euro exit is the next best thing to impossible, but as we have recently seen, things which are only “almost impossible” do sometimes happen.

  18. More important than the absolute level of debt is the absolute level of deficit; here Spain is second behind the US. This deficit has been financed by a pretty novel and opaque system: Spanish banks have tapped the Euro capital markets (born 1 Jan 1998) via securitisations, bonds, cedulas and other instruments.
    German and French institutions have financed the Spanish fiesta as if there were no tomorrow, happy primarily with the fact that they are lending euros and not pesetas.
    Looking at spanish banks´ sources of funds would produce a pretty scary view, deposits being in some cases less than 50% of liabilities and the rest comprised of assorted and innovative financial instruments developed after 2000 mostly.
    The govt is not hugely indebted, neither are spanish individuals and corporates with foreign banks. The debt financing the silver medal deficit was assumed by individuals and corporates with domestic banks and is sitting in their balance sheets and being progressively rolled over thanks to the incessant liquidity from the ECB and the spanish govt.
    Meanwhile the spanish economy is being starved of funds because each mortgage being redeemed is used to repay capital markets funding. The main culprits of this drama, i.e. the govt and the banks, are hoping that the deposit to loan ratio can hopefully be reestablished closer to 1 in the next few years.
    Glad that this debate is finally surfacing

  19. How can i attach a presentation particularly relevant to this debate?
    Please help

  20. José,

    I completely agree with you that private debt HAS been the problem, but as you rightly point out, this private debt has created a huge level of national indebtedness, which of course the private sector now cannot pay. So the debt simply gets transfered over to the public debt. That is how things work.

    Look at Latvia, in 2007 Gross debt to GDP was around 12% (ie virtually nothing), then banks households and corporates went bankrupt, and now Gross debt to GDP is predicted at 80% in 2010 and rising – ie they cannot enter the euro due to this problem. I agree completely about Spain’s CA deficit. Spain needs to pay 3 billion euros a month on the income account just to pay the interest.

    “More important than the absolute level of debt is the absolute level of deficit; here Spain is second behind the US. This deficit has been financed by a pretty novel and opaque system: Spanish banks have tapped the Euro capital markets (born 1 Jan 1998) via securitisations, bonds, cedulas and other instruments.”

    I absolutely agree on all this, see my Spain economy watch blog, and my post (identified in the top of the sidebar) on cedulas hipotecarias.

    I don’t entirely agree with this:

    “The main culprits of this drama, i.e. the govt and the banks, are hoping that the deposit to loan ratio can hopefully be reestablished closer to 1 in the next few years.”

    The main culrpits here (although they were obviously aided and abetted along the way by a motley assortment of banks, builders,developers etc), were all the Spanish people who told me incessantly that property prices could never come down in Spain, and bought flats, houses, stud farms whatever and remortgaged and remortaged furiously to buy SUVs and 4 wheel drives, on the back of this mistaken new religion.

    I think the Spanish citizenry is in complete denial about its own part of the responsibility here, and while there are many others obviously to blame for this huge tragedy, the first thing that has to happen is that people who are bankrupt have to recognise that the buck stops where it stops, and not try to shift the blame onto others.

    I’m afraid you can’t post presentations directly onto a blog. Find a link to it, or upload it yourself at eg, Google docs, and then post a link.

  21. Edward, thanks for your comments. I am more inclined to believe that if banks sell a particular product strongly enough, clients end up buying it. In this particular example, in my view, the burden of gilt is more with banks than with clients. I am a spanish citizen with a mortgage and have I worked in a spanish Caja, so I can claim to have seen both sides of the picture. My general impression is that financial ignorance by clients has been used by banks to make money, which obviously is not illegal but certainly questionable.

    I´m getting started with blogs, here is my first attempt at attaching/linking presentations.

  22. José,

    That is a great summary! Re Spanish banks dubious advising of clients (= out and out selling), the latest scam has been to sell prefeence shares as to retail clients as if they were deposits. Someone (the OCU?) should be taking out legal action about this.

  23. Thanks Mark
    By the way those preference shares are a perfect example of what I am talking about. Round about the time the banks were selling them (Jan 09-Jun09), the institutional market was pricing identical transactions by the same issuers in the secondary market at 25%-40% of nominal value.
    The preference shares being sold in the retail branches were sold at 100% of nominal value (as you would expect with any normal fixed income product). As I said before, it is not illegal but clearly questionable.

  24. José,

    OK, thanks for the presentation. It is excellent. I will cover it this morning, it ties in completely with what Jonathan just did at Variant Perception.

    Also I see much better were you are coming from now. Of course, I agree the banks are not without blame. Personally I hold Jaime Caruana pretty responsible. Basically, having a full recovery bankruptcy law in place, and a tradition among young people of not emigranting (the Spanish family ties) was surely on of the reasons the banks were prepared to engage in such reckless behaviour, as he pointed out in a speech (which I can no longer find) in 2006, where he said that property was overvalued by 30% but risks to the banking sector were low for the reason just mention.

    One of the first things that will be needed is a new personal bankruptcy law to get the young people out from under all that debt before they HAVE to emigrate.

    Anyway, I think we should talk. Our analyses are very similar. Mail me at



  25. I’m not sure if the full bankruptcy law is that relevant to the housing bubble in Spain. Compare with the US where most of the loans are non-recourse and you’ve got the same problem.

    Of course, people are really shafted in Spain as they can never escape paying back the ol’ mortgage for the rest of their lives.

  26. Hi Mark,

    Just one detail:

    “Compare with the US where most of the loans are non-recourse and you’ve got the same problem.”

    You may be right that the bankruptcy law wasn’t an important part of the thinking – although as I say, Caruana explicitly, and cynically in my view, referred to it – but I can’t agree that the US has the same scale of problem Spain has – proportionately Spain is a much, much bigger deal.

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