Spain Weighing a Fast, Costly Cleanup of Banks

By JONATHAN HOUSE And CHRISTOPHER BJORK

MADRID—Spain's incoming prime minister, intent on curing the country's ailing banking sector, is considering cleanup plans that could dwarf the cost of previous efforts, including the creation of a state-funded "bad bank" to acquire toxic assets or a move to force banks to dramatically boost loan-loss reserves, people close to the situation say.

European Pressphoto Agency

Spanish Prime Minister-elect Mariano

Rajoy, right, with outgoing Prime 

Minister José Luis Rodríguez Zapatero

Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust, although he played down the potential cost of his plans ahead of last month's elections.

The bad assets are choking off the flow of credit and making international investors wary of the euro zone's fourth-largest economy.

Bank cleanup is a key element of a program of economic reforms that Mr. Rajoy will present to French President Nicolas Sarkozy, German Chancellor Angela Merkel and U.S. Treasury Secretary Timothy Geithner on the sidelines of a meeting of the European People's Party, a gathering of leaders of center-right parties from around Europe, in Marseilles on Wednesday and Thursday. European leaders are looking for clear commitments to reform from ailing countries like Spain and Italy ahead of a summit on Friday where they are expected to agree on new mechanisms of governance and financial support to underpin the euro.

More

• Santander to Sell Colombian Interests 

• The Source: Move Puts BBVA Under Spotlight

"It makes sense to give restructuring a push by cleaning up balance sheets; it signals things are moving along," said Tano Santos, a finance professor at Columbia University in New York. "That has been one of the most damaging things in the Spanish crisis: the lack of movement."

A more aggressive response won't come cheap. Analysts estimate a quick fix, such as setting up the bad bank or forcing banks to dramatically boost loan-loss reserves and providing government capital to backstop them, could cost the Spanish state as much as €100 billion. That sum raises concerns that the effort could break the government's finances, as happened to the Irish government when it recapitalized its banks and blew out its deficit to 32% of gross domestic product in 2010.

But a growing chorus of economists and policy makers say the risks of failing to act decisively now are even greater; a new recession could further stress banks, and investor concerns about euro-zone debt problems threaten to scuttle the common currency.

Previous cleanup efforts of the outgoing government of Socialist Prime Minister José Luis Rodríguez Zapatero have fallen short, largely because they were designed to spread the cost over time and avoid a big one-time hit to the government's finances.

Mr. Rajoy isn't expected to publicly disclose his plans for dealing with the collapse of Spain's decadelong housing boom before taking his oath of office sometime around Dec. 19. But some people close the situation say the fastest way to deal with the problem would be to create a bad bank that purchases the impaired assets from lenders at discounted prices. This would force the institutions to recognize losses. It also would likely undermine their solvency ratios and require further funds to shore up their capital bases.

According to analysts at Morgan Stanley, Spain could acquire the entire €176 billion pile of impaired real-estate assets at the 58% discount applied by Ireland's bad bank, or a cost of €73.9 billion. This could be funded by swapping new government debt for the banks' soured real-estate assets.

However, the state would have to raise sufficient funds from investors to provide the banks with an estimated €28.5 billion in new capital to absorb losses that the banks would take in selling the assets at a steep discount. In all, the cost of the plan to the Spanish state could be €102.4 billion, or around 10% of Spanish GDP.

Still, if the €28.5 billion proves difficult to raise from private investors, given current market conditions, Mr. Rajoy has said he is open to the idea of requesting funds from the European Financial Stability Facility, the euro zone's bailout fund, to help finance the new capital needs. That is one of the facility's new mandates after it was revamped earlier this year.

Mr. Rajoy seemed to pour cold water on the bad-bank idea when, in the heat of his pre-election debate with Socialist rival Alfredo Perez Rubalcaba, he pledged not to give the banks a "single cent."

But one person close to the situation said Mr. Rajoy's team is studying the possibility of using Spain's deposit guarantee fund, which holds €6.59 billion and is financed by contributions from the banks, to pay for necessary capital injections. That wouldn't go against his campaign pledge because the bank-financed fund, not the government, would provide the cash. Requesting money from the EFSF, however, would because the EFSF is funded by Spain and other euro-zone countries.

Spain's outgoing government approved new regulations on Friday that will double banks' annual contributions to the deposit guarantee fund to around €1.5 billion. These are paltry sums compared to the banks' likely capital needs, but a system could be devised whereby the deposit guarantee fund repays over time any monies the government injects in the banks now, the person said.

On the sidelines of a conference last week, Spain's central bank chief said the country's banks need further "restructuring" and urged the government to consider approaches that had previously been ruled out because of their high cost, including the creation of a bad bank. "This mechanism should be studied…situations change," said Miguel Angel Fernández Ordóñez, noting that the EFSF was now on hand to provide financing.

Write to Jonathan House at jonathan.house@dowjones.com and Christopher Bjork at christopher.bjork@dowjones.com
Fuente: THE WALL STREET JOURNAL