The mix of high external indebtedness, the fragility of the financial sector and the probability of further declines in asset prices increase the probability of a funding squeeze at some point means that “Spain will be the next country to seek financial assistance from the EU and the International Monetary Fund”, argues one of the Financial Times respected columnists.
Under the heading of “Complacent Europe must realize Spain will be next” Wolfgang Münchau points out that the latest statements from European finance ministers are merely “a metric of the complacency that has characterized the European crisis from the start” while the debt of several peripheral Euro zone countries continues to build up.
Last Thursday, the European Central Bank raised its main rate by a quarter point to 1.25% and more are likely to follow says Münchau. He anticipates the main interest rate to rise to 2% by the end of this year and to 3% in 2013. This trajectory “will have negative consequences for Spain in particular” and not only on economic growth, but also for “the Spanish real estate market since almost all Spanish mortgages are based on the one-year Euribor money market rate, which is now close to 2% and rising”.
Münchau says “Spain had an extreme property bubble before the crisis, and unlike in the US and Ireland, prices have so far fallen only moderately” and forecasts prices would have to fall by “another 40% from today’s level”. He adds that in “terms of supply conditions Spain is more similar to the US and I have yet to hear an intelligent reason why Spanish real house prices should be any higher today that they were 10 years ago, and indeed why they should keep on rising”.
More important the number of vacant properties is about one million, “which means that the market will suffer from oversupply for several years”. This will be the driver of further price declines given the stress in the system: recession, high unemployment, a weak financial sector, higher oil prices and rising interest rates.
Meantime “falling house prices and rising mortgage payments are bound to push up the still moderate delinquency rates and the number of foreclosures”. This will then have an impact on the balance sheet of the Cajas (regional savings banks) since their balance sheets carry all property loans and mortgages at cost.
Münchau adds that as default rates rise, the savings bank system will need to be re-capitalized to cover the losses. “The Spanish government implausibly estimates the re-capitalization need to be below € 20bn, while other estimates put the number at between € 50bn and € 100bn. The assets most at risk are loans to the construction and real estate sector, €439bn as of end-2010”. Spanish banks also have an additional exposure of €100bn to Portugal.
However there are also good news says FT: under a worst-case scenario, Spain would still be solvent since the public sector debt-to-GDP ratio was 62% as of end-2010, which according to Ernst & Young, in its latest Euro zone forecast, projects the debt-to-GDP ratio to increase to 72% by 2015, still below the levels of both Germany and France.
But the Spanish private sector debt-to-GDP ratio is 170%. Münchau says that the current account deficit peaked at 10% of GDP in 2008, but remains unsustainably high, with projected rates of more than 3% until 2015. “This means that Spain will continue to accumulate net foreign debt and its net international investment position – the difference between external financial assets and external liabilities – was minus € 926bn at the end of 2010, according to the Bank of Spain, or almost 90% of GDP.
Münchau concludes that “if my hunch on the Spanish property market proves correct, I would expect the Spanish banking sector to need more capital than is currently estimated. It is hard to say how much because we are well outside the scope of forecasting models. When prices drop so fast, there will be much endogenous pressure that no stress test could ever capture”