How Bankia broke Spain

As Bankia imperilled Spain's finances its executives, politicians, regulators and the media ignored ever-growing signals of a doomed business model. Now the behemoth is under investigation for crimes including false documentation, embezzlement and fraud.

"A very solid group with more than 10 million customers.”

That was how a senior Bankia executive described the big Spanish bank on the last Friday of April.

Amid rumours of grave financial problems, he assured two sceptical journalists that the task of integrating the seven regional savings banks in the group was largely complete, and that plans to cut costs, reduce debt and minimise dependence on fickle wholesale funding markets were well advanced.

"We've created a brand – Bankia" the executive said at the group’s headquarters in northern Madrid, although the confidence he sought to convey was undermined by his evident unease and hasty exit from the room after being summoned to a meeting.

Just over a week later, the centre-right government of Mariano Rajoy, prime minister, intervened to save the bank. The game was up for an ill-fated behemoth that began life with more than 4,000 branches and nearly 25,000 employees.

Rodrigo Rato, a former Spanish finance minister and ex-managing director of the International Monetary Fund who became Bankia’s executive chairman, was obliged to resign. The government announced a partial nationalisation at an estimated cost of up to €10 billion.

Then came the most shocking blow of all: on May 25, Jose Ignacio Goirigolzarri, an experienced banker brought out of retirement to replace Rato and rescue Bankia, said it needed twice as much to clean out bad loans. He requested €19 billion in new emergency capital, on top of earlier state aid of €4.5 billion. Bankia restated its 2011 results to reflect a net loss of €3 billion instead of the reported net profit of €309 million.

Created in January last year, and floated on the Madrid stock exchange six months later, Bankia and its parent Banco Financiero de Ahorros were touted by Rato as the biggest bank in Spain in terms of domestic business, with €341 billion in loans and deposits, and a 10 per cent market share. Yet by last month, less than 18 months later, Bankia had become the biggest banking catastrophe in Spain’s history.

The Bankia debacle, however, is not merely a stain on the reputation of Spanish banking. Goirigolzarri made his appeal for capital at a moment when Madrid was finding it increasingly hard to raise money with sovereign bonds. That triggered the decision two weeks later by Rajoy to swallow his pride and appeal to the EU for a bailout of up to €100 billion to help recapitalise Spanish banks.

And the failure of that Spanish "mini-bailout” to soothe the markets could yet prompt the need for a full bailout of Spain, along the lines of the earlier rescues of Greece, Ireland and Portugal – and so imperil the 17-nation eurozone.

"What detonated the latest phase of this crisis was the situation at a big financial institution and its enormous capital requirements,” Angel Ron, chairman of Banco Popular, a listed Spanish commercial bank, said earlier this month in a reference to Bankia. "That was the tipping point,” agreed one analyst.

Trouble in the regions

The origins of the institution that did so much damage to Spain are in the country’s regions, which have gained considerable powers in recent years. Bankia’s components – Caja Madrid, Bancaja from Valencia and smaller savings banks from the Canary Islands, Catalonia, Rioja and the towns of Avila and Segovia in central Spain – were typical of the cajas that accounted for half of Spain’s banking system by assets before the crisis began. They began as regional businesses and were in most cases closely connected to politicians in the areas where they operated, so that Caja Madrid and Bancaja were influenced and run by the Popular party now in government.

Above all, the cajas were exposed to property, having financed the homebuilding bonanza in the decade up to 2007 and lent freely to developers, construction companies and housebuyers.

Since 2009, other cajas and groups of cajas have failed too. They were seized by the state and sold or simply nationalised – in Castilla La Mancha, Andalucia, Valencia, Galicia and Catalonia. Bankia’s fall was worse, however, because not only did it exemplify all the political and managerial weaknesses of the Spanish financial system, it was also so large as to be 'systemically important'. Its failure would threaten the entire banking network and it was therefore 'too big to fail'.

Interviews with Bankia executives, other bankers and analysts show mistakes were made on all sides: by national and regional politicians of both the PP and the Socialist party, stock market and bank regulators, the previous and current managers of the bank and its component cajas, by investment bankers, bank analysts and by an insufficiently inquisitive media. While it is easy to make such judgments with the benefit of hindsight, it is also true Spanish commercial bankers have long been scathing in private about the property lending follies of the cajas, especially around Valencia where Bancaja was based.

Madrid was only slightly better. During Spain’s housing boom, mortgage lending at Caja Madrid, the largest of the savings banks that formed Bankia, started to grow so quickly that, by 2007, some executives were trying to slow things down. After its mortgage book expanded by 25 per cent in 2006, Carlos Stilianopoulos, Caja Madrid’s then head of capital markets and later Bankia’s chief financial officer, said: "We don’t want to grow this fast. We are a savings bank so we don’t have to keep shareholders happy. We prefer to have a solid institution.”

At the same time, warnings from abroad about the overheating of Spain’s property market were dismissed. "Perhaps in other countries this pace of growth would be seen as a bubble,” he told Euromoney. "But not in Spain.”

Caja Madrid continued to grow and moved into marketing exotic financial instruments to foreign investors, such as bundled packages of loans.

"Fifty per cent of the banking sector in Spain – which was the cajas – did not have the corporate governance or the management skills to withstand a crisis,” says one of the many investment bankers involved in the July 2011 initial public offering of Bankia.

After 2008 – when the Spanish property bubble started to deflate, Lehman Brothers collapsed and the eurozone’s sovereign debt crisis began – the Bank of Spain and the socialist government of Jos Luis Rodrguez Zapatero launched a program of 'soft mergers' between cajas to improve efficiency. At first, however, the reforms were far from brutal. Managers responsible for failing cajas were often either retained or sent into retirement with multi-million euro compensation packages.

A problem goes public

As the crisis deepened, Spanish, European and international regulators increased capital requirements. For Bankia, a fateful decision was the introduction of a Spanish rule that forced banks to have a minimum core tier one capital ratio of 10 per cent of their assets – unless they were listed, in which case they were allowed 8 per cent. The idea was to save taxpayers’ money but it pushed Bankia into an IPO that most agree now should never have happened in the way it did.

"I find it very hard to believe that those who created the Bankia structure, and who were working on the listing were not aware of the problems of the bank,” said one adviser involved in Bankia’s nationalisation.

Ahead of its listing, Bankia hired Lazard, where Rato had worked after leaving the IMF, to co-ordinate and advise on the sale of shares, later taking on a group of international investment banks – led by Bank of America/Merrill Lynch, Deutsche Bank, JPMorgan and UBS – to market the deal to international investors. Lazard in Spain declined to comment.

In spite of this army of financial support, investment bankers who worked on the deal said there was negligible interest from foreign institutions. They could think of only one fund manager in London who was interested in buying a few shares.

"If I was an investment banker I would never have done the Bankia IPO – I would never have been able to recommend this to a client,” says a UK-based fund manager who declined to buy.

The process of selling Bankia abroad was described by some of those involved as "chaotic” and "mayhem”, with numerous banks struggling to get their views heard over each other, and being forced to filter negative feedback from potential investors back to Lazard and another core adviser, STJ Advisors.

Several advisers reported back to Bankia that it needed to raise more money, particularly given the large gap between loans and deposits, its €32.9 billion of real estate exposure and its need to repay its high-interest €4.5 billion loan from the state Fund for Orderly Bank Restructuring.

A crucial factor holding Bankia back from agreeing to sell more of its equity, giving it a greater buffer to withstand losses, was that it was impossible to do so without diluting control of the savings banks that formed Bankia to below 50 per cent, unacceptable to regional politicians seeking to retain their influence.

Roadshow blues

Bankia was floated on the basis of unaudited accounts – "due to the recent creation of the Bankia Group”, the prospectus said – and it was eventually Deloitte’s refusal to sign the 2011 accounts that prompted the government’s intervention last month.

"The risks of investing in a Spanish bank were known, and the prospectus made it clear,” says one of the advisers. "But what came out about the €19 billion hole? None of us could have expected that.”

Bankia was also short of experienced top executives, a failing that prompted some of the investment banks trying to market the IPO to threaten to withdraw from the process shortly before the international roadshow. Rato then chose Francisco Verd, the little known vice-chairman of Banca March, as his chief executive.

"There was a lot of improvisation,” says one banker. "It was a very odd IPO.” And when foreigners shunned the share offer, senior members of the Zapatero government called the heads of Spanish banks and corporations, and strong-armed them into buying 40 per cent of the €3 billion worth of shares 'in the national interest'. Retail clients across Spain – some 350,000 of them – were persuaded to buy the rest.

"The big mistake was when they came back from the roadshow and saw that there was no interest. They should have stopped the deal,” says Iigo Vega, a banking expert.

Bankia has had an exceptionally rough ride since listing. In September, Santiago Lpez Daz, analyst for Exane BNP Paribas and a critic of the cajas, inaugurated coverage of the bank by advising investors to sell, a rare stand among analysts attached to institutions working for Bankia. BNPP had been a bookrunner for the deal.

Executives at Bankia describe months of difficulties as European regulators and then the PP government, elected last December, imposed a succession of ever steeper capital demands on struggling Spanish banks as protection against their bad property loans. "You passed one barrier and then another one appeared,” says one Bankia executive. "That gave us a lot of headaches.”

It was clear in April that the end was near when the IMF, without naming Bankia, called for yet more capital for Spanish banks to preserve financial stability. "It is critical that these banks, especially the largest one, take swift and decisive measures to strengthen their balance sheets, and improve management and governance practices,” the IMF said.

Within two weeks, Rato was pushed out by his former colleagues in the PP government. Within five weeks, Miguel Angel Fernndez Ordez, Bank of Spain governor, was persuaded to step down a month early amid criticism of his regulatory role.

Vega, the bank expert, calculates Goirigolzarri’s latest demands for capital mean total bad loan provisioning requirements for Bankia/BFA – including the amount already set aside by the bank – reached more than €41 billion up to December last year, nearly double Rato’s number. "That is like 18 per cent of the original credit portfolio, which is an amazingly high number.”

He continues: "What went wrong? The underwriting [loan assessment] standards of Bancaja and Caja Madrid were basically rubbish... it’s been a big bubble and the banks were lending like crazy.”

Hopes shattered

Among the victims were not only Spain’s international standing and the reputation of its banking system, but also the hundreds of thousands of bank customers who bought Bankia shares in the belief that they were a safe investment. The government is resisting a public inquiry, but the public prosecutor has launched an investigation into five possible crimes at Bankia, including fraud, false documentation and embezzlement.

Bankia’s branch workers were encouraged to buy its shares by their trade union as a show of support. "I buy Bankia. Do you?” was the slogan of the union’s campaign, which also ran on Facebook.

Staff who did were seemingly oblivious to the likelihood that all shareholders would have their investments diluted to almost nothing by the injection of rescue funds. It was another tragic footnote to the sorry tale of the bank that broke Spain.

Copyright The Financial Times 2012.

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