Spanish lenders had been making their loan books look healthier than they really were by refinancing big numbers of loans to struggling homeowners and businesses

Spain’s Banks Boost Books by Refinancing Loans to Homeowners

Bank Earnings Reveal Part of Answer to Question Puzzling Analysts

ILAN BRAT and CHRISTOPHER BJORK

Nov. 6, 2013 12:12 p.m. ET

MADRID—It has puzzled Spanish bank analysts for years: Why did the country’s mortgage delinquency rate rise so slowly even as unemployment soared above 26%? A big part of the answer—revealed by a spate of bank earnings reports in recent days—is that Spanish lenders had been making their loan books look healthier than they really were by refinancing big numbers of loans to struggling homeowners and businesses.The lower interest rates and easier terms of refinancing helped hundreds of thousands of Spaniards like Juan Carlos Díaz, who stopped making mortgage payments more than a year ago, remain in their homes and keep their businesses afloat longer than otherwise would have been possible. It has also helped banks bury a growing risk in their credit portfolios and avoid recognizing losses on debts they are unlikely to recover.

Now, more stringent disclosure guidelines from Spanish banking authorities are bringing these risks into the open. Partly as a result, mortgage delinquency is rising fast—a trend that could damp recent investor enthusiasm for a bailed-out banking industryrebounding from a property-market crash.

Spanish banking stocks have declined 5% since the first third-quarter results came out in late October.

The Bank of Spain, the country’s central bank, began forcing banks in April to re-evaluate and disclose their refinanced loan books out of concern that some lenders had been taking advantage of relatively loose guidelines to mask the deteriorating creditworthiness of their clients. As Spain’s economic slump deepened, the Bank of Spain said at the time, “Difficulties considered to be temporary in many cases have become structural.”

The bank reviews should apply stricter guidelines for classifying the health of refinanced loans, the regulator said. For instance, if a borrower spends more than half his monthly income on interest payments or is benefiting from a lengthy grace period, his loan can no longer be classified as normal, it said.

Enlarge Image

 

The results have been striking. Since December 2012, the amount of refinanced home mortgages gone sour has doubled at Spain’s six largest banks even as their refinanced loan books grew a little, according to the banks’ financial statements. The Bank of Spain has said banks had refinanced roughly one of every 12 outstanding home mortgages, or €50.8 billion ($68.5 billion). All doubtful loans, including those to businesses and government entities, now account for 46% of the six banks’ refinanced total, compared with 36% in December.

Banco Santander SA, SAN.MC +0.52% Spain’s biggest bank by assets, reclassified €2 billion worth of mortgages as nonperforming due to the rule change. In 2011, the bank offered a three-year grace period to customers who had seen their income drop more than 25% and were having trouble servicing their loans. By June, the bank says, just over 22,000 customers had signed on to the moratorium. Many of these loans have now been reclassified as nonperforming. A Santander executive in July said that 93% of the loans that were reclassified actually continue to pay monthly mortgage payments.

Banco Bilbao Vizcaya Argentaria SABBVA.MC +0.98% has shifted €3 billion into its pool of nonperforming refinanced mortgages since the beginning of the year. A chunk of that came from a savings bank BBVA took over last year. A spokesman said many of the mortgages labeled as nonperforming are still being serviced.

The banks’ new rigor is part of a push by the central bank to prepare Spain’s financial sector for Europe-wide bank health checks next year. But the deterioration of refinanced loans may also serve as a warning sign for investors who have recently turned more bullish on Spain’s banking sector.

Spanish banks are devoting billions of euros in provisions to cover newly recognized refinanced loans gone bad. The hit, though large, is manageable for Spain’s banks. But it will drag on bank profits this year and likely next year, said Santiago López, a bank analyst with Exane BNP Paribas. BNP.FR +0.66%

It also raises questions about whether banks have continued to sweep under the rug loan losses lurking on their balance sheets, a concern that has dogged the sector since the start of Spain’s economic crisis. For years following the real estate crash in 2008, analysts say, lenders applied an “extend-and-pretend” approach by refinancing ailing real-estate developers. Ultimately, banks were forced to recognize those losses, spurring last year’s €41 billion European Union bailout of Spain’s banking system.

Refinancing struggling homeowners “only pushes the problem forward without finding long-lasting solutions because in the end, the debts only grow while the borrower’s capacity to repay doesn’t improve,” said Carlos Baños, chairman of AFES, an association that advises mortgage holders who have trouble paying their debts. “These days it’s hard to see things getting better unless you win the lottery.”

For Mr. Díaz, a 49-year-old account manager at a company that makes chemical pumps, the extend-and-pretend approach worked for a while. In 2007, he took out a €600,000 mortgage on a suburban Madrid home. At the time, his wife’s fast-food restaurant in southeastern Madrid was going gangbusters, selling roasted chicken whole and in sandwiches to construction workers during a big housing bubble.

In 2008, the bubble burst, leaving her business with few customers.

Her take-home pay dwindled, and paying the mortgage starting eating up most of the household’s monthly income.

In 2010, Mr. Díaz asked his bank, Caixabank SA, CABK.MC +0.79% for help. The bank agreed to refinance the mortgage, allowing him to lower his monthly payments by paying only interest during four years. The lender also furnished him with a second mortgage, for €32,000, to pay off credit card and other bills.

By 2012, the family’s finances were stretched so thin that Mr. Díaz began drawing from savings to keep his wife, two children and himself in their home.

In July last year, he stopped paying the mortgages, rebuffing his bank’s offer for an additional grace period that would further lower his monthly payments.

Caixabank has begun the process of foreclosing on his home. In June this year, the Barcelona lender reclassified €2.29 billion worth of mortgages into the nonperforming category as well as €2.86 billion in business loans. A Caixabank spokesman said the company in 2009 began offering grace periods, debt restructuring and other options for customers with temporary economic problems. The bank can’t comment on Mr. Díaz’s situation, because as a rule it doesn’t disclose information about its customers, the spokesman said.

Mr. Díaz said he has few good options.