The subprime mortgage crisis in the United States has created problems in many economies around the world, including in Europe. Indeed, European banks have begun to reveal how the junk mortgage virus has infected their earnings results, which are beginning to show red ink for French, British, Swiss and German banks. Only the Spanish banks, which have done practically nothing that exposes their assets to junk mortgages, seem to be immune to the subprime contagion. Their way of doing of business, the rise of Spain’s domestic market and the vigilance of the Bank of Spain are key reasons why Spanish banks have kept out of danger.


According to Mauro Guillén, director of the Lauder Institute at Wharton, “American banks have clearly been the most affected. The European and Asian banks are going to feel the impact but I don’t believe they will suffer a direct blow.” As for institutions in Europe, he adds, “There are dozens of banks with investments in bonds that were guaranteed with junk loans; most of them were Swiss, British, German and French.” Some of them “have already announced that they have sizable losses but there aren’t any European institutions that have entered the subprime market per se; that is to say, offering mortgage loans to high-risk customers.”


UBS, the largest bank in Switzerland in terms of assets, has been the latest bank to announce its earnings. It expects net losses of €7.716 billion in the fourth quarter, including €9.475 billion because of its exposure to high-risk mortgages. More specifically, UBS’ fixed income, foreign exchange and primary market losses related to positions in the subprime mortgage market in the U.S. amounted to $12 billion in the quarter. An additional $2 billion in losses came from positions related to the market for residential mortgages in the United States.


In France, Société Generale is one of the most noteworthy cases. The second-largest institution in terms of market value has announced that it is writing off assets worth €2.05 billion from its balance sheet in the fourth quarter of 2007 because of its exposure to junk mortgage loans. Add to this a colossal fraud attributed to one of its employees that will cost the bank €4.9 billion. Meanwhile BNP Paribas, its great rival and the largest bank in France, suffered a 43% decline in its profits during the fourth quarter of 2007. Its profits dropped to €1 billion because of €589 million in losses from write-downs related to the subprime crisis and €309 million in precautionary measures.

In Germany, some state-owned financial institutions have been seriously affected by the crisis. In one case, WestLB has announced losses for the past year amounting to €1 billion. The bank will also make provisions for a similar amount on its books. Martin Blessing, chief executive of Commerzbank, Germany’s second-ranked bank, has also acknowledged that he will have to announce greater provisions related to the subprime market. That will bring the institution’s total exposure to about €1.2 billion. The most serious problems have been in the United Kingdom, where the Bank of England had to make an urgent loan to Northern Rock of £25 billion (about $50 billion) in order to keep that institution out of bankruptcy. Northern Rock was the fifth-largest mortgage bank in Britain before the crisis.


More Exposure than Announced


Experts say that investors and markets will be getting more bad news about the exposure of European institutions to the subprime crisis. “European banks are more affected than people have realized until now,” suggests Manuel Romera, director of the finance department of the Instituto de Empresa business school. “The institutions most affected will be the specialists in investment banking,” he adds. Francesc Xavier Mena, a professor of economics at the ESADE business school, notes that many of the bonds tied to subprime mortgages still haven’t matured. Until that happens, one can’t know the total extent of the losses suffered by the institutions that purchased them. “Up to now, what we do know is who is more or is less affected [by the crisis]. But we still don’t know the specifics about how this mine field is distributed,” says Mena.


This entire avalanche of asset depreciations and losses seems to be alien to the Spanish banking sector. BBVA, the second-largest Spanish bank in terms of market value, has announced its results for 2007, revealing an increase of 29.4% in its net profits, up to €6.13 billion euros. There was no trace of any problems caused by subprime loans. This case could provide a good example of what will happen in the rest of the sector, including at Santander, the largest bank in the country.


Why have Spanish institutions escaped the impact of the American junk mortgage crisis? Juan Antonio Maroto, a member of the finance and accounting department at the Complutense University in Madrid, emphasizes that “banking must anticipate, evaluate and manage risks, both assets and liabilities. Problems occur when ‘financial engineering’ makes it hard to anticipate; when banks trust ratings agency that don’t adequately consider the risks on questions of valuation and when they intermingle asset risks with liability risks; and when they simultaneously assess the risk of non-payment of securitizations with the risk of providing loans to those who acquire such securitizations. This is the virtue of Spanish banks and savings institutions. They are showing that they know what their ‘core business’ is.”


For his part, Guillén sees two key reasons why Spanish banks have been immune. “First of all, we’re talking about commercial banks where the investment banking divisions are relatively small. Second, as commercial banks, they have followed practices that are more cautious and rigorous when it comes to granting loans. If there are any problems in Spain, it will be because of the slowdown in the real estate sector, and the losses will be relatively limited. There have not been any large buyers of bonds whose value is guaranteed by mortgages.”

Mena points to two factors. “First, in some cases the Bank of Spain counseled [banks] against investing in products guaranteed by subprime assets, and in other cases, the Bank prohibited that kind of behavior. At the time, we didn’t realize the successful impact that [Bank of Spain] has had as the regulator of the Spanish banking sector.” Second, Mena notes that there has been a significant expansion of credit in Spain in recent years. This has enabled institutions to become large-scale issuers of bonds that are secured by mortgages traded on the market, in order to “issue all the liabilities that they have needed without having to go into other markets such as the United States.”

Sellers, not Buyers, of Bonds


Along the same lines, Romera emphasizes, “Spanish institutions have securitized [many] mortgages, but they have not been buyers [of securitized bonds] the way other European banks have been.” The level of securitizations in Spain reached its all-time high in 2007 despite turbulence in financial markets in the second half of the year.  The volume of securitizations in the Spanish market reached a record high €142.826 billion in 2007, 55% more than in 2006, according to Moody’s Investors Service. The growth rate was “significant,” said the report — a 62% increase in the value of securitizations backed by residential mortgages, and a 55% increase in the value of those [securitizations] backed by assets. The report stresses that this process has continued although such securitizations are now used mostly as a guarantee to the European Central Bank when banks need to get financing.

With this kind of growth, Spain has become the European market with the highest volume of asset backed securitizations (ABS). This puts Spain ahead of the U.K., which unseated Germany as the second-largest market in the region. Italy ceded its position in the top five because of a decline in deals backed by traditional assets. The Bank of Spain suggested that the market has enjoyed strong growth in Spain despite a drop-off during the second half of the world.

According to Guillén, “The crisis reinforces the image of Spanish banks as one of the best managed [banking sectors] in the world.” Eventually, he adds, “people will recognize that Spanish banking is one of the most solid and competent [banking sectors] in the world. You have to give credit to the Bank of Spain as the regulator and supervisor of banking.” Nevertheless, this doesn’t provide any market guarantees for investors, and most of them have decided to sell their bonds. So far this year, bond prices have fallen by between 10% and 20%. Only Banco Pastor has been immune, rising by more than 16%.


“Their wallets are being hurt by domestic factors,” argues Mena. “The mortgage market has already hit a ceiling and has begun to slow down. In addition, issuing liabilities is becoming more and more costly. In order to attract people’s savings, you have to offer them higher and higher returns. Beyond that, there are fewer buyers in the bond market because of the current crisis.” Rising interest rates and the slowdown in the residential market have meant that the Spanish mortgage market has entered a slowdown period despite the highs recorded in 2006. In 2007, the growth rate in the volume of mortgages managed by institutions was lower than in the last two years. And the trend will intensify in 2008, according to the Spanish Mortgage Association.

Latin America’s Strength


Within this context of international financial turbulence, Spanish banking has found a major ally on the other side of the Atlantic. “Its exposure to Latin America does a lot to help,” says Mena. He emphasizes that “the countries of the [Latin American] region have not been affected by the crisis. Moreover, because prices for their raw materials are at record highs, the economies of the region are enjoying good times, and more people are starting to use the banking systems [in those countries].” The only reason for the banks to be concerned is the political instability of some countries in the region.

Opportunities in South America provide major investment banks with a strong argument when they recommend that investors buy shares of Spanish [banking] institutions. BBVA and, above all, Santander are favorites of Morgan Stanley. U.S. analysts at Morgan Stanley recently wrote a report in which they recommended that investors put “extra weight” on shares of those two banks. The two banks’ advantage is their geographical diversification and their presence in Latin America, says the report; “a region that has been less affected by financial turbulence [than other regions] in recent months.”


Morgan Stanley emphasizes that although the U.S. is entering a recession, Latin America will continue to grow more rapidly than the developed countries will. That view is shared by Goldman Sachs and JPMorgan. In its report Goldman Sachs emphasizes that in the case of Santander, “The growing role of banks in Latin America and the high volume of accumulated provisions for dealing with any future problems are two structural reasons why the banks can protect their earnings.”

The strong financial condition of Spanish banks suggests that they might become major players in any hypothetical period of consolidation in the European or global banking sector. The problems derived from the subprime crisis have dispelled earlier rumors about possible hostile takeovers aimed at some of these Spanish institutions. Meanwhile, Citigroup, which began 2007 as the largest financial institution in the world in terms of market capitalization, has been surpassed by Bank of America and JPMorgan after Citigroup’s market capitalization dropped by 50% over the course of that year. That means Citibank is “cheaper” now and rumors have re-surfaced that Citigroup could be the object of a takeover effort. Another bank that might also be ripe for a takeover is Société Generale. BNP Paribas has already acknowledged that it is interested.


“Because of the subprime crisis, some banks have gone from being hunters to being prey, as in the case of Citigroup,” notes Romera. Adds Mena, “The sector will continue to consolidate in Europe if there are opportunities and if [a banking] institution becomes a takeover target because of a steep decline in its market value.” Although Romera thinks it is unlikely that BBVA and Santander will become targets of such a hostile takeover, he believes that the chances of that happening are higher in the case of midsize banks, such as Pastor and Bankinter.

Looking to the future, Guillén believes that Spanish banks “are going to take even stronger positions in the U.S. Over the past two years, Santander, BBVA, Sabadell and Popular have all made acquisitions [in the U.S.] The dollar is very cheap and the banks need capital, so it would not be surprising if Spanish banks made more acquisitions,” he says.