Real estate developer Martinsa Fadesa has been monopolizing headlines in the mass media of Spain and other countries because the company’s bankruptcy filing is the largest in Spain’s history. The company, which is headed by Fernando Martín, has debt of more than 5.2 billion euros ($8.23 billion), and has not been able to meet its financial commitments. As result, on July 15, it filed for voluntary suspension of its payments.


In a press release, the company blamed its plight on the fact that the “Spanish economy and the real estate market are clearly undergoing a recession.” The rest of the damage resulted from the refusal of the ICO, the Institute of Official Credit (state-owned corporate entity attached to the Ministry of Economy and Finance of Spain) to provide the company with a loan of 150 million euros, as well as the unwillingness of its 45 creditor banks to provide the firm additional time to borrow what it needed through other means. Last Monday will go down in history as a black day for the Spanish stock exchange because the CNMV, the country’s stock market commission, suspended shares of the real estate developer, which had already dropped by 50.2% over the last two sessions. Trading in its shares could be suspended until 2009 because of the complexity of the filing process.


It wasn’t so long ago that Martinsa was monopolizing headlines in the mass media for very different reasons. After the acquisition of Fadesa in 2006 through a tender offer valued at 4.045 billion euros, the company became one of the main players in the Spanish real estate sector and an authentic engine of growth for the economy of the country. According to Juan Ignacio Sanz, a law professor at ESADE, the corporate indebtedness that resulted from this acquisition is one of the reasons why the real estate developer faces its current plight. Conditions “have worsened as a result of declining sales” that resulted from the mortgage crisis, Sanz adds.


According to Sanz, the company’s excessive liabilities and lower sales have had two kinds of impact: “In the first place, a lack of liquidity; in addition, the drying up of the real estate market has led to a decline in the value of its assets (homes and other buildings). Martinsa’s own resources have eroded as a result of the declining [property] assessments of its assets; these appraisals have to be done every six months for the banks. This lack of liquidity leaves you unable to pay the debt, and the declining valuations mean that you eat your own resources.”


Starting from that point, the company needed only to refinance its debt. Nevertheless, says Sanz, “When your liabilities have been syndicated loans involving 40 or 50 banks, such measures require unanimous approval [of those banks], and there is always someone who is within his right to say ‘no.’” Parallel to the financing processes, he adds, “The law establishes a two-month period so that when companies are in a condition of illiquidity or erosion of their own capital, they can add capital, request the liquidation of the company, and suspend their payments.” That’s what Martinsa Fadesa wound up doing. According to bankruptcy law, administrators have two months, starting from the date when there is knowledge of a critical situation, for the company to file for voluntary bankruptcy. If a creditor manages to get a judge to force such a measure, managers risk losing all of their personal ownership because they failed to act with due diligence.


According to Manuel Romera, technical director of the finance department of the IE business school, the downfall of Martinsa Fadesa was an open secret. “In hindsight, they paid too much when they purchased Fadesa.” Fernando Martín adds that “They lost a little of their eagerness for excessive growth but they did not evolve because they may have thought that the hen that lays golden eggs can live forever.”


Possible Ways Out


In a press release, the company said that its suspension of payments is the best way to “avoid a worsening of a critical situation that could become irreversible and have serious repercussions for its creditors and the interests of all of its shareholders.” The board of directors believes that Martinsa Fadesa is still viable but it said it needs time to rebuild the confidence of its banks until “the economy re-builds and the confidence of Spanish families increases.” Starting now, under the country’s bankruptcy provisions, the company will be able to focus on generating revenues by selling its assets and managing the land it owns. It will also carry out a restructuring process “that enables it to launch a new plan.” The company has already confirmed that it plans to reduce its workforce by one-third.


By filing for voluntary bankruptcy, the company avoided being subject to an administrative team formed by a lawyer, an economist and a representative of the creditors, who would have substituted for Martinsa Fadesa’s own managerial team. That’s what would have happened if one or more of its creditors had imposed bankruptcy on the company. Nevertheless, experts agree that it is not so easy to legally force a company to file for bankruptcy because the plaintiffs must be able to prove, among other things, that the condition of non-payment is generalized (it involves most of the company’s creditors), and systemic (it is not a temporary situation.)


Romera believes that Martinsa’s decision to declare voluntary bankruptcy makes it more viable for the business to move ahead and renegotiate its debt. “This way, it’s the company itself that is managing the bankruptcy. [Martinsa Fadesa’s] managers believe that there is something to gain and, apparently, that when the terrible storm affecting the [Spanish] economy is over, conditions [in the real estate market] will return to normal.”


Experts say that the entire legal process could take until the middle of 2010. Extending the repayment deadlines for debt can hurt debtors, who have may trouble functioning even if they continue developing their activity at a normal pace. Suppliers and customers resist working with any company that has suspended its payments. Financially, the situation is better than with a refinancing of the debt, however. The interest earned on loans that are not guaranteed by mortgages remains suspended, and the banks negotiate debt release with bankrupt companies.


The company is confident that it can recover if the crisis is not prolonged beyond two or three years. Sources close to Martinsa Fadesa told Expansión, the economic daily, that “if the real estate sector recovers in the not too distant future, Martinsa Fadesa will move ahead.” If that doesn’t happen, the most likely thing is that it will be headed toward liquidation. Sanz notes that some real estate developers are working with a game plan that forecasts a market recovery in 2010, “but the situation looks so bad [now], no one knows.” However, in his opinion, not all of the news is bad. “Martinsa has residential land and good assets in cities. The banks are prepared to hang on, depending on the quality of those assets. If they are rural properties that aren’t worth anything, the banks will normally let you fall.”


“I always say that the banks wind up collecting [their money] if they are capable of waiting,” adds Romera. On the other hand, whenever the lion’s share of creditors agree on what to do with more than 50% of the debt, the rest of a company’s creditors have to listen to what that majority says. “Everything will depend on how they convince their banks to wait.” For all that, he notes, “The financial costs, the cost of leveraging and the interest rate burden are very substantial. And if that interest is not forgiven, the debt keeps on getting larger and larger, and it gets more and more complicated to evaluate how much you are going to forgive, and when. One of the problems with rising interest rates is that the debt keeps getting more and more expensive.”


Domino Effect


Sanz and Romera believe that almost all of the companies in this sector face similar conditions, and that will be other developers collapsing in coming months. According to Romera, “It could set off a significant negative chain of events if the plans of several real estate firms show that they believe things are going poorly.” 


Actually, Martinsa Fadesa is not the mostly heavily indebted of the publicly traded real estate firms. The ratio of its indebtedness to the value of its portfolio of assets (40%) is lower than that of Metrovacesa (55.1%), Colonial (73.3%), Reyal Urbis (57%) and Renta Corporation (55%). A clear indicator of bad times is the recent collapse in contracts for new housing sales, which are only accounted for in earnings results about two years after they take place. In the first quarter of this year, Reyal Urbis suffered a 97% decline in the volume of such sales contracts.


Colonial has a strong commercial property division in Spain and France, which generates recurrent and stable revenues. At the end of July, Colonial hopes to convince its syndicate of banks to refinance its debt, which was valued at 5.973 billion euros at the end of March.


Experts have been talking about the disappearance of the entrepreneurial model that has recently prevailed in the real estate sector. According to Romera, the construction and real estate sectors have been more highly leveraged than they should have been, and banks have tightened credit. In addition, there are enormous problems acquiring liquid assets.


Romera believes that many people saw this “perfect storm” coming. In his view, the real estate market was overvalued. The problem is “not just that the analysts say that the market was overvalued and that we got there through extreme over-leveraging, as well as from too much indexing of the variable interest rates on debt borrowed by construction and real estate companies. The problem is also that the current mess is very complicated and it is very hard to fix.”


Both professors agree that the government should not come to the rescue of the private sector. Although Pedro Solbes, Spain’s minister of economics, insisted that, in principle, the government was not going to intervene directly or indirectly, the ministry of housing has announced that after July it will proceed with the purchase of land and real estate in order to increase construction of state-subsidized housing and end up strengthening the construction sector.


“The reason why companies like Martinsa Fadesa are going through bad times is that they did some very bad things,” Romera says. So who is going to suffer? “Everyone who put their trust in the company, as well as the company itself; its managers and employees have [already] lost a great deal of money. You also have to ask that question to the banks because they loaned such tremendous amounts of money.” For his part, Sanz believes governmental measures should involve fiscal policy more than direct intervention in these sorts of operations. “I don’t believe that the state wants that [intervention], so that investment funds can come in, and negotiate and buy.”


The Consequences


Experts say that the decision made by Martinsa Fadesa’s board of directors will have multiple consequences. Nevertheless, Martinsa Fadesa is convinced that it will complete the construction of the 12,500 housing units that are currently under way. The company says it has the funding it needs to do that. “The banks are not interested in cutting off their financing line with a developer in midstream; it makes more sense for them to have an interest in finishing [off construction projects],” noted Expansión. None of the credit facilities that the company receives from the date of its filing for suspension of payments are affected by the bankruptcy process.


Sanz is not worried about the firm’s customers. “If everything has been done in an orderly way, there should not be any risks [for home buyers] because the funds they have paid [for housing] are guaranteed by banks, savings banks, and insurance companies.” Nevertheless, he notes, “This could raise the risks for all of the banks that are guarantors of Martinsa Fadesa. The risk is not so much for home buyers but for the banks that would have underwritten their purchases.”  He stresses that the big banks and savings banks such as La Caixa (which has about one billion euros in debt), Caja Madrid (700 million), and Banco Popular (400 million) have very substantial risks in absolute terms. However, the problem can be more serious for small institutions that have a lower volume of debt in absolute terms. A significant 3.54 billion euros of Martinsa Fadesa’s 5.2 billion euros in debt are concentrated in 12 financial institutions.


On the other hand, businesses that rely on the real estate sector for their revenues are moving down the same trail marked out by the real estate developers. For example, Roca, a multinational maker of bathroom equipment and ceramics, has announced plans to reduce its workforce in Barcelona. Romera calculates that for each direct job loss in the real estate sector, 10 jobs are lost indirectly [in related sectors]. “The impact on ancillary industries, such as for subcontracting, can be brutal. It is especially going to affect midsize and small companies. Extremely small companies and self-employed workers are going to be left without any work. And it will expand the unemployment rolls,” he says. “Although I don’t want to sound like a prophet [of doom],” unemployment could reach 15% to 16% next year, Romera adds.

Sanz stresses that the most worrisome aspect of this situation is that the plight of Martinsa Fadesa and other publicly traded companies could lead to panic on the stock exchange. “One day, it’s the American mortgage companies; the next day, it is a Spanish [real estate] developer… When conditions in the market are normal, this kind of situation, no matter how serious it is for Martinsa Fadesa, would not create news for more than a day because the market functions [normally] and it continues to move ahead. But in a situation like the one we have today – that is, a crisis – this news can generate a climate of panic.” In his opinion, bankruptcy in the real estate market has yet to have an impact on the real economy, or on employment, or on the level of corporate arrears. However, it will begin to do so starting with the last quarter of this year, and the first quarter of next year.


According to a recent report by the International Monetary Fund, the Spanish economy will grow at a rate of 1.8% in 2008. However, the IMF cut its previous forecast for 2009 by a half percentage point, to only 1.2%. The IMF blamed the problems derived from adjustments in the real estate sector along with rising prices for fuels and a toughening of conditions for access to financing.


Romera believes that everyone needs to take responsibility, not just a handful of people. For many years, he notes, Spain was more interested in investing in land than in creating companies. This fact, he says, “has been promoted by legislation; by the [significant amount of] land that has been made available, little by little, by town councils; and by the financing [that was available] for [purchasing] scarce land, as well as by the fact that the banks lacked any logical structure for financing since they wanted to make huge profits that way” rather through other mechanisms.

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