Bank of Spain Approach to Nonperforming Real Estate Loans

The Bank of Spain, doing what Fed and the U.S. Treasury should have done with loans backing worthless real estate, has notified lenders that they should be prepared to set aside much greater loss reserves against assets, "such as real estate, acquired in exchange for bad debts once the holdings have been on their books for more than two years."

The staggered loss provision schedule will call for a 10% loss assumption for real estate acquired in foreclosures, 20% for real estate held for more than a year, and 30% for anything held for more than 2 years. Bloomberg reports that Spanish lenders have foreclosed upon property worth nearly €60 billion, which means that very soon Spanish banks, which are already suffering a liquidity crunch, will have to take up to an additional €18 billion in asset write-downs, a development which will have a major adverse impact on Spain's banking sector once it funnels through the banking system, and especially once the need for liquidity spikes.

From Bloomberg:

The Bank of Spain plans to make lenders set aside more reserves against assets, such as real estate, acquired in exchange for bad debts once the holdings have been on their books for more than two years.

Banks that received property, for instance, from developers unable to pay back their loans, would have to make provisions to take account of a drop in value of at least 30% if they keep the assets for more than two years, the regulator said in a statement sent by e-mail.

The regulator is taking steps to force banks to recognize the declining value of real estate after lenders acquired property worth almost 60 billion euros ($73.3 billion) through foreclosures, debt-for-asset swaps or purchases. Banks must immediately provision for a 10% drop in value of the assets when they’re acquired and 20% after 12 months.

The regulator also wants to impose a new calendar ensuring banks fully provision for bad loans after 12 months, rather than as long as 72 months previously.

At the same time, the Bank of Spain said it would take steps to recognize the value of real-estate guarantees while adjusting their value according to their level of risk. For example, a loan guarantee consisting of a finished home that’s the normal residence of the borrower would carry a 20% cut in value, while plots of land would carry a 50% reduction.

The proposals will undergo a period of consultation before taking effect. The Bank of Spain said a study of the impact of the change on a sample of banks estimated a 2% increase in provisions for 2010, implying a 10% average drop in pre-tax profit from the lenders’ domestic business.