It was highly anticipated since January this year that the Bank of Spain would raise –yet again– the provisions lenders have to set aside on real estate assets held in their portfolios as a result of NPL (http://belegal NULL.com/articles/showArticle/home-repossessions-in-spain-defaulting-on-mortgage)’s or on accepting daciones en pago (http://belegal NULL.com/articles/showArticle/spanish-mortgage-dacion-en-pago-handing-keys-bank) from ailing developers or struggling borrowers. The purpose of these provisions is to offset the likely capital depreciation.
Lenders are required to set aside 10% on adjudicating themselves these assets and deposit it before the BoS. If after 12 months the asset remains in their books they have to set aside an additional 10%. If a further 12 months go by a further 10%. So basically after 24 months they are unable to offload these real estate assets from their portfolio they must set aside provisions for 30%.
So the BoS not only has raised these provisions but additionally has also proposed to shorten the timeline to deposit them down from 24 months to 12 months. The outlined proposal will bring serious consequences on many fronts:
i) As a direct result lenders will suffer a further impact on their already deteriorating balance sheets as they will have to allocate additional funds to offset asset depreciation which sincerely couldn’t come at a worst time as credit is tight. Spanish savings banks will foreseeably suffer the greatest with this change to the point that some may even collapse (http://www NULL.cotizalia NULL.com/en-exclusiva/cajas-colapso-provisiones-banco-espana-20100527 NULL.html). The BoS itself estimates the huge impact of yesterday’s change in a reduction of 10%, on average, of Spanish banks’ pre-tax profit.
ii) Indirectly, as I had already anticipated in my article on “Advice to Struggling Mortgage Borrowers (http://www NULL.levantelifestyle NULL.com/index NULL.php?mod=art_det&art_id=707)”, this change in law would have as collateral victims those borrowers that seeked to hand the keys (http://belegal NULL.com/forums/showthread NULL.php?t=622) in lieu of being repossessed (AKA as Dación en Pago de Deuda (http://belegal NULL.com/articles/showArticle/spanish-mortgage-dacion-en-pago-handing-keys-bank)). Lenders were already increasingly reluctant on accepting them due to the BoS continued raises in these generic provisions in 2008, 2009 and now 2010. This is explained in detail in this post (http://belegal NULL.com/forums/showthread NULL.php?t=73&page=15#150).
What the above translates into, for practical purposes, is that when I wrote in my article on Dación en Pago on 2007 that as a rule-of-thumb 20% of positive equity was required (AKA no-negative equity rule) for a lender to accept a dación procedure the collar must now be raised to 30 or maybe even 40% following the changes in law over the last three years. If you compound this with a foreseeable hike of interest rates by the ECB by this year’s fall or early next year you have brewed a perfect storm for struggling Spanish mortgage borrowers who will no longer have this option available and will most likely be repossessed (http://belegal NULL.com/articles/showArticle/home-repossessions-in-spain-defaulting-on-mortgage) by their lenders on slipping into arrears.
And the reason is simple, property prices of new-build second homes on the Spanish coasts have fallen by an average of 40% from the appraisal value as the BoS itself acknowledges with the proposal of change in law. So it will be hard to find off-plan properties with 30 or 40% positive equity in them built over the last five years as borrowers typically took 80% or 100% LTV mortgage loans to acquire them. There simply isn’t enough equity left in such cases with such high LTV loans when you compound asset depreciation (- 40% on average). Which is why I think that properties built post 2005 are now probably in the red zone for the purposes of following a dación en pago procedure as owners will be unable to fulfill lenders’ new criteria to accept them.
The Dación en Pago was a solution of last resort to waive the dire consequences of a full-blown Spanish repossession procedure with everything that it entails (personal and unlimited liability with all your assets, both now and in the future); sadly, even this has probably now been removed as an option for all those who purchased with a mortgage loan post 2004 following the proposal announced yesterday by the BoS.
Source: Cotizalia (http://www NULL.cotizalia NULL.com/noticias/exprime-banca-provisiones-tocado-beneficio-20100526 NULL.html) and Expansión (http://www NULL.expansion NULL.com/2010/05/26/economia-politica/1274892946 NULL.html)
- Buying Property In Spain Tips Part II. Off-Plan Property (http://belegal NULL.com/articles/showArticle/buying-off-plan-property-in-spain) – 18th April 2010
- Advice to Struggling Mortgage Borrowers (http://www NULL.levantelifestyle NULL.com/index NULL.php?mod=art_det&art_id=707) -13th April 2010
- 10 Common Abusive Clauses in Spanish Mortgage Loans (http://belegal NULL.com/articles/showArticle/10-common-abusive-clauses-in-spanish-mortgage-loans) – 4th June 2009
- The Dación en Pago Explained (http://belegal NULL.com/articles/showArticle/spanish-mortgage-dacion-en-pago-handing-keys-bank) – 28th March 2009
- The Dación en Pago Procedure – 21st November 2008
- Bank Repossessions in Spain: A Legal Perspective (http://belegal NULL.com/articles/showArticle/home-repossessions-in-spain-defaulting-on-mortgage) – 25th June 2008