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State aid: Commission's contribution to Spanish financial assistance programme focusing on banking sector

European Commission - MEMO/12/1013   20/12/2012

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European Commission

MEMO

Brussels, 20 December 2012

State aid: Commission's contribution to Spanish financial assistance programme focusing on banking sector

As a consequence of the deterioration of the financial conditions for the Spanish banking sector during the first half of 2012, the Eurogroup agreed to a financial assistance programme. A Memorandum of Understanding (MoU) on Financial Sector Policy Conditionality was signed between Spain and the Heads of State and Government of the Euro Area countries on 20 July 2012.

The Spanish financial assistance programme focusses on tackling the problems of the Spanish financial sector. This is achieved through two types of conditions. First, there are horizontal conditions referring to the regulatory and supervisory framework, consumer protection legislation for limiting the sale of financial products to non-qualified retail clients as well as the strengthening of non-bank financial intermediation.

Second, there are bank-specific conditions which are defined in reference to EU state aid rules. In this field the role of the Commission – acting as authority in charge of state aid control in the EU - is to ensure that state aid given under the programme is in line with EU state aid rules. The MoU foresees that resources from the European Stability Mechanism (ESM) are paid out to the Spanish Fund for Orderly Bank Restructuring (FROB) for the recapitalisation of the banks only after the Commission has approved their restructuring or resolution plans.

The MoU has set a strict timeline for the recapitalisation and restructuring of different groups of banks established on the basis of the results of the stress tests carried out by independent consultants in September 2012, which identified the capital shortfalls of each bank.

The MoU states that banks which were already state owned at the time of the stress test (Group 1) have to be recapitalised by the end of November 2012 and banks that are unable to cover their capital shortfall on their own (Group 2) by the end December 2012. The MoU also foresaw that the individual restructuring plans of each bank needed to be presented in time to allow the Commission to approve them by the end of November and December 2012 respectively.

On 28 November, the Commission approved the restructuring plans of the four banks in Group 1. With the decisions of 20 December on the restructuring of the four banks in Group 2, another important step of the MoU has been successfully and timely completed.

This memo is dealing specifically with the role of the Commission under EU state aid control, and can be read in conjunction with an earlier memo published on 28 November 2012 (see MEMO/12/918).

  1. What is the timeline and what are the main steps of the Spanish financial assistance programme as regards the recapitalisation of banks?

The Spanish programme sets the ambitious goal to recapitalise banks only after specific steps defined in the MoU have been completed and the restructuring plans of banks that need state aid have been approved by the Commission.

The MoU steps are:

  1. Stress test diagnostics: a thorough bottom-up stress test and asset quality review are established to identify the capital needs of each bank. The stress tests, which were finalised in September 2012, determined the capital shortfall of each bank under a base and severe adverse scenario of deteriorating macroeconomic and market conditions. The stress tests were conducted by Oliver Wyman under the close monitoring of the Spanish authorities and of European and international partners, including the Commission, the European Central Bank and the International Monetary Fund (IMF). 90% of the Spanish domestic banking system was covered by this exercise.

  2. Recapitalisation plans: As a consequence of the results of the stress test exercise which revealed capital shortfalls for eleven banks, these banks had to present recapitalisation plans in order to check whether they would be able to fill the identified capital shortfall through their own means, or if they would need to resort to state aid. Accordingly, four groups of banks were established:

  • Group 0 are banks without any capital shortfall, for which no further public action is required: Unicaja, Sabadell, Bankinter, Caixabank, Kutxabank, Santander, BBVA.

  • Group 1 are banks already owned by the FROB: BFA-Bankia, CatalunyaBanc, NCG Banco, Banco de Valencia.

  • Group 2 are banks unable to meet their capital shortfall without having recourse to state aid: Banco Mare Nostrum, Banco Caja 3, Liberbank, CEISS.

  • Group 3 are banks which have a capital shortfall but are able to meet it without recourse to state aid before the end of December 2012, based on credible recapitalisation plans: Ibercaja and Banco Popular.

  1. Restructuring plans: Group 1 and 2 banks had to present restructuring plans to the Commission. No bank may receive funding under the financial assistance programme, if the Commission has not approved the bank's restructuring plan. Burden sharing measures and the transfer of problematic assets to an asset management company (AMC) are important elements of the restructuring plans.

  2. Burden sharing: All stakeholders (i.e. holders of capital and of hybrid capital) of Group 1 and Group 2 banks need to make significant contributions to the restructuring effort, in order to minimise the cost for taxpayers. In this regard, not only will former owners of these banks be wiped out, but losses will also be allocated to holders of preference shares and subordinated debt holders of these banks by implementing both voluntary and, where necessary, mandatory subordinated liability exercises (SLEs).

  3. Transfer to the AMC: Group 1 and 2 banks have to transfer their problematic assets (real estate related foreclosed assets and real estate development assets) to the AMC.

  1. What are the Commission's objectives with regard to state aid control in the Spanish programme?

In the EU, state aid for the restructuring of financial institutions must be approved by the Commission on the basis of restructuring plans that comply with EU rules. Under the MoU for Spain, state aid from the programme can only be granted after it has been approved by the Commission. Therefore the Commission had to assess and approve the restructuring plans of all banks that needed state aid within a few months. Under the Spanish assistance programme, these are the banks from group 1 and 2. The Commission verifies that their restructuring plans are in line with EU state aid rules and the criteria set by the MoU.

The key objectives of the Commission under EU state aid control is to support banks that are able to re-establish a viable business model, subject to restructuring, and to wind down those that are unable to return to viability through an orderly resolution. The Commission assesses whether the restructuring plans submitted are based on credible assumptions and business plans that allow restoring long term viability without continued state support. At the same time, the Commission wants to make sure that state aid remains limited to the minimum amount necessary to complete the restructuring, so as to minimise the cost to the taxpayers. This means that so-called "burden sharing" measures from banks' capital and subordinated debt holders are required and that the banks need to contribute to the financing of their restructuring costs by selling assets, equity participations, subsidiaries, etc.

Finally, to mitigate the economic advantage that aid beneficiaries have received as compared to non-aided competitors and to address moral hazard, banks have to make a number of divestments and agree to certain behavioural restrictions such as dividend and acquisition bans, remuneration limits and ending certain business lines.

The restructuring plans are assessed on the basis of these principles of EU state aid control, based on the situation of each individual bank.

  1. What are the key elements of the banks' restructuring plans?

The Commission has approved restructuring plans for all Group 1 and Group 2 banks, with the exception of Banco de Valencia for which it has approved the state aid required for the takeover of the bank by Caixabank. In the absence of the takeover, Banco de Valencia would have been wound down, since it was not possible to establish a viable business model for the bank on a stand-alone basis.

The banks' restructuring plans aim at addressing the reasons of the banks' failures and restore their long term viability while at the same time limiting the use of taxpayers' money to the minimum by ensuring a proper burden sharing and addressing distortions of competition created by the aid.

In general, Group 1 and 2 banks' restructuring plans set out the following measures:

- Banks will focus on their core business both in terms of banking activities (focusing on retail and SMEs financing) and geographical scope (focusing on their historical regions), withdrawing from risky activities;

- They will restore their solvency, profitability and liquidity profile over the course of the five-year restructuring period;

- They will become smaller banks with an adjusted risk profile and improved corporate governance structure;

In practice this means that the banks will refocus their business model on retail and SME lending in their historical core regions. They will exit from - or keep at a marginal level - lending to real estate development and limit their presence in wholesale business. They will improve their cost base, by cutting on average about 30% of both staff and branches, when compared with the peak of their earlier expansion (mostly in 2010).

All these measures will contribute to reinforcing their capital and liquidity positions and reduce their reliance on wholesale funding. Central bank funding will be reduced to pre-crisis levels during the course of the restructuring period.

- They will address the moral hazard issues, and potential distortion of competitions with behavioural commitments on top on the structural commitments such as acquisition bans, a ban on aggressive commercial behaviour and commitments as regards remuneration of employees.

The Commission's decisions approving the restructuring plans of the group 1 and 2 banks will be published once confidentiality issues have been checked by the Spanish authorities and the banks.

  1. Why is burden sharing an important part of the restructuring plans?

EU state aid rules require that all stakeholders significantly contribute to the restructuring cost in order to minimise the cost for taxpayers. In the context of the programme, the Spanish authorities require that existing equity holders shall lose their claims, depending on the economic valuation of each bank, when state capital is injected. For holders of preference shares and perpetual subordinated debt, burden sharing will be implemented firstly by applying a haircut to the nominal amount of the instrument and subsequently through conversion of these securities into equity or equity equivalent instruments. As regards the holders of dated subordinated debt they would be given the choice between conversion into equity or into a senior debt instrument after taking an appropriate haircut.

As a result, there will be no cash outflow from banks to the holders of these securities with the sole exception of the holders of dated subordinated debt instruments deciding to convert into new debt securities with a maturity matching that of the subordinated debt being exchanged.

Spain has introduced legislation to ensure the effectiveness of the burden sharing measures, including when necessary by mandatory means.

In addition, each bank will carry out other divestments generating capital to the extent possible. That means, for instance, that selling stakes below book value would not be useful, as it would increase the loss for the bank and therefore the respective bank's capital need.

The final capital needs of the banks to be met through state aid were determined only after having considered all these elements. This ensures that the contribution of taxpayers is limited to the minimum necessary.

What is the role of the Commission in setting up the Asset Management Company (SAREB)?

While the Commission has been present in the working group monitoring the set-up of SAREB under the assistance programme, the Commission's competition department has monitored closely the methodology for establishing the value of the problematic assets transferred to SAREB.

The Commission has assessed the conditions of transfer of those assets with the help of external experts and concluded that they were in line with EU state aid rules. The Commission had to check whether the transfer price based on the base case value of the stress test exercise plus a variety of haircuts related to the specific conditions of the transfer to SAREB, is in line with the so-called real economic value, i.e. the long-term hold to maturity valuation. For these purposes, the Commission has relied on its own external experts who have verified the figures and the respective haircuts applied to the assets before transferring them to the AMC.

Transfer of assets to the AMC, in EUR billion*

Gross book value of transferred assets

Estimated transfer value

Haircut in %

Total

125.1

59.6

52%

*Figures refer to June 2012 values which could still change until the final transfer of the assets to the AMC.

How are the capital injections coming from the Programme determined?

Out of the original €57 billion of capital needs derived from the stress test by Oliver Wyman in September 2012, only about €39 billion is going to be finally disbursed. The initial amount has been reduced by around €12 billion through burden sharing measures. Further reductions of about €1 billion derive from the transfer of problematic assets to the AMC and around €5 billion from other mitigating measures, such as divestments.

Figures and graphics available in PDF and WORD PROCESSED

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