Spain plans to pour billions more euros into its troubled savings banks

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Spain plans to pour billions more euros into its troubled savings banks and force them to be more open about their lending practices, people familiar with the matter said, an acknowledgment that previous efforts to fix the banks have fallen flat as the country seeks to ward off an international bailout.

In a first step, Spain is preparing to issue €3 billion ($4 billion) in debt in coming days, the people familiar with the matter said. Government officials are putting plans in place to eventually raise as much as €30 billion, according to these people, though some say the final tally will be less.

The hope is that a series of capital injections will quell investor jitters about the savings banks, known as cajas (literally, "boxes"), which have been a thorn in Spain's side as it seeks to convince investors that the country's finances are stable.

The fate of the cajas is inextricably tied to the fate of Spain and potentially to the euro itself. Fear that the savings banks can't raise funds on their own and will need a government bailout was one reason ratings agency Moody's put Spain's rating on review for a downgrade last month.

Another step the government is taking to boost investor confidence in the cajas is simplifying their complex structures, making them more like traditional banks. The cajas have long had confusing ownership and governance structures and disclosed far less financial information than other banks. Their boards consisted of local politicians, union members, clients and, in some cases, Catholic priests, many of whom were reluctant to relinquish their influence over lending decisions.

The Spanish government last year forced a wave of mergers among the cajas—reducing their number from 45 to 17—but confusing, unwieldy structures persisted, scaring off investors. Another part of last year's rescue attempt was an injection of €11 billion via the newly formed Fund for Orderly Bank Restructuring. At the time, Spain said it could put up to €99 billion into the fund, but until recently had said further injections wouldn't be necessary. Now, it's reversing course.

Going forward, people close to the matter say, the idea is to force the cajas to transform themselves into centralized, transparent entities that more closely resemble traditional banks by placing all of their assets into a central holding company and streamlining management. The changes would be made either through legislation or by making it a condition of accessing government funds.

"We think that the restructuring and recapitalization of the savings bank sector is probably the most important issue for the government at this juncture," said Antonio Garcia Pascual, an economist at Barclays Capital.

Raising any new capital for the cajas carries risks, as it comes on top of Spain's existing financing needs. Economists estimate that the country needs to borrow €125 billion this year just to finance its deficit and roll over maturing debt.

Many of the cajas, which account for €1.3 trillion in assets—or 42% of total bank assets in Spain—used liberal lending practices to fuel a decade-long housing boom that went bust and left many of the institutions holding billions in bad loans and facing heavy losses.

The new moves reflect the fact that last year's fixes didn't stick. The shotgun weddings forced by the government proved difficult to execute in practice, with the governing boards of merged cajas bickering over issues like labor, salaries and operating hours. In most cases, the new banks only partially merged their assets.

Some investors were skeptical. Private equity firm J.C. Flowers, which in July committed to buying €450 million in debt from the newly formed Banca Civica, put its investment on hold until it sees what the bank's final merger looks like, said a person close to the fund. Banca Civica couldn't immediately be reached for comment.

By the end of November, with Spain's borrowing costs soaring, the Bank of Spain publicly urged the cajas to move faster in combining businesses and cutting costs. In recent days, the government has been more aggressive. Last week, Spanish Prime Minister Jose Luis Rodriguez Zapatero said recapitalization of the banks was an "urgent objective."

"In Spain, the government has a clear interest in sending a message to the markets and investors that they are taking this very seriously," said David Franco, a corporate partner at Freshfields Bruckhaus Deringer LLP in Madrid.

Already, some of the savings banks, urged on by government officials, have decided to abandon the decentralized model, and transform themselves into entities resembling regular banks. Cajastur, for example, in its merger with three other lenders, announced at the end of last month it would be pooling 100% of its assets.

The government will wait to give any ultimatum to the cajas until it sees the results of detailed disclosures about the type and quality of loans that savings banks have made to the real-estate sector, said people close to the matter. Those will be made public for the first time later this month and in February.

The Spanish government is also studying changes to allow the Fund for Orderly Bank Restructuring to inject capital in the banks through direct stake purchases, considered the safest kind of investment and one that would give the government more control over the entities, in contrast to the nonvoting preferred shares it bought in the past.

Government officials are also weighing the possibility of setting up a government-administered "bad bank" for the toxic assets of some of the cajas, according to one of the people familiar with the matter, although it is unclear how that would be funded and structured.

Spain's government debt isn't that high compared to other troubled countries in the euro zone, such as Greece and Ireland. But borrowing costs for Spain soared at the end of last year after Ireland received a €67.5 billion bailout from the European Union and the International Monetary Fund. After a successful bond issuance by Spain earlier this week costs have ebbed some. Nonetheless, investors worry that the authorities haven't come clean on the problems of the savings banks, which will leave the government with a big bill down the road. Analyst estimates of the amount of capital needed are less conservative then that of the government's. UBS AG estimates banks could need anywhere from €20 billion to €120 billion.

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