This content is from: Local Insights

New regulation brings distressed opportunities

Distressed investors and their lawyers were still digesting the impact of Royal Decree Law 18/2002 (RDL 18/2002), dated May 11, on the restructuring and transfer of real estate assets from financial entities, when a draft of the July 2012 Memorandum of Understanding (MoU) agreed at EU Council level on financial-sector policy conditionality was disclosed some days ago. There is now an agreed MoU dated July 20 which sets up a broad variety of specific measures to reinforce financial stability in Spain in the context of the recapitalisation of the Spanish banking sector.

The MoU comprises new coordinates, policies and principles which will require a full internal review and heavy amendments of Spain's financial system, including its key institutions, during 2012-2013. The main points of the MoU are, among many others: enhancement and harmonisation of disclosure requirements of loan portfolios; strengthening of the resolution powers of Fund for Orderly Bank Restructuring (FROB) and Deposit Guarantee Fund (DGF); enhancement of transparency of banks; incorporation and operation of asset management companies (AMCs); regulation over Subordinated Liability Exercises (SLEs); enhancement of the public credit register; transfer of sanctioning and licensing powers of the Ministry of Economy to the Bank of Spain; new provisioning framework; regulations on non-bank financial intermediation; amendments to consumer protection and securities legislation; review of governance arrangements of the financial safety net agencies; and issues on credit concentration and related party transactions.

One main objective of the Spanish government has been to require financial entities to segregate their impaired assets from their balance sheets. Initially, the pressure came through imposing higher provisioning levels for certain real estate assets in order to ensure an orderly downsizing of the banks' exposures. Recently, independent external consultants have conducted accounting and economic value assessments of credit portfolios and foreclosed real estate assets held by banks in order to verify the capital shortfall under stress tests. Although some relevant transactions have been executed in the last year, the above measures have proven insufficient to give incentives for the sale of impaired assets at discount.

At this point, it has again emerged as a significant issue how the segregation of impaired assets should be implemented while achieving deconsolidation by a financial entity in Spain. This has long-been a controversial issue dealt with among Spanish banks and the Bank of Spain in the past. At that stage, it was not admitted to set up a vehicle owned or controlled by a bank to which its impaired assets were contributed, since risks remained for the bank. RDL 18/2012 was a big step forward since it introduced for the first time the regime of AMCs. Each financial institution must create its own AMC(s); only certain assets such as foreclosed assets and those received as compensation for the outstanding debt shall be contributed; transferred assets will be valued at a reasonable price or, if this is not possible, at book value (taking into consideration the applicable provisions); and funding may be guaranteed by the state.

Having said that, the MoU has overridden the main features of AMCs under RDL 18/2012. As executed, there would be one single AMC for all banks (toxic bank), instead of one or more AMCs for each bank (in exchange of the assets, each bank will receive a suitably small equity participation in the AMC, bonds issued by the AMC and guaranteed by the State, or cash and/or high quality securities); the MoU would apply not only to deteriorated real estate and foreclosed assets, but may apply also to other assets (flexibility); transfers will take place at real economic value of the assets (and considering long term value), so losses will crystallise at the time of the separation; and the FROB will contribute cash and/or high quality securities to the AMC to pay for the contributed assets. As a result, the regime will change totally if it is finally defined as described before.

All of the above is still under discussion, and may be subject to additional changes. For instance, rumours now say that the FROB will be the majority shareholder of all toxic banks/AMCs while the financial entities may have minority stakes in order to take a portion of the future upside if any. The management and operation of AMCs is under review and preparation by the Ministry of Economy, European Central Bank, European Commission and IMF in order to enact the applicable rulings by Decree in August. The goal is to have AMCs operating in November.

Due to the above contradictions and uncertainties, some financial entities have suspended ongoing structures and transactions until the new rules are enacted and effective. It is clear, however, that impaired assets would be required to be transferred immediately out of the banks' balance sheets to AMCs. Thus, sooner or later, such assets will be on sale at significant discounts by independent asset managers without previous constraints derived from accounting policies. In fact, reports state that €16 billion ($19.5 billion)-worth of asset portfolios are ready to be sold. Distressed investors, hedge funds, asset managers, servicers and other players are waiting for the right time and this is sure to occur within the following months once the Spanish so-called toxic bank is up and running. Be prepared – do not miss it.

Iñigo de Luisa

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