Banking Sector: RE Hangover Continues To Undermine ROE

28 October 2015 – Cinco Días

How to improve profitability has become the great challenge for the Spanish real estate sector now that the chapter involving the clean up of toxic assets from the banks’ balance sheets is coming to an end. The (sector’s) return on equity (ROE) has decreased by 6.8 basis points over the last six years, to 5.3% at the end of 2014, mainly due to the higher capital requirements demanded as a result of the clean-up process. But the current low yields, which will never return to their pre-crisis levels, are due not only to the near-zero interest rates, which are slashing margins, or to the scarce flow of credit. The real estate hangover from the long financial restructuring process is also weighing down heavily on the ROE.

According to AFI’s calculations, the sector has accumulated non-performing assets amounting to €238,000 million – including doubtful loans and foreclosed assets – which are generating zero yields and are consuming capital and provisions. In short, they could be reducing the sector’s annual profitability by up to 5.4 percentage points.

AFI says that some of these assets are actually generating negative returns, due to the management and maintenance costs associated with them. And the company calculates that if they were sold at their net book values – even ignoring the fact that some assets may be accounted for at higher than market value – and the liquidity obtained was reinvested in loans to households and companies, then “the sector could achieve an average annual return of 3% and moreover, it would save the provisions associated with those assets, which we estimate represent 10% of their net book value”. AFI added that this saving would result in around €13,000 million, a result that would finally release the burden of these assets, which still represent 8.8% of the sector’s balance sheet.

Modest expectations

The firm emphasises that “in order to improve returns, we need to accelerate the digestion of these unproductive assets”. However, its estimation of the improvement in Spanish banks’ ROE in the coming years does not exceed 6% or 7%.

AFI also points out that the decrease in the ROE in recent years has not been greater mainly thanks to the ECB, whose policy has allowed financing costs to be lowered and high capital gains to be generated on fixed income portfolios. Even so, it warns that the carry trade profits on these portfolios are not going to be repeated and it adds that unrealised gains on fixed income portfolios have decreased by more than 50% in 2015, due to the sales that have already been made and the valuation at market prices. “Therefore, the sector now needs to look for recurrent sources of profitability”.

Original story: Cinco Días (by Nuría Salobral)

Translation: Carmel Drake

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