Bankia's whopping bailout is double-edged sword

Bankia’s whopping bailout is a mixed blessing. The Spanish lender has asked the government for a higher-than-expected 19 billion euros to fill its capital hole. State support will shore up a systemic institution. But the scale of the cleanup implies other weak lenders are also short of cash. It is unlikely that Madrid can fill the gap on its own.

The recapitalisation of Bankia’s recently nationalised parent, BFA, should go a long way to protecting against further shocks. The bank’s new board - mercifully free of political representatives - has taken a no-nonsense approach to building up bad debt buffers. When the dust settles, provisions will cover 12.6 percent of Bankia’s entire loan book, and 50 percent of its total real estate exposure. The lender’s core Tier 1 capital ratio will be a respectable 9.5 percent.

Bankia’s shareholders, who currently own 55 percent of a company with a market capitalisation of 3.1 billion euros, are likely to suffer massive dilution. Though they will have the right to participate in Bankia’s 12 billion euro equity issue, which will be underwritten by BFA, those rights are likely to be worthless. Other creditors will get off more easily. The bank has decided not to convert 4 billion euros of preference shares into equity, because these are mostly owned by depositors.

The scale of the cleanup raises questions about unrecognised losses in Spain’s other banks. True, Bankia had the sector’s highest real estate exposure, and a large chunk of the write-down is due to the falling value of stakes in listed companies and tax credits. But Bankia is also assuming that 8 to 10 percent of its mortgages will go bad - more than three times the sector’s current ratio. And the bank’s real estate haircuts are now greater than required by the government.

It’s also far from clear where Madrid will find the additional money. Spain’s bank bailout fund, the FROB, has only about 5.3 billion euros of cash left over - a fraction of the 50 to 100 billion euros that analysts estimate is needed. One option would be to inject capital in the form of Spanish sovereign bonds which Bankia could then exchange for cash with the European Central Bank. But that type of fudge - similar to the promissory notes that Ireland has issued to its banks - would undermine the objective of restoring confidence in the financial sector. Spain is still resisting asking for help from Europe. Bankia’s bailout means it is running out of arguments.