Banks pushing to finish developments unlikely to sell

There was a time when Spanish banks were relaxed about letting developers go under, but that changed when banks realised that even wounded developers are better at the property game than they are. Now it seems banks would rather keep developers afloat and working on completing homes with a slim chance of selling, even if that means pouring more cash into Spain’s real estate smash up.

For example, just a few weeks ago, Santander and La Caixa, Spain’s biggest bank and savings bank respectively, signed agreements with Spain’s Association of Promoters and Builders (APCE) to keep the cement mixers turning on developments that are not yet finished, even if developers have run out of money. They want those developments finished bad, so to speak.

How can this be? Why would banks keep pouring money into developments they know are unlikely to sell? Because, thanks to a new accounting rule introduced by the Bank of Spain (BoS), it now works out cheaper for banks to spend a bit more and finish the job than pull the plug before construction is completed.

Under the new rule, introduced by the BoS to take some of the heat off Spain’s financial system, which is too exposed to the real estate melt down for comfort, banks only have to make a provision of 30% for bad loans where the collateral is a finished development. On the other hand, if construction is not complete, they have to set aside 100% of the loan. Beforehand, provisions had to be 100% regardless of whether developments were finished or not.

So banks now have a choice: Either set aside 100% for a bad loan on an unfinished development, or stump up the cash to finish the construction and get away with provision of 30%. It’s not a difficult decision.

A finished development has more chance of selling one day than an abandoned building site, but beyond that it’s hard to understand the BoS’s logic, which has little to do with market values (of course I understand the bit about making life easier for the banks). For the regulators, the important thing, it would seem, is that new developments are finished, not what they are worth. That said, setting the provision at 30% tells you something about the BoS’s opinion on how far property values will fall.

Meanwhile, banks, and the developers they are keeping afloat, are pushing to finish half-built projects up and down the coast, so they can put them on the market with all the other unsold new properties. But perhaps that’s better than leaving them as abandoned building sites, of which there is no shortage on the coast either.