Spain's property fiesta stopped in its tracks

By Leslie Crawford
Copyright The Financial Times Limited 2007
Published: July 14 2007 03:00 Last updated: July 14 2007 03:00

Since the start of the year, the Spanish economy has felt like a huge party on the Titanic, cruising heedlessly onto an iceberg of corporate debt.

The danger signs were there for all to see: a real estate bubble; corporate borrowing up 37 per cent in a year; frenzied merger snf acquisition activity, and last but not least a current account deficit that has ballooned to become the second largest in the world in absolute terms after the US.

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By and large, these are all symptoms of the same phenomenon: Spain is having the mother of all fiestas, paid for with other people's money. Real estate and construction groups are on a debt-financed acquisition spree, offering overvalued assets as collateral for borrowed funds.

Timid warnings from the Bank of Spain have been ignored. "Spain is different!" the over-borrowed say. There won't be a property crash - foreigners will always want a place in the sun. And who cares about the current account deficit? We are all in the euro now.

But in recent weeks, the flight from risk in Europe and the US - triggered by turmoil in the US mortgage markets - has brought the Spanish fiesta to an abrupt halt. Banks that freely lent into the Spanish boom are having difficulties syndicating loans. Real estate listings on the Madrid bourse have flopped. Companies once feted as the drivers of the Spanish economy are now treated as pariahs.

"International investors only care about one thing, your exposure to the real estate sector," laments one Spanish banker.

A year ago, foreign lenders were willing to finance up to 120 per cent of a Spanish property group's net asset value. These days, says one senior investment banker in Madrid, real estate groups are lucky to raise 30 per cent of their NAV. This is the strongest sign yet of the bursting of the Spanish property bubble. In effect, bankers are saying assets of real estate groups, mainly in land, are overvalued.

Although house prices are not falling yet, house sales are. According to the association of Spanish property registrars, property sales fell 7 per cent in 2006.

This year, building permits have been issued for 800,000 new homes. And while not all will come on to the market this year, it is difficult to escape the conclusion that the Spanish real estate market is overheated, overpriced and oversupplied.

The flight from Spanish property risk is affecting other parts of the economy with lots of companies reporting tighter credit conditions. But it is unfair to tarnish all Spanish businesses with the same brush. This is therefore a good time to sort out the good from the bad from the downright ugly.

Some Spanish companies are borrowing to renew plant and equipment. Strong growth in the German economy is creating renewed demand for Spanish exports, and manufacturers are responding by expanding capacity. Mario Armero, the country head of GE in Spain and Portugal, says investment in capital goods has been growing at double digits. "What surprises me is the resilience of the Spanish economy," he says. "Investment in capital goods is a new motor of economic growth."

Other companies, notably construction groups, have borrowed to diversify into new businesses and new regions. Ferrovial, an engineering and construction group that bought UK airport operator BAA last year, is a case in point. Although they represent highly leveraged acquisitions, investors have been comforted by the fact that the monies have bought control.

There is a third group, however, whose balance sheets are looking stretched. These are real estate or construction groups such as Sacyr Vallehermoso, ACS, Acciona and Colonial, who have borrowed heavily to make highly speculative acquisitions in companies they do not control.

Sacyr's net debt of €18.8bn ($26bn) has doubled in a year and now totals almost 17 times earnings before interest, tax, depreciation and amortisation. However, those borrowings have not bought control of either Repsol, an oil group in which it owns a 20 per cent stake, nor Eiffage, a French engineering group. Sacyr, which launched an all-share takeover bid for Eiffage, could be forced by French regulators to mount a cash bid at a higher price. At this point, Sacyr would have to sell its Repsol stake and/or raise more debt.Companies such as Acciona, which borrowed €7.6bn to buy 21 per cent of Endesa, a Spanish power group, argue Endesa's generous dividends more than cover the costs of interest payments on their debt. ACS and Sacyr also rely on dividends to service debt. This is an unstable foundation on which to build business empires.

Will it all end in tears? Perhaps not. The Spanish economy is still growing and not all of it is made of bricks. But some of Spain's biggest companies are no longer the masters of their own destiny; that now depends on the vagaries of share prices, interest rates and the appetite of creditors for more Spanish risk.