Unicaja wants Caja España to create a bad bank before merger goes ahead

The solution to the merger of Unicaja with Caja España-Duero is not going to be easy. If the Málaga savings bank does not get the assistance it wants from the government, it is not going to go through with the operation, meaning the Castilla y León lender will need to be bailed out. That would cause problems for the government, which would have to let Brussels know the restructuring of the Spanish banking sector is still plagued with difficulties, three years after the process began.

Nor are the markets going to understand, most likely prompting Spain’s risk premium to rise once more.

The president of Unicaja, Braulio Medel, has a suggestion for the Bank of Spain and for the Economy Ministry with a view to solving the problem. He is proposing that Caja España get an injection of between 1 and 1.5 billion euros before the merger takes place. This money would be destined for Caja España’s “bad bank,” and would serve to clean up all of its damaged real estate assets. The newly created bad bank would not form part of the merger deal.

This would be the first bad bank created in the sector with public funds. Given that Caja España already received 562 million euros from the Orderly Bank Restructuring Fund (FROB), such a deal would take its bailout package up to 1.6 billion euros.

How would it return this money? This is one of the key points of the operation — as well as one of its pitfalls. Unicaja would cede 20 percent of the shares of Caja España’s good bank — i.e. the one that will merge with Unicaja — to the bad bank, as a payment for the healthy assets the good bank would be keeping. The dividends of the good bank should pay back the received capital. The bill would reach 150 million euros of annual interest, as well as the capital received.

But not everyone is convinced. “The numbers don’t add up,” say sources from the market. “It would be very difficult for the share in Unicaja to be so profitable, and that would mean an unfair disadvantage.”

The project would see Unicaja left with 40 billion shares in Caja España. Together with the 35 billion it has, that would leave a group of 75 billion. Medel would manage to acquire a reasonable-sized, healthy bank, while at the same time freeing up the system from a problem.

The ball is now in Brussels’ court, which is studying the numbers. If the European Union decides that the money cannot be returned at interest rates of between 8 and 10 percent, it will not authorize the operation. It could, however, be allowed as “state aid,” in which case any funds injected into Caja España would have an effect on its spending targets. That would be unacceptable for the government, given that it cannot permit any further increases in the deficit.

The operation is, of course, also being examined by the Bank of Spain and the Economy Ministry, which will soon give their opinion. If Caja España is unable to return the money it receives, the FROB would convert the bailout funds into shares, and it would become a shareholder in Unicaja, with 30 percent of the bank.

That would be the lesser of two evils for Medel. Unicaja may have more options. Whatever the outcome, this is a merger that the sector has been awaiting for the last eight months.