In 2010, the former Socialist Party government of José Luis Rodríguez Zapatero took the decision to save Spain's savings banks, or cajas - most of which were teetering on the brink of bankruptcy after the decade-long property boom that they had helped fuel collapsed - by merging them into a number of groups.
Bankia, the result of merging Caja Madrid, the country's largest savings bank, with Bancaja, the third biggest, and five other smaller players, collapsed in May and was taken over by the Bank of Spain. Its chairman, Rodrigo Rato, a former IMF head and economy minister under the Popular Party administration of José María Aznar, is now at the center of an investigation by Spain's High Court into fraud and mismanagement during his brief tenure.
The minutes for Bankia's board meetings between April and June, which EL PAÍS has seen, suggest that the majority of the bank's directors were unaware of the perilous state of the group's finances. The board accuses Deloitte, the bank's auditors, of failing to inform them of the true situation. Deloitte denies this, saying that it warned a congressional committee.
- April 2012. Everything OK. Rato told the board that the Bank of Spain had approved his plan to recapitalize the bank and that Bankia would meet the authorities' funding requirements, and that its debts were slightly lower than the sector average. Two weeks later, Rato would step down as president.
- New team, reappraised results. May 9. Rato's successor, José Ignacio Goirigolzarri, introduced new CEO Francisco Verdú, who warned euphemistically of "the likelihood of adjustments to Bankia's annual results as a result of Bankia's valuation... the origin of which is not related to the bank's management, but in existing or prior problems."
In response, several board members demanded that their protests be recorded in the minutes. "This is the first news that we have of any problems related to the audit report." Verdú picks up the gauntlet: "The board members have knowledge of the issues raised recently by the auditor." Jorge Gómez of the Socialist Party expresses concern. "I understood that the Bank of Spain had approved the recapitalization plan presented by the bank." He is referring to the plan handed to the Bank of Spain on May 4, which contrary to media reports, the bank never formally acknowledged receiving.
- No objections. May 28. New figures emerged regarding Bankia's finances. Rato's team predicted profits of 300 million euros for 2011. It now emerged that in fact the bank had lost 3.3 billion, and that the lender needed 19 billion euros from the Bank of Spain.
Rafael García Fuster, a member of the Congressional Audit Commission, accused the former management team of a cover up. "At no point over the last 18 months has the auditor raised any objections. We have always been told that Bankia met all recapitalization requirements demanded by the Bank of Spain; Bankia's management have consistently recommended decisions in relation to a public share offering. We had no reason to doubt their actions. We have always taken the advice of the auditors regarding share price and the timing of a launch."
Questioning his predecessor's handling of the bank's accounts, Goirigolzarri replied: "It is unusual to formulate accounts without an audit report."
Francisco Celma of Deloitte pointed out that the accounts "are the only ones that it has produced," and that this was the first time that the board has seen its draft report.
Several board members question the procedures and criteria for reformulating the bank's figures. Ricardo Romero de Tejada of the PP says that Deloitte has been working on the process of merging savings banks for a number of years, but that its criteria for reformulating Bankia's accounts are "debatable." Celma replied that the criteria he followed "are understood by all financial experts," adding: "international accounting norms clearly establish a 40-percent limit on share price decline, from which point it is necessary to register an impairment."
Celma was referring to Bankia's nominal valuation of 12 billion euros, while the Madrid stock exchange put its worth at around three billion euros. This huge difference is what sparked the need for Bankia to ask for a bailout.
Celma added that Deloitte informed the investment banks working on Bankia's stock market launch of the sharp fall in the value of its assets. But the company failed to mention the issue in the document it produced on the launch.
Celma's explanation to Bankia's board members are key to establishing whether the investment banks working on the IPO were aware of the accounting problems that would eventually affect Bankia's share price.
Several board members repeatedly pointed out that they were not informed of the discrepancies between the auditor and the bank regarding the formulation of the 2011 accounts despite the fact that Deloitte supervised the merger and the stock exchange launch.
- Still in the dark. June 27. Several board members complained again that they had been kept in the dark about the true situation of Bankia. Mercedes de la Merced of the Popular Party expressed her concerns: "I am surprised at the valuation bearing in mind that until now the bank's management painted a totally different picture. The previous management team should have been called to explain their actions."
- The Bank of Spain's concerns. Rodrigo Rato had resigned as president of Bankia on May 7, prompting much speculation. The Bank of Spain knew the full story, but chose not to share its information with the media, and has only done so now as a result of the High Court's investigation. An internal report from March 2012 accused Bankia of "not reflecting in its figures the full extent of the failure of borrowers to repay money."
This would happen again two months before the accounts were reworked and the board would blame the auditor for not informing it of the true state of its finances. But on the basis of its report referring to "non-formulated accounts" it now seems clear that the Bank of Spain was aware of serious imbalances at Bankia. Its diagnosis of a terminally ill patient leaves little doubt: "The risk profile of BFA-Bankia is high, given its profitability, liquidity, and solvency problems, and because its corporate governance could be improved. This is a bank with a high risk, and in receipt of 4.4 billion euros of public money."
"Bankia's main problem is the consistent generation of results that are clearly inferior to those needed to be able to strengthen its assets. This has been the case since before the government passed legislation to help rid the banks of toxic assets. There is a considerable difference in this regard from the figures outlined in the previsions for the merger plan," said the Bank of Spain.
"The biggest threat," continues the report, "until December 2011 was lack of liquidity, due to inadequate financial structures. This problem has not been resolved, but has been deferred by the two injections of three-year money by the ECB and the renewal of the program of loans backed by the state, two decisions taken outside the bank's remit. The government-backed loans and the ECB money come to 60 billion euros, almost 20 percent of the bank's value."
The Bank of Spain's inspectors could already see that there was no way to improve Bankia's situation. "It would be difficult for any solution regarding the solvency of Bankia and BFA to meet the regulatory requirements that will be in place in 2012." It noted that the BFA Group only just met the government's eight-percent core capital requirements.
- "Plan not approved" by the central bank. On August 7, the Bank of Spain wrote to the High Court judge overseeing the investigation into Rato's presidency of Bankia distancing itself from Rato's plan to clean up the bank's finances. The plan, presented on May 4, had subsequently been used to defend Rato's handling of the bank by his team. It had also allegedly been approved by the Bank of Spain. Addressing Congress in the aftermath of the collapse of Bankia to explain his actions, Rato admitted that the plan had not been approved by the regulator, despite "an intensive exchange of opinions" with the Bank of Spain that saw Bankia follow "all the suggestions" made by the regulator.
But the Bank of Spain dismissed this in its letter to the High Court, noting: "Attached is the alternative plan that Rodrigo Rato sent to the Bank of Spain dated May 4, 2012. This plan was never discussed, due to the decision, on May 7, of Rodrigo Rato to resign as president of Bankia."
The report that Rato "informally" presented contained several sheets of paper with a series of proposals to clean up the bank's toxic assets, and that would require a further seven billion euros in public money. Prior to this, Bankia had asked for - and been granted - 4.4 billion euros in December 2010. Rato resigned from Bankia at the moment when he had offered to meet one of the Bank of Spain's demands, made during an inspection in 2010.
"It would be advisable that the CEO of the bank came from the banking sector, bearing in mind that the current team built around the president has no experience in banking, and has not produced good results." Rato had offered to do just this in his clean-up plan, promising to establish a "clear separation of functions between the chairman and CEO in running the business on a day-today basis."
At the end of August, Spain's national bank rescue fund announced that it was to inject emergency liquidity into Bankia immediately after the bank reported losses of over four billion euros in the first half of 2012.
Bankia lost 4.448 billion euros in the six months to June after provisioning 2.7 billion euros in the second quarter against bad debt and assets.
Spain's Orderly Bank Restructuring Fund (FROB) said it would inject capital into Bankia as an advance on European aid negotiated by Spain for its ailing banking sector in June. It did not specify how much capital would eventually be given to Bankia.
"I am very satisfied with what the European and Spanish authorities have said because it means there is big support for our project," said Bankia Chairman Jose Ignacio Goirigolzarri.
Bankia, now Spain's fourth largest lender, says private sector deposits fell by 8.3 billion euros to 98.844 billion euros in the first six months of 2012.
The bank's bad loan rate reached 11 percent at end June, compared to 7.6 percent at the end of 2011.
Spain negotiated a 100-billion-euro European Union bailout package for its wobbly financial sector in June but Bankia had yet to receive any funds since it reported its first-half results.
At the same time as announcing the rescue package for Bankia, the government also unveiled plans to create a so-called bad bank to take over tens of billions of euros in defaulted loans and unsaleable property from lenders and to accelerate the clean-up of the banking sector. Banks have had to take huge writedowns on toxic property assets in line with provisions ordered by the Spanish government, resulting in steep falls in profit even for relatively sound lenders such as Banco Santander.
"We have 280 property firms, mostly insolvent"
The argument as to which apple spread the rot that spoiled the six savings banks that formed BFA-Bankia around the shell of Caja Madrid continues. The Bank of Spain's report contradicts Caja Madrid's version of events, which largely blames Valencian savings bank Bancaja. But although the Spanish banking authorities were aware as far back as 2010 of the risks that Caja Madrid faced, they argued that the merger would help stem its already significant losses.
José Manuel Fernández Norniella, Bankia's second-in-command, and the man tasked by former Bankia Chairman Rodrigo Rato with assessing the new entity's property portfolio, painted a grim picture of the new group's finances at a board meeting held on December 12, 2011.
As a result of their exposure to the property market, Bankia's seven savings banks had taken over the assets of 280 construction companies and property developers, "the majority of which are insolvent," Fernández Norniella told his fellow directors.
He then made an assessment of the risks facing the new bank, based on a statistical evaluation of each of its members, and saying that 51 percent of the risk came from Bancaja, 20 percent from Caja Madrid, and the remainder from the other five banks.
The Bankia group faced a difficult situation at a particularly difficult moment for the Spanish economy. According to Fernández Norniella, it had 53,123 properties on its books. "Our total risk exposure is 20.9 billion euros," he said, a figure close to the amount that Rodrigo Rato's successor would later request from the Bank of Spain to refloat the bank.
Fernández Norniella closed his report with further bad news: "The evaluation of the group's assets means additional provision for this financial year. Negotiations are under way with the Bank of Spain to extend that period."
Given the large number of assets requiring management, Fernández Norniella suggested "isolating the real estate business." He managed to persuade the board to bring in experts to manage the property portfolio "to make it self-financing and attractive to investors. We need an overall solution. This decision means anticipating taxes of 13 million euros a year for the next two years, even if we are able to win some fiscal concessions and apply synergies in 2012 and 2013," he said.
But at the same time that Fernández Norniella was laying the lion's share of the blame at the door of Bancaja, the Bank of Spain's October 2010 report on the savings banks that would merge to create Bankia suggested that Caja Madrid presented a bigger problem. "This is an entity with limited solvency and declining profitability. It has mounting debts that are higher than the rest of the group, due mainly to debts accumulated by mortgage holders, although its own investments in the property sector, which are significant, are already having a big impact. Low levels of coverage; high level of dependency on the money markets."
This contrasted with the Bank of Spain's assessment of Bancaja. "This is an entity whose profitability is closely tied to traditional banking, although it has exposure to the risks of the property sector... The strong growth of its investment in lending during the growth period of the economic cycle increasingly led to dependence on the international money markets. When these were closed to it, the bank turned to the ECB, which makes it impossible to for it to extend its repayment periods when repayments are due. It has adequate levels of solvency."
That said, the Bank of Spain report identified a number of problem areas. "The main weaknesses are the decline in lending investment, in particular in the property development and real estate sectors, its delicate liquidity situation and exposure to risk."
The central bank's analysis of the other savings banks that merged to create Bankia was equally gloomy. "They have all invested heavily in the property development and construction sectors, and in lending to home buyers. There are notable problems of efficiency and of poor results in many of them, the result of increasingly narrow margins due to the lowering of interest rates, and maintaining too many branches."