Red Giant, Black Hole

The following is more suited to a flow chart. But seeing as the writer can not read them properly, let alone design one, words will have to do.

The long awaited Bankia IPO has been in progress since last Thursday. Its almost assured success (between Rodrigo Rato's lowered valuation expectations, the hard sell inflicted on retail customers, the circling of the wagons by corporate Spain and an intense lobbying effort among certain sovereign wealth funds) merits a short commentary on the relationship between what will certainly be a rich dividend, its ownership structure and which group will end taking the lumps for all those bad property developer loans.




First, a couple of quotes from today's Spanish press (both from Expansión, translation ours):

Bankia considers selling more than 50 percent of its capital;

Rato tells institutional investors that the Bankia dividend will be 7 percent.

Now, in point form, the ownership structure of what is, cobbled together from the amalgamation of Caja Madrid, Bancaja and several other cajas de ahorros, the third largest Spanish bank:

Until the IPO is completed, the 100 percent owner of Bankia is an unlisted bank by the name of Banco Financiero y de Ahorros;

In turn, BFA is owned in some semblance of proportionality (although Bancaja ended up over-represented) by the charitable institutions which remain of the cajas following their passing over of all of their banking assets to this entity.

Now, who owns what of the mishmash of assets from the original partners:

BFA ends up with most of the bad real estate assets - NPL's, repossessions, equity-for-debt transfers, etc.) - all of the dividend producing industrial portfolio (Iberdrola weighing heavily here) all of the not-high-yielding-enough unsecured retail debt known as participaciones preferentes and the four and a half billion euros in convertibles that constitute the state bailout fund's contribution to date;

Bankia keeps the live banking assets, the non-dividend producing equity holdings and the normal course-of-business wholesale and retail debt - including deposits.

A few points that need to be understood:

BFA, despite being characterized as a 'bad bank', has to be able to pay the high interest on the FROB funds (as well as pay back the principle in about four years) and it must show a profit. Failing to do either allows the state to intervene, in which process the Banco de España becomes the dominant shareholder in Bankia. Hence, the handing over of the dividend-paying equity portfolio (including what ends up being their final share of Bankia). As an aside, Bankia is taking advantage of the situation in order to deal with Basel III accounting standards which lower the value of equity holdings in a bank's capital structure;

Bankia needs to raise something approaching four billion euros from the IPO in order to achieve an eight percent core capital ratio;

The end result of these fixed monetary requirements is twofold:

Bankia, as the reality of investor interest has become manifest, has had to approximately double the percentage of itself that it is selling off;

As this public portion expands, in order to accommodate the income required to keep BFA solvent and to continue to feed the NGO's that remain of the original cajas (whose sole income will be the BFA dividend), Bankia has to increase the dividend yield as the initial price drops. A rough guess - keeping in mind how truly bad the writer is at these estimates - as to how much has to be turned over would be 280 million euros a year.

So, who takes it on the chin when things don't turn out exactly as planned? That's simple. The original cajas via the BFA dividend which, by force of nature, will be the shock absorber of first and last resort. That means fewer stupid, brand new and underused community centres in the thousands of small towns which dot, like an outbreak of measles, the Spanish administrative and political aspect and more bankruptcies and disappearances of second and third division football teams - the support of which somehow falls under the legal definition of obra social.

The upside to the above is that the situation has the potential to align the political and financial incentives of regional hot-shots that control the disbursement of the caja's funds with those of the folks charged with administration of Bankia. Simply put, Bankia's enormous capacity to reduce duplicate branches and otherwise achieve economies of scale will be less resisted by the homeboys if the BFA dividend is at stake.

Bankia stock, in our opinion, will (besides being a no-growth proposition for the foreseeable future) probably drop in value following the IPO. But that 7 percent is juicy - and safe.

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