Banking bounceThe signals indicatea revival ofconfidence amongthe nation’s lendersPage 2

Inside »

Hedge fundssnap up qualityManagers aresettling into alonger­term viewPage 2

Price is rightBuyers and sellersin property marketmay finally havereached agreementPage 3

Risks accompanysigns of hopeInvestors give theirapproval but roadremains rockyPage 3

Jobs on the linePrime minister’sfuture may hangon getting nationback to workPage 4

FT SPECIAL REPORT

Investing in SpainTuesday June 24 2014 www.ft.com/reports | @ftreports

When Spaniards speakabout “the crisis” thesedays, it is no longerclear which crisis theyare referring to.

Until recently, it was obvious thatla crísis could only mean the brutaleconomic downturn triggered by thebursting of Spain’s housing bubble sixyears ago. Today, however, the wordmay just as easily refer to the deepen-ing political and institutional crisisthat has engulfed the country.

Symptoms of this second Spanishcrisis have, of course, been visible forsome time, and are closely linked tothe bitter economic hardship sufferedby millions of Spanish families inrecent years.

Now, however, they appear withgreater frequency, and in ever moresensitive parts of the body politic.Rebuilding trust in the state and itsinstitutions will take a Herculeaneffort, and this time neither the Euro-pean Commission nor the EuropeanCentral Bank nor the InternationalMonetary Fund will be there to help.

“The economic crisis has made peo-ple realise our political system is lessperfect than they thought. Trust inour institutions has collapsed,” saysAntonio Barroso, a political analyst atTeneo Intelligence, a consultancy.

Politicians, parties and parliament,the government and the judiciary, themonarchy and the constitution, busi-ness and the unions – they are allfacing hostile scrutiny as neverbefore.

In the region of Catalonia, mean-while, more and more people say theywant to have nothing to do with thestate of Spain. Secessionist pressuresare on the rise, and will come to ahead in November, when the regionalgovernment plans a referendum onCatalonia’s political future.

The depth of the institutional crisisbecame starkly apparent on June 2,when King Juan Carlos stunned thecountry by announcing his abdicationin favour of his son, Felipe VI. Hisdecision was based on a number offactors, including poor health and aseries of scandals and public missteps

by royal family members. But there isno doubt that Juan Carlos was grow-ing increasingly concerned aboutSpain’s shifting political landscape.

The dominance of the country’s twoestablished parties, the Popular partyon the right and the Socialists on theleft, is under serious threat.

At last month’s European elections,their share of the vote fell below 50per cent for the first time. A small butsignificant number of voters desertedthem for insurgent, anti-establish-ment parties such as Podemos, whichtook 8 per cent of the vote.

No one knows if the trend towards

fragmentation will continue. Theroyal house was, by all accounts,becoming more anxious that Spain’sbroad political consensus in favour ofthe monarchy might shatter in theyears ahead. By securing the transi-tion to Felipe VI, the monarchy lookssafe for several decades.

The same cannot be said for otherpillars of the state. The biggest chal-lenge, without doubt, lies in Catalo-nia, where disaffection with Spain hasreached such proportions that a largeshare of the population – perhaps asmany as half – are seeking a historicbreak with the rest of the country.

Artur Mas, the Catalan president,has called for an independence refer-endum, albeit non-binding, forNovember 9. Mariano Rajoy, the Span-ish prime minister, insists that such aplebiscite is illegal. He has the sup-port of the Spanish parliament andconstitutional court behind him.

Most analysts agree that a Catalanclimbdown is not on the cards: ifMadrid blocks the referendum, MrMas is expected to call an early elec-tion, in the hope that Catalans willgive overwhelming support to

Continued on Page 2

Crisis of trust as downturn endsNational institutionsface hostile scrutinyand there is a threatof secession, writesTobias Buck

Royal succession: King Felipe VI acknowledges the crowd on the day of his coronation last week following his father’s abdication from the throne on June 2 Getty

2 ★ FINANCIAL TIMES TUESDAY JUNE 24 2014

Investing in Spain

regional political partiesthat support independence.

If that bet comes off, anew Catalan parliamentcould be tempted to issue aunilateral declaration ofindependence, plunging thecountry into a constitu-tional crisis unparalleledsince Spain’s transition todemocracy in the late 1970s.

Fears that Spain may beheading for a period ofpolitical instability have yetto resonate with investors.

Indeed, this month, theyield on Spanish sovereignbonds fell below those ofthe US, while the Ibex-35index of large listed compa-nies reached a new multi-year high.

Market confidence in theSpanish economy has recov-ered to pre-crisis levels,helped by recent ECB poli-cies and signs of a broaderturnround in the eurozone.

“I hope the markets areright and Spaniards willsomehow find a way toresolve the tensions,” saysLuis Garicano, a professorof economy at the LondonSchool of Economics.

“But,” he adds, “I am sur-prised that every time newspoints to instability, thereis no reaction. You have apopulist party such asPodemos coming fromnowhere and getting 8 percent, and there is not theslightest response in themarkets.”

There is no shortage ofpoliticians and officials whooffer a tranquil reading ofthe political situation.

They point out, rightly,that the long recession isover, that economic growthis accelerating and thatunemployment has finallystarted to fall. And theyargue, with some justifica-tion, that both the Social-ists and the PP have proba-bly reached their electoralnadir.

The former are due toelect a new leader nextmonth, while the latterstand to profit from animproving economy, withgrowth expected to exceed 2per cent next year.

What is more, Spain’selectoral system makes itfiendishly difficult for smallparties to gain a largenumber of seats in parlia-ment. That means the nextlegislature could end uplooking less fragmentedthan current polls – andwidespread public discon-tent with the main parties –suggest.

As for Catalonia, theRajoy government seems tobe pinning its hopes on theregion’s commercial eliteand middle class.

The assumption in

Madrid is that, sooner orlater, the economic risksassociated with independ-ence will drive a wedgebetween mainstream Cata-lan society and the seces-sionist movement. The anti-independence camp alsohopes disaffection withSpain will start to decreaseas the broader economyimproves.

It is a hope, however, thatappears fanciful to say theleast. “Here in Madrid, theyjust don’t understand theseriousness of the Catalanproblem,” says one well-connected business leaderin the Spanish capital.

Like a growing number ofhis peers, he believes that“the risk of political insta-bility in Spain is huge.”

What is clear is thatSpain faces challenges onseveral key fronts: the eco-nomic crisis is easing butunemployment is stillappallingly high and debtlevels remain worrying.

The situation in Cataloniais volatile, while the coun-try in general is gripped bya crisis of confidence in thepolitical system.

In a nation that still bearsthe scars of civil war anddictatorship, one shouldnever underestimate thepolitical and social forcespromoting stability.

But rarely has Spain’simmediate future been sohard to forecast.

Continued from Page 1

Crisis oftrust asgrowthreturns

‘I am surprised thatevery time newspoints to instability,there is no reactionin the markets’

It seems only a short timeago that Spain was whathedge fund managers called“a clear short”.

With banks reluctant toadmit the consequences ofa property collapse and gov-ernment loath to admit thatits banks might need addi-tional capital, hedge fundmanagers swarmed in tobet against the economy.

Over the past year, theposition has almost entirelyreversed as hedge fundshave rushed to profit fromthe recovery and scoop upundervalued assets.

The rationale behind thereturn of hedge funds toSpain varies according tothe type of fund. Some seekdistressed opportunities tomake quick profits; othersseek high quality butunderpriced companies forlonger term holdings.

As public finances haveshown signs of stabilisingand the risk of eurozonebreak up has faded, manymanagers’ fear of touchingSpanish assets has passed.

This has allowed reassess-ment of the values thatmany companies were trad-ing at compared with otherlocations, such as the US.

A London-based hedgefund investor says: “Manypeople were looking forvalue in Spain, because ifEurope was cheap in com-parison with the US, Spainwas very cheap.”

Some hedge funds, such

as $1.5bn Amber Capital,raised a special fund toinvest in southern Europeand buy into high qualitycompanies in Spain andItaly.

José de la Rosa, who man-ages the $350m fund,

wanted to take advantage ofSpanish valuations to builda portfolio that he couldhold for the long term. “Wehave tried to buy the qual-ity in the periphery, compa-nies that are well run withlittle debt,” he says.

“Others are buying highlylevered companies with theview that they will berestructured. We are posi-tioned in quality.”

Aside from lower valua-tions than in other Euro-pean markets, hedge fundshave been attracted to spe-cific themes in Spain.

Spanish property, whichthrough the bursting of adecade-long bubble was thedriver of the financial cri-sis, has been a focus forhedge fund investors overthe past year, as banksspeeded up their offloadingof property assets.

Such big names in thehedge fund world as GeorgeSoros and John Paulsonwere among backers of theSpanish property invest-ment trust HispaniaActivos Inmobiliarios inFebruary, as they sawthe chance to exploit low

valuations and distresseddeals.

Mr Paulson and Mr Soroseach took a €92m stake inthe €500m listing in one ofthe strongest statements ofhedge fund interest inSpain since the easing ofthe crisis.

Last year, funds associ-ated with Mr Soros, whohas closed his fund to out-side investors in order tomanage his family money,took a stake in FCC, theindebted construction com-pany, when few otherswanted to touch the sector.

Others followed thissearch for some of the mostdamaged and indebted prop-erty and construction com-panies, knowing thatSpain’s improved creditworthiness and the coolingof the European sovereignbond crisis would sendtheir share prices surging.

One example was Poly-gon, a UK-based hedgefund, which profited fromtrading in Colonial, a Span-ish property company thatcompleted a €1.2bn capitalincrease in April, helpingreduce the debt of a com-pany once seen as almostbeyond repair.

Another important cata-lyst that hedge fund manag-ers have identified as hav-ing the potential to offer bigreturns is the need forSpain’s banks, and poten-tially the state itself, to con-tinue to sell down stakes incompanies.

While Bankia, the savingsbank that in 2012 was thesubject of Spain’s largestever financial rescue, hassold most of its holdings inlarge listed companies, otherbanks still control stakes insmaller listed companies.

These will most probably

be disposed of in the com-ing years. This, experts rea-son, should gradually eradi-cate less “shareholder-friendly” owners, such aslocal governments, fromSpain’s listed companiesand help their share prices.

Yet, while Spain hasswung from one of the mostshunned countries forhedge funds to one of themost loved in three years,most managers agree theopportunity to make fastmoney in Spain may haveall but passed.

While select and esotericsituations may crop up,those who have remainedinvested in the countrymust do so for at least themedium term. Some arguevaluations have moved fartoo far upwards and thatinvestors have started tomisprice the risks they aretaking.

Distressed asset seekers spot quality amid the debrisHedge funds

Managers havemoved from a shortto longer­term view,writes Miles Johnson

What a difference threeyears make.

In 2011, Spain was a landso economically toxic thatonly a handful of vulturefunds dared venture into it.These days, you can find allkinds of private equitybirds flocking there.

They are keen to buy any-thing from companies,infrastructure, loans andproperty – and they aredoing so in such numbersthat dealmakers are start-ing to wonder whether thebargains may have van-ished.

“We felt, two to threeyears ago, that Spain wasover-shorted,” says GabrielCaillaux, a London-basedpartner at General Atlantic.“Now the trade is goingaway. It may have gonealready.”

A year ago, GeneralAtlantic and fellow US pri-vate equity group WarburgPincus purchased a 50 percent stake in BancoSantander’s asset manage-ment business, in a €2bndeal. Spain’s largest bankhad spent years trying tosell the unit, which hasabout two-thirds of itsassets under managementin its domestic market.

“The deal would attractmuch more competition if itwere done today,” Mr Cail-laux notes. “Santander two

years ago was happy towork with us and WarburgPincus. Now, it would be usand Blackstone and KKR,and so on,” he says.

With the economy show-ing signs of improvementand the threat of anothereurozone debt crisis havingreceded, deal activity hasbeen buoyant.

More than $3.4bn worth ofSpanish buyouts have beenannounced so far this year,a third more than in thesame period a year ago,according to data compiledby Thomson Reuters. Thisis also the biggest amountsince the 2007 peak of$3.54bn.

Cinven is among thosethat have recently decidedto gamble on the countryagain. This month, the Lon-don-based fund manageragreed to buy the fibre tele-communication network ofSpanish utility Gas Naturalfor $510m.

To clinch the deal in asector it had identified andresearched over the pastyear, Cinven made a knock-out fully funded offer to theseller to squelch competi-tion.

The move came after Cin-ven’s unsuccessful €2bn bidfor Applus, the Barcelona-based product certificationspecialist owned by Carlyleand Investindustrial, whichinstead decided to float thecompany in May to tap into

Spain’s buoyant stock mar-ket.

BC Partners, anotherLondon-based buyouthouse, had also submitted afirm offer for Applus.

“We’ve been looking atbuying assets in Spain inthe past few years,” JorgeQuemada, a Cinven partner,says. “We’ve been luckierthis time.”

Cinven is likely to revivea plan to open an office inMadrid, following in thefootsteps this year of KKR.

The reopening of the ini-tial public offering marketin Spain, led by eDreamsOdigeo, the online travelagent backed by privateequity houses Permira andArdian, has helped lift themood. The Madrid flotationof the company that oper-ates under the Opodo brandin the UK, helped dispelmemories of the disastrouslisting of Bankia in 2011.

Growing appetite fromindustrial groups seeking tobuy into the Spanish recov-ery has also allowed buyoutgroups to boost theirreturns on investmentsmade before the crash, fuel-ling a more positive senti-ment towards the country.

Providence Equity Part-ners made a 60 per centcumulative profit on itsinvestment in Ono, thecountry’s second largestcable operator, when it soldits stake to Vodafone inMarch. The US buyouthouse had written down thevalue of its stake by 80 percent during the downturn.

Investindustrial and KKRsold Avincis, which startedas a helicopter operatorbased in Alicante, to Bab-cock International, afterexpanding the businessthrough acquisitions inItaly, France, Scandinaviaand the UK.

Bill Gates, in October,invested €113.5m to becomethe second largest share-holder in Spanish builderFCC.

Spanish regulators havebeen supportive, says MrCaillaux. “They are pro-business. They want toattract foreign capital.”

The government hasstarted Fondo ICO Global, a€1.2bn fund that aims toback local private equityand venture teams whoseportfolios have beenwrecked by the downturn.

Foreign funds looking fornon-performing bank assets– such as Apollo, Lone Staror Centerbridge – havenever been busier, as lend-ers start disposing of unitsand loans after increasingprovisions.

“You find competition forevery portfolio,” saysAndrew Jenke, a director atKPMG Portfolio Solutions.“Every private equity grouphas an interest in Spainthese days. It’s partlybecause of the supply ofdeals. There are €160bn ofreported non-performingloans on banks’ balancesheets.”

Jaime Bergel, a partner atHIG Europe, warns thatinvestors have become toooptimistic about Spain:“Private and public spend-ing has not recovered.”

Cinven’s Jorge Quemada,too, is taken aback by thelevel of excitement for hiscountry. “Spain was not asbad as investors thoughttwo years ago and I don’tthink this is the Eldoradopeople think it is now.”

Vultures mayhave had theirrichest pickingsPrivate equity

The best could beover, writes Anne­Sylvaine Chassany

After the Brazilian entre-preneur Marcelo Weisz soldCrio-Cord, the Madrid stemcell preservation companyhe founded in 2004, hesearched for opportunitiesin the medical testing field.

When he looked at Brazil,he saw a €350m specialisedmedical testing market thatwas growing 20 per centannually, compared withSpain’s stable €60m market.

But he did not buy in Bra-zil. In March 2011 he bought70 per cent of Cerba, a Bar-celona clinical analysiscompany for €3.5m.

Mr Weisz still has accessto the growing Brazilianmarket; Cerba collects sam-ples in Brazil and sendsthem to Barcelona for test-ing. But by buying in Spain,he avoided Brazil’s longimport delays on medicalequipment.

Businesses in Spain were

cheap after the financialcrisis and offered access tothe larger EU market.There were monetary con-siderations, too.

“The big motive is thestability of the euro,” hesays. “Investing in Brazil orother emerging countriesinvolves a big currencyrisk.”

In recent years, what wasa one-way investment flowhas become two-way, asLatin American investorshave put their money intoSpain. According to Spain’sBBVA bank, flows of for-eign direct investment fromLatin America into Spainbegan to grow in 2001 andin 2010 equalled Spanishinvestments in Latin Amer-ica, at €8.8bn.

Where once “the worldexpanded in Latin Amer-ica,” says Javier Santiso, aneconomics professor atMadrid’s Esade businessschool, “now, Latin Amer-ica is expanding into theworld.”

The question is whetherthat is a long-term trend ora crisis-inspired bubble.

Spanish banks and utili-ties moved into Latin Amer-ica after its economies

opened to foreign invest-ment in the 1990s. Between1992 and 2001, Spanish busi-nesses invested €80.4bn inLatin America, beside theUS’s €97.7bn, says theElcano institute in Madrid.

While BBVA reportshigher revenues and profitsin Mexico than in Spain,Banco Santander says itmakes more profit in LatinAmerica than in Europe,the US and UK combined.

Such Latin Americandiversification has helpedSpanish businesses weatherthe crisis at home.

Áreas, a travel, restau-rant and retail companybased in Barcelona, firstmoved into Latin Americain the 1990s.

In 2006, it used its Mexi-can operations as a base formoving into the US. The USprovides about 25 per centof Áreas’s €650m annualrevenues, down from a 2007peak of €720m.

“We lost a lot of incomein Spain during the crisis,”says Áreas chief Pedro Fon-tana. “The growth in the USbasically compensated forthe drop in Spain.”

But as Latin America hasgrown, its businesses have

turned the investment flowback and moved into Spain.

Between 2008 and 2013,Latin American companiesspent more than $9.2bn buy-ing Spanish companies,according to the marketanalysis firm Dealogic. Mex-ican companies were espe-cially active, buying the buscompany Avanza (for$1.1bn), Sara Lee’s Spanishbakery operations ($154m)and a majority of the Cam-pofrio food group ($1.2bn).

For many, it was a logicalway to diversify andexpand, just as Spanishgroups had done. There wasalso a price consideration:after the crash, many Span-ish companies were on themarket at fire-sale prices

“If there had been nocrisis in Europe, a lot ofthese opportunities wouldnot have existed,” saysMr Santiso. “Neither Cam-pofrio nor Sara Lee would

have been possible to buy.”For many Latin American

companies, Spain offers acommon language, accessto the EU’s common marketand sometimes cheaperdeals than in their ownregion. That said, the flowof Latin American invest-ment into Spain is far froma reverse colonisation. To alarge extent, the figuresreflect Spanish companiesinvesting less in LatinAmerica, something likelyto change once Spain’seconomy improves.

Pankaj Ghemawat, a pro-fessor at Iese businessschool in Barcelona, says:“It’s not exactly LatinAmerica taking over, nomatter how much thatwould cater to how theyfeel about the former colo-nial master.”

In 2012, Latin Americaaccounted for only 10 percent of the foreign directinvestment into Spain.

Instead, with signs of aSpanish recovery, it seemsmore likely the investmentflow will be healthy bothways.

“It’s a much more bidirec-tional relationship now,”says Mr Santiso.

Latin America acts to cushion the blowsInvestment

Former colonieshave helped take theedge off the crisis,writes Ian Mount

Alittle over a year ago, the

leaning tower of Bankia’sheadquarters on the Paseode la Castellana, Madrid’smain thoroughfare, provided

a gleaming – if unintentional – symbolof all that was wrong with Spain’sbanks.

Knocked hard by a decade of care-free property lending that culminatedin a €19.2bn loss in 2012, Bankia wasthe biggest of a handful of banks res-cued by the government, forcingSpain into a €100bn sovereign bailout.

Today, a resurgent Bankia carrieswith it the hopes of Spain’s fragile –but determined – recovery. The gov-ernment has even started to sell downits 68 per cent stake.

The lender’s shares trade at 1.4times book value – well above averageeurozone and Spanish multiples ofabout 0.8 times and 1.2 times – and upfrom barely 0.1 times mid-crisis.

Analysts say that valuation looksstretched, as if investors have arrivedat the fiesta too early – especially asthe scars of Spanish banks’ darkestdays are still apparent. True, bankprofits are rebounding off the lowbase set by the drastic bad loan provi-sions imposed by the Bank of Spain.But many lenders’ revenue growthremains lacklustre.

Net interest margins have recoveredsharply since the insane “depositwar” that broke out in early 2010,when banks offered ever higher ratesto lure depositors. Santander was pay-ing 0.91 per cent on time deposits inSpain in the first quarter, comparedwith 2.04 per cent a year ago.

But credit demand remains subduedand private and public debt high. InSantander’s case, overall income felldespite the margin improvement, asits domestic loan book contracted by9.4 per cent. By contrast, BancoSabadell’s net interest income rose by17.5 per cent in the same period.

Josep Oliu Creus, Sabadell’s chair-man, says: “This year, the driver ofSpanish bank earnings will be fallingprovisions and improved interestincome, which, in our case, has risenfor three consecutive quarters.”

Even so, like other banks, Sabadelljuiced its first-quarter revenue withtrading income, making more fromtrading than lending – though it usedits 223 per cent leap in trading incometo boost bad loan provisions. Analysts

argue that reliance on trading incomecan detract from earnings quality.

Santander and BBVA, Spain’s mostinternational banks, rely less on theirdomestic market. Excluding propertyportfolios in run-off, it accounted for14 per cent of the first-quarter profitof Santander’s operating areas and 36per cent of BBVA’s. Currency weak-ness in their Latin America units,however, dented overall profit. Bank-ers accept the need to be bolder withcost cuts. “With such low interestrates, it is absolutely essential to be alow-cost producer,” says Jaime Sáenzde Tejada, BBVA’s strategy andfinance head. BBVA’s first quartercosts fell 7.9 per cent from a year ago.

Bank of Spain data show that non-performing loans (NPLs) stillaccounted for a high 13.4 per cent oflending at the end of March. Butdeclining bad loan charges havehelped drive profit recovery. Banksreport a slower pace of bad loan for-mation and some have sold bad loanportfolios to bring down their ratios.

Perversely, post-crisis measureshave created an anomaly, notes NickAnderson, an analyst at BerenbergBank. “Banks have been able to cleanup their balance sheets by sellingNPLs and other assets, because buy-ers have benefited from low interestrates and the associated liquidity,” hesays, “yet low rates also mean banks’revenue is struggling.”

With loan quality still in doubt,investors increasingly demand a com-mon equity tier one capital ratio ofmore than 10 per cent of risk-weightedassets. Banks have been creativeabout capital raising.

Santander has sold stakes in listedsubsidiaries in the Americas andother assets. Sabadell raised capitalthrough a rights issue and brought innew investors from Latin America, asdid Banco Popular.

The Bank of Spain has limited thecash portion of bank dividends to 25per cent. Last year, lenders were ableto reclassify €30bn of deferred taxassets from property lending losses asstate-guaranteed tax credits thatcount towards regulatory capital.

Rapid consolidation post-crisis hascreated a smaller number of better-capitalised banks. Further consolida-tion beckons, as Spanish bankers talkirrepressibly of making bolt-on acqui-sitions of loan portfolios or branchnetworks in Spain.

Santander has bought a majoritystake in the consumer lending busi-ness of department store group ElCorte Inglés. Banco Popular is report-edly in talks to buy Citigroup’s Span-ish retail banking and credit cardbusiness.

The banks must negotiate one morehurdle before they can grow morefully into stock market ratings thatincreasingly look stretched: the ECB’scomprehensive review of eurozonebanks, due in the autumn, with itsstrict stress tests. But Spain’s bankersare mostly more upbeat about theirrenascent growth than their Europeanpeers. How fortunes change.

Lenders enjoy renascent spiritBanking The signs emerge of a fragile yet steady revival, writes Richard Stovin­Bradford

PedroFontana,chiefexecutiveof Áreas

Onwards and upwards: thegovernment has begun tosell down its original 68 percent Bankia stake Bloomberg

‘Every single grouphas an interest herethese days – partlybecause of thesupply of deals’

‘If Europe wascheap incomparison withthe US, Spain wasvery cheap’

FINANCIAL TIMES TUESDAY JUNE 24 2014 ★ 3

The recovery in Spain’seconomy has been amplyrewarded by investors.

Since the beginning of2013, the main stockmarket index, the Ibex 35,has risen by 32 per cent.And with 10-year bondyields at 2.7 per cent, thegovernment has never beenable to borrow so cheaply.

In May, the InternationalMonetary Fund endorsedthe investors’ seal ofapproval, saying Spain had“turned the corner”.

It is reasonable tobelieve the improvement inthe economy will continue.A survey of manufacturinglast month climbed to itsbest reading in four yearsand marked the sixthmonth in a row that thesurvey had signalled anexpansion in activity.

The recovery, initiallydriven by exports, hasstarted to feed throughinto an improvement indomestic demand andbusiness investment.

Investors have been rightto take advantage of fallingeconomic and financialrisk. But they shouldremain alert, not just tothe question marks overthe sustainability of theeconomic recovery, butalso to other risks lurkingin the shadows.

One that has retreatedthere, but not disappeared,concerns the robustness ofthe financial system.

Spain’s banks have donea good job of shifting riskoff their balance sheets.But bank lending is stillcontracting, creating bigproblems for the manysmall and medium-sizedcompanies that remainunable to access publicbond markets.

And the level ofindebtedness in theeconomy as a whole hasbarely budged since thepeak of the financial crisis.

Lombard Street Researchcalculates that Spain’stotal debt – public andprivate – at three timesgross domestic product, islittle changed from 2010.

Spain is not the onlyeurozone country strugglingwith a huge debt burden.But reducing it, in theabsence of inflation, willrequire sustained growth.

This seems unlikely.Standard & Poor’s, which

recently upgraded Spain’scredit rating, expects theeconomy to grow at 1.6 percent a year on averageuntil 2016.

Many of the banks’ baddebts, rather thandisappearing throughdefault as has often beenthe case in the US, havesimply been shifted, eitherinto Sareb, thegovernment’s bad bank, orinto the shadow bankingsystem, often in the formof debt-funded Europeanprivate equity buyers.

The European CentralBank’s asset quality review,

due in the autumn, willpick up the improvementin the capital positions ofSpain’s largest banks, butwill not capture the risksremaining outside them.

The secondunderestimated risk ispolitical. According to theIMF, 5.9m Spaniards areunemployed, more thanhalf of them for longerthan a year. The absolutenumber may be falling – itdropped for the fourthmonth in a row in May.But it still represents morethan a quarter of theworking population.

Not only does this puthuge social strains on thecountry and its people, butit will also keep a lid onany recovery in domesticdemand and on growth.Average household incomeis still below pre-crisislevels and the unemployedcannot afford to spend.

High unemployment isone of several factors thatwill hamper thegovernment’s attempts topursue further reforms.

Spain’s policymakershave made painful decisionsabout spending, taxes andpensions. But to sustainthe improvements incompetitiveness to whichthese have contributed willrequire further action.

Disincentives to hiring,such as the highlyprotected nature ofpermanent contracts, needto be addressed, as do theregulatory barriers tocreating and operatingbusinesses. The IMF hasidentified 2,700 of these,mainly at regional level.

Drumming up popularsupport for such measureswill prove challenging inan environment wheregrowth has picked up butits benefits – in particularlarger falls in the numberof people out of work – arenot felt by many.

The other political riskon the horizon is thepossibility of Cataloniavoting to secede inNovember. Businessleaders in the region have,on the whole, remainedreticent about how anindependent Cataloniawould affect them.

Given that the regionrepresents a fifth of thecountry’s output and that,admittedly on the Catalangovernment’s estimates, itmakes more than €16bn offiscal transfers to thecentre each year, thefinancial impact of asecession – not to mentionthe resulting political andsocial fissures – should notbe underestimated.

Central government isputting up a robust defenceagainst a referendum inCatalonia. But with pollsshowing that half theCatalan population wouldvote for independence,investors ignore politicalrisk at their peril.

Risks remaindespite signsof recovery

EconomySARAH GORDON

Unemployment willhamper thegovernment’sattempts to pursuefurther reforms.

Before the economic crisis,Spain was a haven forenergy investors. Generoussubsidies to renewablesturned the country into oneof the world’s leading pro-ducers of wind and solarpower, while high electric-ity and gas demand fuelledinfrastructure growth.

The subsidies to renewa-bles, however, widened thedeficit between regulatedprices and energy produc-tion costs, a serious concernfor successive governments.

The deficit – includingsubsidies to coal, consum-ers in Spain’s islands andpayments to utilities datingback to privatisation – hasreached €30bn.

After years of wrangling,

the government last yearpushed through reforms totackle the deficit by slash-ing subsidies – some retro-actively – and raising taxes.Investors have been up inarms ever since.

The country’s largestpower utility, Iberdrola,produces about a quarter ofits electricity in Spain fromrenewable sources, mainlywind farms. It estimatesthat the reforms cost it€801m in 2013 and already€255m more in the firstquarter of 2014 than in thesame period last year.

“We had been hoping fora reform that gave clarityto the sector, resolved thetariff deficit, resolved struc-tural distortions and estab-lished a framework toinvest with reasonablereturns,” says an Iberdrolarepresentative. “Instead, wehave had a series of reformswhose primary aim is toraise tax revenue.”

Iberdrola generates 57 percent of its power outsideSpain and has responded tothe reforms by increasingits investment in other

countries. Out of a total of€8.9bn it has earmarked forinvestment for 2014-16, itplans to invest 85 per centon projects abroad, includ-ing offshore wind farms inthe North Sea.

“Investments will con-tinue in Spain, but they willbe on maintenance and notfor now on new projects,”the representative adds.

Analysts say the reforms,while painful, have at leastin theory stopped the deficitgrowing and that theformer renewables subsidyscheme was unsustainable.

“Many investors hadinternal rates of return ofmore than 20 per cent,”says Víctor Peiro, analyst atbrokerage Beka Finance.

They could expect torecoup investments withinfour to five years. “Thatwas too attractive for somepeople,” he adds. “The gov-ernment realised that andchanges had to be made.The current system makesmore sense.”

The other bugbear forenergy investors in Spain isovercapacity because of

optimistic demand forecastsmade in the pre-crisis years.

Spain’s power stationscan generate up to 108GW,or more than twice thehighest demand they haveever had to meet, whichwas 45GW in 2007.

“You will probably haveto wait several years formany [power] projects to beimplemented. There will besome for now, but notmany,” Mr Peiro says.

Electricity demand hasbeen in decline since 2008,although some analystsexpect it to bottom out thisyear in view of the nascentrecovery by the economy asa whole.

Another hurdle that theelectricity industry has toclear is the ability togenerate power at a pricethat makes ailing Spanishindustry competitive with

its European neighbours.In its latest report,

Spain’s energy regulatorestimates that while thebenchmark 2015 futurescontract for power in Spainfell 3 per cent in March, to€47.08 per megawatt-hour,it was trading well abovelevels in France (€42.58)and Germany (€34.27).

The natural gas industrywill also need to undergoreforms, probably in 2015,but they are not expected tobe nearly as drastic as wasthe case with the electricityindustry.

It, too, has fallen victimto ambitious forecasts, andto renewables taking a big-ger share of Spain’s energymix.

The end result is thatinvestors have poured bil-lions into building gas-firedgenerators, gas pipelinesfrom Algeria and regasifica-tion plants in ports, whichare working at nowherenear capacity.

All this infrastructure hasat least diversified Spain’ssupplies and could cutEurope’s dependence on

Russian gas by 12 per cent –if the EU throws its weightbehind a pipeline projectacross the Pyrenees thatwould allow Spain to sell itsgas glut to France and therest of the continent.

“Spain could become partof the solution for Europe’scrisis in security of sup-plies,” says Antoni Peris,head of Spain’s gas industrygroup, Sedigas, with refer-ence to the continent’sdependence on Russian sup-plies in the context of theUkraine crisis.

Alvaro Navarro, an ana-lyst with investment serv-ices company Ahorro, sayslast year’s electricityreforms will have an impacton this year’s companyresults.

“But after that, I believerevenues and earnings fromthe electricity businessshould stabilise,” he adds.

“Most of the reforms havebeen enacted, althoughthere are still adjustmentsto be made.

“But we have left behindthe period of maximum reg-ulatory uncertainty.”

Electricity industry absorbs the shock of reforms

After John Carrafiell co-founded GreenOak RealEstate in 2010, the firm’sfirst investments were inNew York, London and

Tokyo. But in February, GreenOakand several partners announced that,after almost a year of talks, they hadmoved into Spain’s downtrodden prop-erty market and bought eight shop-ping centres for €160m.

“There was very little done [inSpain] before the summer of 2013,”says Mr Carrafiell, who was formerlythe global co-head of Morgan StanleyReal Estate. “There is always a periodof adjustment in terms of where buy-ers and sellers see value.”

GreenOak’s deal is not the onlyrecent example of buyers and sellersfinally agreeing a price. About €5bnwas invested in Spanish commercialreal estate last year, according toCBRE Spain, the property consul-tancy, more than twice the 2012amount. After the government madeeconomic reforms and indicatorsbegan to point upward, some inves-tors decided Spain’s market had bot-tomed and was worth a look.

“No one wanted to put a penny inSpain, because many people thoughtthere was a huge risk of it leaving theeuro,” says Enrique Martínez, execu-tive managing director of CBRESpain. “But at a certain point, theinvestor community realised that thiswould not happen. At that point, itwas the herd instinct.”

At a recent property conference inMadrid, Marta Gómez, director ofinvestor relations for Sareb, the “badbank” formed in 2012 to hold €51bn inassets of Spain’s bailed-out banks,said she had spoken in 2013 to 700funds interested in Sareb’s portfolio.

Last summer, Blackstone bought1,860 Madrid apartments for €125.5mand Goldman Sachs partnered with alocal firm to buy 3,000 more.

This year, Qatari funds bought Bar-celona’s Renaissance and Madrid’sInterContinental hotels. And Cana-dian pension fund manager PSPInvestments and a local partner

bought Madrid’s Castellana 200 com-plex for €140m.

The shopping centre market hasbeen active, because many malls hadforeign owners who were eager todeal, often because they had loans duethat would be hard to refinance, saysCBRE’s Mr Martínez.

Patricio Palomar, director ofresearch at CBRE Spain, expectsretail space transactions to doublethis year, to about €2bn.

The office market has been slower.There were €54.6m of commercialoffice transactions in Barcelona dur-ing the first quarter of 2014, comparedwith €25m the same period last year,says Oriol Barrachina, chief executiveof Cushman & Wakefield in Spain.whose data show the per square metresale price for prime Madrid officespace fell from more than €10,500 in2006 to €5,200 today. Prime office rentsfell from €42 to €24.50 a square metre.Both have recovered slightly in 2014.

The combination of lower prices andhigher rental yields than Paris andLondon has attracted investors;prices have “clearly” bottomed and

will begin to rise, says Mr Barrachina.The residential market is more com-

plicated. After price tumbles of morethan 50 per cent in some areas, thenumber of sales is rising. But nation-wide prices are still falling, albeitslowly; May’s year-on-year drop of 5.3per cent was the lowest in threeyears, according to Fotocasa.es, thereal estate portal.

Mark Stücklin, founder of the Span-ish Property Insight website, notesthat there are two residential marketsin Spain: a healthy market for foreign-ers who pay cash for prime properties;and a difficult market for locals whocannot get mortgages.

Some prime neighbourhoods areseeing increases. In Barcelona, 21 of35 districts recorded rising prices inMay, according to Fotocasa; inMadrid, it was 22 of 52.

Still, there are drags on the residen-tial market. Despite several big trans-actions, most portfolios for sale arenot interesting for investment funds,says Fernando Encinar, co-founder ofIdealista.com, a property website.

“Funds are interested in a con-

dominium with 50 units and goodprofitability,” he says. “What they arefinding is dispersed collections ofproperties, and they don’t have teamsto manage all these units.”

And despite a 2 per cent rise inhome mortgages in March, the first infour years, most Spaniards cannotaccess the market, says Beatriz Tori-bio, head of research at Fotocasa.

“With unemployment and lack ofaccess to credit, we can’t talk aboutrecuperation,” she says. “Interestfrom foreigners isn’t enough.”

For now, property recovery is nas-cent. Indeed, the €5bn in deals in 2013is still only half its 2007 peak.

“Spain has attracted a tremendousamount of interest and a lot of talk,but not as many people have actuallygot things done,” says Mr Carrafiell.

That could change as Spain’s econ-omy improves. Mr Carrafiell says heexpects consumer spending and otherindicators to improve in 12-18 months,helping the market: “I don’t knowwhether it will be in two or three oreven four years, but I do think therewill be a powerful recovery in Spain.”

Buyers and sellers haggle out a price

Signs of thetimes: propertydeals are still atonly half their2007 peak

Bloomberg

Large construction groupswere hit hard when Spain’sproperty bubble burst.Builders such as ACS, FCCand Sacyr saw up to 80 percent of their domestic mar-ket vanish, as the privateand public sector slashedspending on new projects.

Investment in the sectoras a whole more thanhalved between the finalquarter of 2007 and the lastthree months of 2013, from€58.4bn to €25.4bn, accord-ing to estimates by Spain’snational building confedera-tion.

Juan Béjar, FCC’s vice-chairman and chief execu-

tive, says: “I believe realestate is going to recoverfaster than people think,but public investment ininfrastructure will remainquite weak, at least, for thenext two or three years.”

To make matters worse,many companies borrowedin the boom years in anattempt to diversify, onlyfor their debts to pile upafter the crisis hit in 2008.

Sacyr bought 20 per centof Repsol, the oil company,but was forced by creditorbanks to halve its stake.

Others invested in renew-able energy but sufferedwhen the government cutback formerly generoussubsidies last year.

Several companies joinedforces to bid for toll roadconcessions in Spain, butwere hit when traffic flowsdeclined. The government isplanning a €2.3bn bailoutfor the toll roads.

The construction compa-

nies have sought richerpickings abroad.

Sacyr and OHL are lead-ing respective consortiumsto expand the PanamaCanal and to build a high-speed rail link in Saudi Ara-bia between the cities ofMedina and Mecca.

ACS, meanwhile, hasacquired Hochtief, the Ger-man construction company.

Today, analysts saySpain’s six largest construc-tion companies rely onoverseas projects.

Such schemes account for84 per cent of the compa-nies’ order books – a turn-round from 2007, when thedomestic economy was stillbooming and the proportionwas 30 per cent.

Juan Moreno, an analystwith Ahorro Corporación,says: “The companies arewell aware that the con-struction business in Spainwill take years to getback to what it was,

because there is an oversup-ply of infrastructure in thecountry.”

He adds: “The crisis camewhen the companies werehighly leveraged. Now weare seeing the fall in con-struction activity bottomingout in Spain, the companiesare growing internationallyand there is some substan-tial deleveraging.”

While the market remainssubdued, the mood in theindustry has brightened,not only because of big con-tracts abroad, but alsobecause companies haveshed non-core assets andreduced debt.

Sacyr sold its stake intwo Madrid hospitals in thefirst three months of theyear, as well as a holding inthe Seville metro.

At present, the companyis engaged in selling Valle-hermoso, its property divi-sion and removing €1.2bnin associated debts from its

balance sheet in the proc-ess. Sacyr has already cut€400m in debt linked toVallehermoso after handingover assets to creditorbanks. It plans to dispose ofthe remainder of the divi-sion’s assets and debt bythe end of the year.

FCC, which has interestsin infrastructure andenergy as well as construc-tion, plans to divest andgenerate cash until its netdebt is no more than threetimes earnings before inter-est, taxes, depreciation andamortisation.

“More than 80 per cent ofthe divestment plan is com-plete,” FCC’s Mr Béjar says.“Our €2.2bn divestmentstarget will be achieved bythe end of the year.”

At the end of the firstquarter this year, the bigsix had trimmed theirtotal debts by 9.1 per centfrom a year previously, to€33.98bn.

Construction companieshave benefited from a dropin borrowing costs, on theback of a fall in sovereigndebt yields since Spain wasin the depths of its crisis in2012.

Rafael Fernández, an ana-lyst at Beka Finance, saysthis reduction may allowthe government to spendmore on civil engineeringafter it meets deficit reduc-tion targets.

“Construction has beenthe big job creator in recentyears, because it typicallyemploys two or three times

more than other sectors,and the government’s bigconcern is to reduce theunemployment rate tobelow 20 per cent,” he says.

A revival of investorappetite can be seen by thefact that, after a privateplacement of shares inApril, Sacyr managed toincrease its capital by€166m and sold a €250mconvertible bond in May.

OHL, meanwhile, sold a€400m bond in March andplans to issue up to €3bn indebt. FCC, for its part, hasrecently lured investorssuch as Bill Gates andGeorge Soros.

Looking ahead, MrMoreno expects to see themarket bottoming out athome, bigger internationalgrowth and more deleverag-ing.

“These will be key factorsin 2014, which could be theyear of the sector’s recapi-talisation,” he says.

Foreign opportunities sought as home market splutters

Energy

Subsidy cut onrenewables takes itstoll but there may belight ahead, writesMartin Roberts

Construction

Overseas projectshelp keep groups inbusiness, writesMartin Roberts

Property

Commercial sector picks upas foreign funds buy officespace and shopping centresbut residential market lagsbehind, writes Ian Mount

Investing in Spain

Tobias BuckMadrid bureau chief

Miles JohnsonHedge fund correspondent

Richard Stovin­BradfordFast FT

Anne­Sylvaine ChassanyPrivate equity correspondent

Ian MountFT contributor

Sarah GordonEurope business editor

Martin RobertsFT contributor

Andy MearsPicture editor

Steven BirdDesigner

Peter ChapmanCommissioning editor

Contributors »

‘Companiesare growinginternationally andthere is substantialdeleveraging’

Stirred up:investors inwind farmshave beenup in arms

4 ★ FINANCIAL TIMES TUESDAY JUNE 24 2014

MELILLA (SP)CEUTA (SP)

Minorca

Majorca

Ibiza

PORTUGAL

FRANCE

MOROCCO ALGERIA

AT L A N T I CO C E A N

M e d i te r ra n ea nSea

GIBRALTAR (UK)

100 km

CANARY ISLANDS

BALEARICISLANDS

S PA I N

CASTILLA-LEÓN ARAGÓN

MADRID

ANDALUCÍA

EXTREMADURA

ASTURIAS

CASTILLA-LA MANCHA

VALENCIA

LA RIOJA

CANTABRIA PAÍS VASCO(Basque country)

NAVARRA

CATALUÑA(Catalonia)

MURCIA

GALICIA

Exports12-month sum (€bn)

2005 08 10 12 14140

160

180

200

220

240

Sources: Eurostat; Thomson Reuters Datastream; Haver Analytics FT graphic

Labour’s pain

Change fromQ1 2013% points

Less than 20%

20%-24%

24%-28% More than 32%

28%-32%

Unemploymentrate Q1 2014

Map key

0.9

0.1

-1.8

-3.5

-1.2

-1.9

-2.4

-1.8

-2.8

X.X

-0.9

-0.7

-2.2

0.3-0.5

0.4

0.3

0.3

Real GDPRebased (Q1 2009 = 100)

2009 10 11 12 13 14

95

96

97

98

99

100

101

102

103

104

Eurozone

Spain

Fotocasa house price index(annual % change)

2006 08 10 12 14-15

-10

-5

0

5

10

15

Females

Males

Females

Males

Females

Males

Females

Males

16-19year old

20-24year old

25-54year old

55 years& above 20.3

19.0

23.6

25.3

53.7

52.0

68.3

72.7

House prices

Unemployment ratesQ1 2014 (%)

Unemployment and labour costs

* 4-quarter moving average

2010 11 12 13 1418

20

22

24

26

28

100.0

100.5

101.0

101.5

102.0

Unemploymentrate (%)

Labour cost index(rebased)*

Mariano Rajoy knows thathis chances of winningthe next general electionare likely to turn on onesimple fact – whether the

nascent economic recovery feedsthrough into the disaster zone that isthe Spanish labour market.

In recent declarations, Spain’sprime minister has sounded increas-ingly confident. He has promisedrepeatedly that unemployment will belower at the end of next year – whenelections are held – than at the end of2011, when his government tookoffice. “We have broken the trend ofemployment destruction,” Mr Rajoydeclared last month.

The latest labour market data offersome support for the prime minister’sassertion, but they also illustrate thescale of the challenge facing the coun-try in the years ahead.

Last month, the number of regis-tered unemployed people fell byalmost 112,000 on the previous month,with strong signs that the decline wasnot just the result of a shrinkingworkforce but of a real boost in hir-ing. New labour contracts weresharply up and the number of work-ers affiliated to the social security sys-tem rose by almost 200,000, the big-gest increase ever recorded.

“Right now, after eight months ofcontinuous growth in employment, wecan be pretty certain the recovery hasstarted,” says Marcel Jansen, a profes-sor of economy at the AutonomousUniversity of Madrid.

“What we are seeing is surprisinglystrong job creation, given how loweconomic growth still is. It suggeststhat companies have been sheddinglabour for so long that even a smallpick-up in activity forces them to hireworkers.”

Along with other labour marketexperts, however, Prof Jansen warnsthat it will take many years forSpain’s crisis-scarred labour marketto recover fully and that many unem-ployed people face the risk of perma-nent exclusion.

Indeed, to get a better picture of thedepth of Spain’s unemployment crisis,

one has to look not at the monthlydata, but at the quarterly labour mar-ket surveys published by the nationalstatistics office. The latest, released inApril, found that six years after thestart of the crisis there are still 5.9mpeople out of a job – down from lastyear’s record high but not by much.

The survey confirmed that Spain’spool of labour is shrinking steadily.This is in part because of migrationbut also because many unemployedhave become so disillusioned thatthey have given up the search for ajob and have dropped out of the statis-tics.

This effect helps explain why theunemployment rate rose to 25.9 percent over the latest quarter, eventhough the number of unemployedfell slightly.

The youth jobless rate also rose,with 55 per cent of workers under theage of 25 out of work

Much of the new hiring is concen-trated in low-skilled services sectors,especially tourism, mostly throughtemporary rather than permanentcontracts. “Employment is growingbut the quality of work is deteriorat-ing,” says Prof Jansen.

Such concerns pale when setagainst the most pernicious legacy of

the recent crisis: long-term unemploy-ment. Three in five jobless Spaniardsare classified as long-term unem-ployed, meaning they have been look-ing for work for at least a year. Closeto 1.3m Spaniards have been out of ajob for more than three years – oftensuffering a near-complete erosion oftheir skills.

Their situation is linked directly tothe heart of Spain’s economic crisis:the bursting of the debt-fuelled hous-ing bubble after 2008.

During the decade-long boom, theconstruction sector sucked in hugenumbers of workers, offering easymoney for largely low-skilled work.When the crisis hit, hundreds of thou-sands ended up in the streets withoutthe basic school-leaving certificate orany kind of vocational training.

The fear is that millions of Span-iards will drift ever further away notjust from the labour market, but alsofrom society at large. For those whohave no job, and who can no longerrely on unemployment benefits orother forms of state support, the riskof social exclusion grows by the day.

Analysts say that the government’ssweeping labour market reform of2012, the cornerstone of Madrid’s eco-nomic reform effort, is doing little tohelp the long-term unemployed.

The reform injected greater flexibil-ity into the labour market, by allow-ing more companies to strike wagedeals at factory level rather than aspart of a collective industry agree-ment. It also made it cheaper and eas-ier to fire workers.

Though deeply controversial, thereform is widely credited for helpingthe private sector keep wages downand restore the country’s export com-petitiveness. But lowering wages doesnothing to help workers who lack theskills for the job in the first place.

Madrid must, say analysts, overhaulSpain’s “active” labour market poli-cies with more targeted measures totrain the jobless for a return to work.

“Our public employment servicesare absolutely not prepared forthe task ahead of them,” saysProf Jansen, pointing out that just

Jobs may prove vital toRajoy’s election fortunesEmployment Prime minister professes confidence, writes Tobias Buck

2 per cent of new labour contracts arebrokered by Spanish job centres.

In its latest report on the Spanisheconomy, the International MonetaryFund voices the same concern, argu-ing that “more needs to be done, espe-cially by regional governments, tohelp the unemployed improve theirskills and find work”. The IMF saysSpain should use more private jobplacement agencies, allow more com-

petition in training services and cre-ate a single portal for job vacanciesfor the entire country.

The government of Mr Rajoy haspromised to table a new package oflabour market reforms before thesummer, with special emphasis onactive labour market measures. If theprime minister wants to fulfil his elec-tion promise for next year, he and hisministers have their work cut out.

Work wanted: jobless total is near 6m

‘Employment is growingbut the quality of workis deteriorating’

Investing in Spain