Financial Crisis? Nope, not here, it's more like Armageddon!

Madrid

28 October 2009

I'm finally beginning to realise how very close to disaster we came a year ago. We are still experiencing the after-shocks of the Lehman failure. Bank lending was very tight this past February and I was anecdotally telling people in the City of London that the banking houses in Madrid had been very lonely places, there wasn't anything going on.

Well, my friends, the truth is that there is still not all that much going on. Here in Spain we are at about 20% unemployment, highest in the EU. In my business, renewable energy, the price of assets is softening and the number of them on the market (for re-sale or for sale after construction) is growing. Owners who six months back were willing to sit on an investment, expecting that prices would begin to rise and that terms would evolve in their favour if only they held out, are now needier, they haven't seen many serious buyers and they haven't closed many deals. The terms are becoming more favourable for buyers and prices are, at a minimum, not rising.

This is not just a shift in my perception of what's happening, it's an important augury of what's really developing out there; there's a realisation taking hold that this is going to take a while to work out. The physical evidence supports this belief; the answer to what actually is going on in the economy is 'not much'. We are seeing a continuation of 'life support' activities, which you'd expect: groceries, fuel, agriculture. What we aren't seeing is what we did expect would be happening by now: a return to some form of normality in the rest of the economy. Naturally, we expected construction to lag; well, actually, to remain comatose for at least another 12 to 18 months. What we didn't expect was that everything else would be hurting. Deals just aren't happening and I think that's for two reasons: banks are not lending (at least they aren't lending easily and without extensive questioning of the deal) and buyers are very much more conservative than they were (and than we expected them to be at this point). The buyers are running scared. The due diligence is longer and more exhaustive. The desire to reduce the number of unknowns combined with a bull market in risk aversion has slowed the pace of business to a dangerously slow speed.

Sclerotic banks, needy sellers, conservative buyers: the way it stands now, we are going nowhere quickly. You cannot make buyers less conservative or quicker unless they've got some confidence in the economy as a whole. Banks are the only part of the dysfunctional algorithm that can be artificially stimulated. The upshot is clear, Governments have got to stimulate credit, they have to get banks to open the taps. Sellers will move enough in price and on terms to stimulate the buyers if they think the banks have enough confidence to lend.

So, are banks the bad guys in this picture? Yep, you betcha! There is no ambiguity; they got us into this mess and they are doing very little to get us out.

The photo-voltaic industry in Spain benefits from a feed-in tariff that is guaranteed by the Spanish Government for 25 years. What that means is that if you can get your solar cells producing correctly and the power you generate is evacuated into the grid, you will get paid. Unless it's got what they call trackers (little machines that turn the solar cell modules so that they get more sun), a photo-voltaic plant has, essentially, no moving parts and is undoubtedly the least risky way to produce power that there is. In other words, if you get your modules in place, there is not much that is going to stop you generating power and if you do, the Spanish Government guarantees you'll get paid. For a lender it doesn't get any better -- the deal is transparent, tick some technical and legal boxes and you've got a nice, steady income.

With these pluses, you'd expect that the photo-voltaic business, along with other renewable energies, would be one of those that would go through the crisis without much damage. Of course the industry isn't immune, a lot of sellers are construction companies that were battered by the residential bubble and have to liquidate assets to improve the balance sheet so, what do they sell, the assets they think will realise the most value, their renewable projects. Still, there is nothing fundamentally wrong with the business (except maybe some over-enthusiasm on the part of Government when they first thought up these rich tariffs). Why can't we get things going then?

The answer is, again, simply that the banks aren't moving. Like deer in the headlights they are simply watching Armageddon hurtling towards them. They think that by strengthening their balance sheets they will survive and any loans they make now apparently do nothing towards that end. But, the fact is that theories about what percentages you need to be safe are all simply calculated risk assessments. The presume that we won't go over some financial cliff where all of those guesses (for that, in the end, is all they are) about bad loan reserves and so on are just so much statistical nonsense.

So, how do we get things going? Really simple, in my view; make some loans, prudent ones, but make them and make them soon! We've got to get money moving or we're really going to face some serious troubles.