Jul
11
By CHRISTOPHER BJORK
MADRID—Spanish prosecutors are mounting lawsuits on behalf of small savers who hold preferred stock in local banks, as the European Union is set to require ailing lenders to impose losses on holders of junior bonds and preferred shares as a condition of its bailout.
Prosecutors claim banks misrepresented these securities as safe deposits when they sold them. If courts rule in favor of clients, sales contracts would be annulled and banks forced to pay back investors.
On Wednesday, conservative bondholders like banks, funds and Asian investors tried to exit their positions in weaker Spanish banks, but found it hard to sell, bond traders said.
About 120,000 small Spanish savers are exposed to the country’s nationalized banks. Among a set of painful conditions attached to the country’s €100 billion ($122 billion) rescue from the EU, subordinated bondholders—many of them preferred-stock holders—are expected to share the burden with taxpayers by assuming losses on their investments.
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The problem: Instead of targeting sophisticated money managers who usually purchase these securities, Spain’s banks sold them to their own clients, mostly pensioners and middle-class workers, through branch networks. Many investors say they were unaware of the financial risks.
The sale of these securities allowed banks to boost their capital as they grappled with heavy real-estate losses and stricter solvency rules. The banks’ reliance on retail investors also played a role in exacerbating the problems in the banking sector by keeping banks from fully recognizing losses. As the crisis intensified and banks failed, these former depositors were left exposed to hefty losses.
Local lenders targeted people like Roberto Coloret, who as a traveling salesman saved around €20,000 before retiring a few years ago. In October, following several calls from his local branch manager at Novagalicia Banco, the 74-year-old pensioner agreed to purchase securities that paid higher interest rates. Months later, he realized he had become an owner of preferred stock.
Distrust among the Spanish population toward their banks is on the rise. In one indication of the banks’ diminished standing, recent polling from sociological institute CIS showed that the fragile situation of local banks is among the top worries of Spaniards, ahead of Basque terrorist group ETA, education and crime. Recent outflows in deposits have also raised worries that clients could withdraw their savings as confidence erodes.
The EU’s burden-sharing plans seem to leave the court system as the only solution left, analysts said, as successful litigation could force banks to compensate affected investors. Lawsuits could take two years to complete.
“Spanish courts are, in general, siding with investors in these cases,” said Juan Ignacio Sanz, a law professor at Barcelona business school ESADE.
A spokesman for the European Commission said the body wouldn’t comment on specific judicial proceedings under way or speculate on their outcome. This week, Spanish Finance Minister Luis de Guindos declined to confirm that retail investors who own preferred shares will be hit by losses, but didn’t rule it out.
One regional prosecutor in Galicia has filed a lawsuit against Mr. Coloret’s bank on behalf of more than 1,600 affected depositors. In two other regions, Andalusia and the Balearic Islands, prosecutors said they are considering lawsuits against other lenders.
Carlos Varela, the prosecutor who leads the case in Galicia, said investors could have been misled in about 70% to 80% of preferred-stock sales Novagalicia made since 2003.
“The bank, needing to recapitalize, aggressively went after loyal customers through the branch network, taking advantage of long-standing relationships between clients and the bank, and often abused this trust,” Mr. Varela said.
A spokesman for Novagalicia said an internal review found significant irregularities in preferred-share sales, and that the bank’s new management is willing to compensate clients. The bank is also seeking to swap preferred shares for other, more tradable securities. So far, it hasn’t received authorization to do either from Spanish and European authorities.
Novagalicia has almost €1 billion in outstanding preferred stock. Two other nationalized banks, Bankia and CatalunyaCaixa, have €3.05 billion and €480 million outstanding, respectively.
In 2011, Spanish banks had €22.5 billion in outstanding preferred stock among 700,000 customers. Many banks have swapped the preferred stock for more easily traded common shares, or for time deposits, reducing the outstanding preferred stock to €5.8 billion. Clients who accepted the swaps have also incurred losses, as Spanish banking stocks tumbled.
For more than a century, Spain’s savings banks were cornerstones of local communities, financing industry and households, guarding the savings of their clients, and spreading profits back into those communities through cultural and social projects. Most Spaniards came to trust their local “caja” with their main investment decisions, such as getting a mortgage.
José Ramón Santomé, a 53-year-old fisherman, was also a loyal Novagalicia customer. Now he might incur a loss of €20,000 of his own savings. He heard about the EU’s burden-sharing plans for Spain’s banks from a colleague Wednesday morning.
“This is terrible,” Mr. Santomé said. “Don’t they understand that we are workers and not investors?”
For years, whenever a client wanted out, banks just sold the same security to another depositor looking for high interest rates, returning the principal to the seller. That helped maintain the appearance that the preferred stocks were low-risk investments.
Many of those affected are pensioners. Prosecutors estimate that 5,000 of the preferred shares investors in Novagalicia are retired.
Messrs. Santomé and Coloret are part of a group of 900 families in the area of Morrazo, Galicia, that have made headlines locally for protesting by littering branches with fish, throwing eggs at windows, and demonstrating and camping out at branches.
Write to Christopher Bjork at christopher.bjork@dowjones.com
A version of this article appeared July 12, 2012, on page A11 in the U.S. edition of The Wall Street Journal, with the headline: Europe Bailout Conditions Pinch Spain’s Small Savers.
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