Spain has owned up to the extent of its banking problem with a $10 billion euro rescue plan for Bankia SA, the country's fourth-biggest lender that is saddled with a huge toxic property portfolio, but investors want more details to be convinced that the financial system is recovering.
The government will unveil its banking reforms on Friday, hiving off property assets from banks' balance sheets as well as pumping cash into Bankia, in a fourth attempt in three years to reassure investors on the health of the sector.
"A step forward in the recognition phase of the problem for the government, which is in itself a positive," said Goldman Sachs in a research note.
But what is still unknown is exactly how the Bankia rescue, involving 7 to 10 billion euros ($13 billion) of public cash, will work and what will be the mechanics of a system to separate property holdings from banks.
Spanish banks have effectively become the country's biggest real estate agents after a devastating property crash in 2008, and investors fear losses could strain the public finances, dragging the country further into the euro zone debt crisis.
Rodrigo Rato stepped down as chairman of Bankia on Monday to be replaced by Jose Ignacio Goirigolzarri, a former chief executive of Spain's second biggest bank, BBVA, who has more than 30 years of experience as a banker.
Investors in Spain's larger banks were relieved that the government was itself stepping in to sort out Bankia rather than forcing healthier banks to foot the bill.
Shares in Santander, BBVA and Caixabank all gained for a second day on Tuesday while Bankia dived another 5 percent, making it the biggest loser in the Spanish blue-chip index as uncertainty continued about its future.
"This is the sort of thing you should do over a weekend, not let out by press leaks on a Monday with vague promises of a resolution on Friday," said one banking analyst.
For months the new government, elected late last year, had said it would not put more public money into rescuing the banks. The Bankia rescue plan, confirmed by government sources on Monday, marked a change in direction under pressure from the country's major banks, the IMF and ratings agencies.
The government on Tuesday said the Bankia operation was not a state takeover, but a restructuring aimed at guaranteeing the bank's viability. Bankia holds a tenth of the deposits in the Spanish banking system.
Economy Minister Luis de Guindos said all depositors and borrowers at Bankia could be absolutely sure the bank was solvent. A source at the bank said there had been no sign of people withdrawing their money.
In the reforms to be announced on Friday, banks will form property units where they will park their real estate assets. Unlike a bad bank, the government aims to make these units work without public money.
"We are skeptical that this will be the silver bullet the market is looking for," said Carlos Berastain of Deutsche Bank, adding there was uncertainty over to what extent loans extended by Spanish banks' may slip into default in the country's second recession in three years.
A poisonous mix of recession and high unemployment means more Spaniards are defaulting on personal and business loans, worsening banks' capital shortfalls.
Mid-sized Spanish savings banks such as Banco Mare Nostrum (BMN), Ibercaja, Unicaja and Liberbank could be strong-armed into transferring toxic assets into these property units.
Spain's biggest banks, Santander, BBVA and Caixabank, have been vehemently against the formation of a state-level bad bank as their plans to write down losses against bad property investments are well underway.
The heads of Santander, BBVA and Caixabank on Friday pressured de Guindos to resolve the Bankia issue as soon as possible, a source with knowledge of the matter said.
CASH OR CONVERTIBLES?
Bankia is likely to receive its injection of up to 10 billion euros in public cash, in the form of loans or direct funding, in order to write down the bank's losses related to bad property investments.
A direct injection of cash would be preferable to loans through a convertible bond, as the latter would raise the question of whether the bank could to pay back the loans.
"It would make more sense to be a direct injection of funds rather than a convertible bond because the market would doubt the bank's ability to repay the bond which would generate uncertainty," said Daragh Quinn, an analyst at Nomura bank.
However, if the government directly injected cash into Bankia, that would affect the public deficit, under EU rules. If the government buys Bankia convertible bonds at a market rate it would not hurt public finances.
Under the terms of the last banking reform law, Bankia must be in a merger process in order to receive state loans in the form of convertible bonds known as "CoCos".
Bankia could merge with its parent company Banco Financiero y de Ahorros (BFA) in order to overcome this restriction.
Whether the state decides on cash or loans to Bankia, either way the state-backed FROB b ank restructuring fund would have to raise money through a bond on the market, which will raise the level of public debt to gross domestic product.
The FROB could also convert its 4.5 billion euros of preference shares in BFA, made as a loan under an earlier bank reform, into ordinary shares, increasing the government's stake in the bank. ($1 = 0.7663 euros) (Editing by Fiona Ortiz and Giles Elgood)