The Wall Street Journal

Depositors Turn Up Heat on Ailing Spanish Banks

 MOAÑA, Spain—Eugenio Nuñez Cobás stormed into a bank branch in this coastal town one morning in August with three dozen fellow customers yelling "Thieves! Thieves! Thieves!" Then they returned to the street and pelted the facade with eggs, forcing the branch to close for the day.

Mr. Nuñez had been coming to the Novagalicia Banco SA branch for eight months with a placard that reads: "I have all my savings trapped in Novagalicia Banco until the year 2999." The 70-year-old retiree said: "I really should be at home playing with my grandchildren. Instead, I'm here every week, fighting for my savings." 

 Mr. Nuñez was one of more than 700,000 Spanish depositors who poured money—in some cases their life savings—into high-yielding preferred shares and subordinated bonds issued by their banks. When the economic crisis erupted in Spain, the securities plunged in value, making it effectively impossible to resell them.

Many customers now say they were swindled, that branch bankers assured them that the complex securities were just as safe as deposits. Some banks offered clients the option to swap preferred shares for deposits or common shares, but the European Union, which is lending money to Spain to prop up its banks, nixed any such deals by lenders bailed out by the government, including Novagalicia. That bank has issued a public apology and agreed to arbitrate thousands of claims brought by customers.

Spanish Finance Minister Luis de Guindos described the securities last Wednesday in Parliament as "complex instruments for institutional investors. The problem isn't the product itself. If people understand it, there's no problem. The problem is that the securities were placed among people that didn't understand them."

"Unfortunately, this situation makes us pretty unique—the only place in the civilized world where these preferred shares were sold to depositors," he said. The Spanish government, he added, is working with the European Union "to try to find the best possible solution for these depositors."

The embarrassing standoff between the banks and depositors is further eroding confidence in a financial system already reeling from capital flight and enormous losses tied to a housing bust. The banking sector has become increasingly hooked on emergency borrowing from the European Central Bank. Through the end of August, Spain's banks had borrowed €412.6 billion ($538 billion) from the ECB, roughly one-third of all central-bank funding to euro-zone lenders.

"As long as distrust in the banking system persists, capital flight will continue," says Domingo Bello, a professor of law at the University of La Coruña.

 Sabotage missions like the one in Moaña take place almost daily. One night last month, protesters in the northern region of Cantabria staged coordinated attacks on 50 branches of Caja Cantabria. In Catalonia, dozens of angry customers have obstructed tellers by making deposits of 50 cents, then getting back on line right away to withdraw the same amount.

In some small communities, branch bankers, once the go-to people for financial advice, have become pariahs. Customers have threatened to beat up bank employees and have slashed their car tires. Novagalicia has moved 25 employees this year because of threats, a spokesman says.

In Moaña, an economically struggling fisherman's town of 18,000 in northwestern Spain, losses on the securities have added to the woes. "Small businesses are hurting, and those maintenance jobs that people used to do on their house, they're not doing them now," said Mayor José Fervenza Costas.

"The preferred-stock problem affected a lot of people," said Noemi Coloret, who closed her women's clothing store at the end of September. "You saw customers coming in who like your product, but they don't have the money to spend. It's a total disaster."

The preferred-share debacle dates back to the early days of the financial crisis. Spain's lenders needed capital after a housing bubble burst and lots of loans went bad. International investors, wary about losses on real-estate loans, were reluctant to buy Spanish bank securities. So the nation's major banks used their vast retail-branch networks to market new preferred shares to customers.

 The product looked enticing. The preferred shares often carried higher interest rates than regular deposits. For example, in the summer of 2009, Caixa Galicia—which later merged into Novagalicia Banco—was offering preferred stocks yielding 7.5%, higher than the 4.05% interest rate it was paying clients who put their savings into an 18-month time deposits.

Some customers and branch managers say customers were told they could sell out whenever they wanted, without the penalties applied to withdrawing some types of deposits. The banks intended to find buyers at full face value.

Lenders swiftly boosted their capital levels, selling €11.4 billion worth of preferred shares in 2009 alone. All told, €22 billion of the securities were sold.

To handle buy and sell orders, banks kept internal order books. "If one client wanted to sell, five more were waiting to buy," says Pedro Alberto San Millán, director of a Novagalicia branch in the village of Cangas.

But in 2010, when loan losses soared at Spain's banks, the number of willing preferred-share buyers shrank. Some banks, including Novagalicia, sold the securities to long-standing customers.

"Regulators looked the other way, and the banks took full advantage," says Francisco López Lubián, a finance professor at the Instituto de Empresa business school. "The average Spaniard who entrusted his savings with his banker was swindled."

Spain's securities regulator said earlier this year that it is investigating potential marketing irregularities at 11 out of the 19 lenders that sold preferred stock.

The Spanish Banking Association, which represents listed commercial banks, says it believes its banks sold the financial instruments "correctly," but if irregularities are detected, it expects the securities regulator to impose sanctions on the banks involved. The Spanish Confederation of Savings Banks, which represents savings banks such as Novagalicia, declined to comment.

Regulators clamped down on the selling in late 2010, forcing lenders to create a transparent secondary market for the securities. But with Spain's banking sector in turmoil, not many investors were willing to buy from the tens of thousands of customers who wanted out. In the secondary market, some preferred shares traded at discounts of as much as 70%.

Last year, several lenders, including Novagalicia, were bailed out by the Spanish taxpayers. The preferred shares issued by those lenders stopped paying interest and became nearly impossible to sell.

In Galicia, a region of 2.8 million, roughly 8 of 10 inhabitants have an account at Novagalicia, according to bank data.

"Novagalicia was particularly aggressive placing these products," says Venancio Salcines, chairman of Galician business school Escuela de Finanzas. "If a customer had €50,000 in savings, the bank would try to sell him €50,000 worth of preferred stock."

Novagalicia sold around €1 billion of preferred shares and subordinated debt to 75,000 customers in the region, the bank says. In Moaña, it sold the securities to 11.2% of its clients, bank data indicate.

Among them were 75-year-old Balbina Pineiro Jalda and her husband, Laurentino González Fernández, age 81. Mr. González suffered a stroke last year and is confined to a wheelchair.

Ms. Pineiro says she stopped by her bank around Christmas to withdraw some of the €56,000 in savings her husband accumulated over more than 50 years of working in Spain and the Netherlands. Their banker, she says, told her that all of it was invested in subordinated bonds and preferred stock, and that because Novagalicia had been bailed out by the government, the bank couldn't give her any of the money.

She says she was stunned, and went home and combed through bank records with her son. She says she discovered that in August 2010, a few months after Europe's debt crisis erupted, the bulk of their savings, some €36,000, had been moved from a time deposit, which is akin to a U.S. certificate of deposit, into subordinated debt issued by the bank. She says the rest had been invested in preferred shares.

Mr. González, who had been in charge of the household finances before his stroke, had agreed to move the money. He says his banker had told him that the money was going into long-term savings products. "I had no idea we owned this," he says.

Twice a week since the beginning of the year, Ms. Pineiro has pushed her husband down to the local branch to join in protests. Money has become a constant worry. The couple is living on a combined pension of €1,300 a month.

"You wake up in the middle of the night and you can't go back to sleep, so you walk and you walk around the house, not knowing what to do," Ms. Pineiro says.

A Novagalicia spokesman declined to comment on individual customers, but said the bank has pledged to never again sell complex products to its savers. Novagalicia has hired an auditor to go through individual cases, and when problems are uncovered, the bank has agreed to swiftly arbitrate those cases and is paying awards within 48 hours.

In recent weeks, Novagalicia customers in Moaña have been buzzing about what will happen next. The first arbitration decisions have been favorable to customers. Arbitrators have annulled sales contracts and ordered banks to fully repay money invested by customers, minus interest payments already made.

The bank spokesman said that, as of Oct. 4, more than 3,500 of the 29,000 arbitration requests received so far have been resolved, all in the favor of customers.

So far, Ms. Pineiro and Mr. González´s case hasn't been taken up.

"People are asking themselves, 'If they've called my neighbor, why aren't they calling me?'" says Marisa Pazos Silva, one of the organizers of the protest group in Moaña. "It's a desperate situation."

In other parts of Spain, some protesters have adopted aggressive tactics. One night last month, protesters vandalized 50 branches of savings bank Caja Cantabria across the region of Cantabria, the local police said.

A spokesman for Liberbank SA, which owns Caja Cantabria, said the vandalism appears to have been carried out by a small group of depositors who don't represent the attitudes of most of the thousands of people who own the securities. A spokeswoman for the regional government said local police are investigating the incidents.

Liberbank had proposed this summer to swap preferred shares into a three-year time deposit. Regulators have shelved the proposal because Spain at that time was negotiating a €100 billion bank bailout from the European Union. The EU told Spain that holders of preferred stock and subordinated debt must share the burden at banks that receive state aid, something that precluded such a swap. The Liberbank spokesman said the bank is studying the legal options for solving the preferred-share problem.

Bankers say they hope to be able to smooth over their relationships with angry customers. In July, Novagalicia's new top executives issued 10 guiding principles, including one that stipulates that the bank only will sell to retail customers products that are simple and easy to understand. "There won't be another situation like that of the preferred shares," the guiding principle reads. "We're dedicating all our efforts to resolve this problem that has caused difficulties for so many people."

But some customers may be hard to win back.

In Moaña, protesting retiree Mr. Nuñez on Sept. 21 won his arbitrage proceedings against Novagalicia. His savings account has been replenished with the €60,000 he had put into subordinated bonds.

The money won't stay there long, Mr. Nuñez insists. "I'm pulling it out," he says. "They say they have changed, but after this, I cannot trust them anymore."