Can Spain’s banks stave off doomsayers?

SPANISH BANKS ARE seeing a rapid increase in non-performing loans coming from the property sector, mortgage holders and small companies. Like banks everywhere, they are also finding the wholesale funding markets less than welcoming. But while the general collapse in confidence worldwide and the severity of Spain’s property crisis in particular has some investors spooked and on the lookout for any signs of trouble, the fundamentals of the picture, although by no means pretty, are not as bad as they might at first appear.

When the European Central Bank this September announced plans to increase the discount it applies to the unsecured bank bonds and asset bank securities that it accepts as collateral for loans, investors immediately singled out Spanish banks, particularly the mutual savings banks, the cajas, as those most likely to suffer.

The singling out of Spanish banks for their use of ECB loans, however, is unfair considering that they are by no means disproportionate users of the ECB’s lending facilities, unlike, say, German banks. It highlights the extent to which investors, panicked by dramatic events elsewhere and acutely aware of Spain’s deflating property bubble, are gloomy on the country’s financial sector.

Although there are plenty of reasons to justify the gloom – a million unsold homes, rising NPLs, slowing economic growth, rising unemployment, exposure to the property sector, and higher funding costs to name a few – the situation is unlikely to be one of doom as Spanish banks are probably better able than most to withstand such a storm and have, to date, held up noticeably better than many of their peers. The picture is complicated, ugly and set to get worse but is probably still not quite as bad as it looks at first glance.

Take Spanish banks’ use of ECB funding, for example. Although borrowing from the ECB had shot up to €49 billion at the end of July 2008 from €18 billion at the end of June 2007, the increase partly reflects just how little Spanish banks, primarily retail institutions with few bond holdings or other assets in a format eligible for use as collateral, have tapped the ECB in the past. Moreover, although the increase was rapid, it stabilized months ago. Spanish funding from the ECB has increased by just €5 billion since December 2007, equivalent to about 0.15% of Spanish banking assets.

Despite the recent growth in borrowing from the ECB, Spain’s share of ECB borrowing is still below its 2003 peak. Also, contrary to popular perception, the quality of securitized assets being used as collateral from Spanish institutions remains high – 93% of total Spanish mortgage securitizations were AAA rated as of December 2007.

Evidence from the ECB and Spain’s central bank suggests that foreign banks operating in Spain, net debtors in the local interbank market because of business models that have been based on high lending growth with little deposit collection, have been responsible for much of the increase.

Foreign exposure

Some of the largest and most concentrated exposures to troubled Spanish property developers are also to be found with foreign financial institutions. Investment banks RBS, Goldman Sachs and Calyon, for example, are among the big creditors of troubled property groups such as Colonial and Martinsa-Fadesa, having underwritten acquisition financing for them in recent transactions.

While some of the weaker cajas have turned to the ECB, the large commercial banks, particularly Santander, BBVA and Popular, have been better able to fund themselves through deposits and wholesale markets.

"There is no question that the country is going through difficult times," says Gonzalo Gortazar, head of the European financial institutions group at Morgan Stanley. "There is pressure on credit quality and pressure, like everywhere else, on funding costs. But there is actually no problem of capital in Spain, which is a big difference with other systems. There is no problem with exposure to structured credit and the banks have very significant cushions of generic provisions that are far greater than you will find elsewhere. The banks are also very efficient, profitable and well run, so although they face a difficult cycle that has yet to run its course and they will have to increase provisions and profits will fall, they face it in good shape and I do not think that there is any systemic risk of any shape or form."

Although there are fears that some of the smallest cajas with concentrated exposures to seriously affected property developers could face threats to their survival, confidence in the Spanish banking system’s ability to withstand the crisis is high. Spain’s largest banks, Santander and BBVA, which derive more revenue from their international operations than their domestic ones and whose local assets together account for about 30% of the banking system, are among the strongest banks to be found anywhere these days. BBVA’s credit rating was recently upgraded to AA by Standard & Poor’s and when the UK’s Alliance & Leicester faced trouble, it was Spanish bank Santander that came to the rescue.

Spain’s banks might be in a good condition to face difficult times thanks to high levels of cost efficiency and years of strong profit growth and counter-cyclical provisioning enforced on them by the central bank but the strength of the weakest will be put to the test as the problems facing the Spanish banking sector are likely to get a lot worse before they get better.

Non-performing loans are rising rapidly. Although NPLs remain below 2%, the proportion of troubled loans has doubled since the end of 2007. The Confederación Española de Cajas de Ahorros (Ceca) – the Spanish savings banks association – expects NPLs for its members to increase from an average of 1.89% in July 2008 to more than 3% by the end of the year and to reach up to 5% in 2009.

"NPLs in Spain have increased faster than we expected" Tomas Varela, Banco Sabadell