In July 2012 US-based Oliver Wyman and German strategy consultant Roland Berger published a then much-anticipated set of stress tests on the Spanish banking sector. The exercise was undertaken to calm market fears over the eventual losses that the banks might face on their problem exposure, primarily to real estate lending. The two determined that the sector faced expected losses of between 170 billion and 190 billion under a base scenario and between 250 billion and 270 billion under an adverse scenario between 2012 and 2014.
New research published by Nomura last month reveals that while NPLs in Spain remain well below the adverse scenario envisaged in the 2012 stress tests, they are currently running at roughly 14% above the base-case scenario. However, a closer look at purely real estate exposure reveals that the domestic banks have now reached around 80% of losses envisaged under the adverse scenario. Questions over adequate provisioning for bank losses in the country are now being raised once again.
In its October Global Financial Stability Report, the IMF stated that corporate loan losses for banks in Spain, Italy and Portugal might hit 282 billion over the next two years based on a 45% loss-given-default assumption. It concluded that corporate loan losses might be as high as 125 billion in Italy, exceeding banks existing provisions by 53 billion; 20 billion in Portugal, exceeding provisions by 8 billion; and 104 billion in Spain where, according to the IMF, provisions are adequate.
But with the European Central Banks asset quality review and stress tests due to be completed by November 2014, not everyone in the market is convinced that mid-tier Spanish banks are fully prepared for what could hit them particularly as details of the stressed items have yet to be announced.
"With regard to the AQR and stress tests, all of the large banks have indicated that they will be fine, but there is a risk that the tests end up being tougher than anticipated," says Jon Peace, head of European banks research at Nomura in London.
"We have concerns over the potential impact of the AQR in both Italy and particularly Spain," says Peace. "We have seen some pre-emptive capital raising in Spain but we are surprised we havent seen more. Spanish banks have been so well audited that the chances of turning up big problems have been reduced. But they have not been eliminated."
Whether or not they have fully provisioned for the real estate losses that they still face could be indicated by a recent comparison undertaken by Nomura of the marks at which the banks are holding these loans with the prices at which similar loans are being transferred to Spains state-owned bad bank, Sareb.
The difference is in some cases quite striking. For example, Santander provisions against its current 20.3 billion exposure to real estate developers at 50.8% while the haircut implied by the price at which such loans have been sold to Sareb is 55.6% a shortfall of 1 billion or 0.1 times operating profit. Banco Popular Español carries its 32.6 billion exposure at 34.3% while the Sareb haircut is 50.7%, resulting in a shortfall of 5.4 billion or three times current operating profit. Banco Sabadell has 29 billion exposure to developer loans, which is provisioned at 42.7% by the bank and 53.3% by Sareb. This 2.3 billion shortfall is twice current operating profit.
The Japanese firm then calculates the total extra provisioning that would be required by banks on both real estate (if marked to Sareb prices) and non-real estate exposure (assuming a 15% increase in base-case losses happening) and the results give an idea of what the new AQR stress tests could mean for mid-tier Spanish banks.
Banco Popular Español has a 9.4 billion shortfall, which is 5.3 times operating profit, and Banco Sabadells 5.8 billion shortfall is 5.1 times operating profit. "Mid-tier Spanish domestic banks have set aside specific amounts for provisioning, but a relatively small increase in an NPL classification of loans on their books could dent profitability very quickly and take a bite out of the equity," Peace concludes. "Visibility on loan-loss provisions in Spain remains limited and the normalization of loan losses could take longer than expected."
Not the only worry
Recent comments by ECB executive board member Peter Praet suggest that real estate NPLs might not be the only assets on their books that Spanish banks need to be worrying about.
In December, Praet suggested that increasing the risk weights associated with government bonds would be a means by which the ECB could ensure that any future LTRO-style funding makes its way into the real economy rather than simply being applied to a sovereign bond carry trade (as was largely the case in the previous two such operations). Although it seems unlikely that such a move would penalize banks existing holdings of sovereign debt, it would make any operation prohibitively expensive for Spanish and Italian lenders.
"Any such rule change would by far and away have the biggest penalizing effect on Spanish and Italian banks two of the economies that need the most significant boost from increasing lending to the real economy by their banks," observes Oliver Burrows, banks analyst at Rabobank in London. German banks hold sovereign debt equivalent to 4.4% of their total assets, Portuguese banks 7.7%, Belgian banks 8%, Italian banks 9.5% and Spanish banks 10.2%.