Spain's Woes Start To Sting Big Banks

Spain's Woes Start To Sting Big Banks

By Sara Schaefer Muñoz | 7 March 2010

Spain's property woes and economic downturn finally may be catching up with the country's two largest banks, Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA. The big banks have remained 'profitable' [[principally by avoiding writing down its losses on RE loans: normxxx]] throughout the financial crisis despite the bursting of the housing bubble in Spain, high unemployment and other problems. One reason: the government's strict requirements for Spanish banks to maintain high reserves against bad loans, in part a response to a previous property downturn in the 1990s.

But now there is concern whether these cushions can withstand the impact of an increase in nonperforming loans. As these mandatory reserves wane, the banks' profits could be hit by the same economic and real-estate-related losses that have dogged banks in the U.S. and Europe.

"Having outperformed the sector during the credit crisis … recent results cast doubt over the adequacy of generic reserves to absorb future losses," said Barclays Capital analyst Tom Rayner in a recent note. Barclays ranks the banks "underweight."

Both Santander and BBVA maintain that their provisions are adequate and in compliance with the central bank's rules. At the same time, some analysts have raised questions about whether the Spanish banking sector in general is underreporting problem loans, by agreeing to loan modifications that help borrowers make payments before the loan is officially categorized as delinquent. Recent data from Spain's National Statistics Institute show a 55% rise in mortgage "novations," or changes to the terms of a mortgage, to 435,835 in 2009, for the sector.

A spokesman for Santander said the bank doesn't say how many mortgages it has restructured, but said the bank has a policy of helping good customers before a loan goes bad. A spokesman for BBVA said it will work with customers in modifying some loans, but its residential mortgage book consists of mostly first-home mortgages on which people are unlikely to default. A spokeswoman for the Asociacion Espanola de Banca, Spain's bank association, said the jump in 'novations' likely was due to borrowers moving from a fixed to a variable rate, and it is unlikely to minimize troubled-loan ratios.

Analysts, however, said these modifications could make risky loans— specifically, those on which the borrower needed to change the terms in order to be able to pay— look better in the short term and help the bank avoid taking a charge. "The banks wouldn't have to recognize the restructured loan as problem loans," said Alastair Ryan, an analyst at UBS AG, which ranks the banks "sell". "But this could generate a drag on income in the future," if the bank is accepting lower interest or the loan eventually defaults.

Thanks in part to significant business operations outside of Spain, Santander and BBVA have managed to ride out the financial crisis better than its peers. Santander posted an €8.9 billion ($12.19 billion) net profit for 2009, up 1% from the prior year, and BBVA, €4.2 billion, down 15% from 2008. Certain provisioning requirements by Spanish regulators have been a big factor. The Bank of Spain requires that lenders set aside funds to offset future losses, according to a formula related to lending that regulators have fine-tuned over the past several decades.

When setting aside cushions against souring loans, the banks typically use a combination of these provisions along with additional funds from recent profits, as needed. These cushions, while currently adequate, have dwindled in relation to problem loans. The amount of funds that Santander set aside, compared with the amount of problem loans on its books, stood at a ratio of 75% at the end of 2009, up from 73% in December but down from 134% at the end of 2008. BBVA reported this "coverage" ratio at 57% at the end of 2009, down from 92% in 2008.

Coverage for the Spanish books are lower still. In 2009, the percentage of Santander and BBVA's nonperforming loans to total loan books was 3.2% and 4.3%, respectively, up from 2% and 2.3% a year earlier. In 2009, Santander reported a core capital ratio of 8.6% and BBVA reported a ratio of 8%. Analysts say the banks remain well-capitalized.

The problem now is that the Spanish economy is continuing to deteriorate, making the dynamics of the property market even worse. Unemployment is expected to hit 20% this year, by some estimates, and Spain's gross domestic product contracted 3.6% in 2009 and is expected to shrink again this year. Property prices have fallen an estimated 15% from their highs and are expected to keep declining.

Yet the cocktail of problems is taking a toll. While analysts said Spain's two biggest banks are well-capitalized, they said reserve provisions will wear thin by the end of the year for BBVA and by 2011 for Santander. This will cause the banks to pony up more funds to cover problem loans, weighing on profitability in 2011 and 2012.

Santander's share price has fallen 15% in the past three months, closing at €10.05 ($13.76) Thursday in Madrid, up 1.1%, while BBVA's share price was down 23% in the same period, closing Thursday at €10.06, up 1.4%. Meanwhile, the Dow Jones Total Europe Financials index fell 10% in the same period.

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Normxxx    
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