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No end in sight for Spanish bank pain
19 November 2010 @ 14:51

MADRID (Reuters) - Anyone hoping for the sun to shine on Spanish banks again could be in for a long wait.

Rising levels of unpaid loans, increased provisioning against exposure to the country's ailing property market and a deposit price war have a deathly grip on margins.

The depth of the problem is clear from the banks' net interest income, broadly what they earn on loans minus what they pay for deposits. Bank of Spain data shows this fell by 5.3 percent year-on-year in June 2010, the first decline since the peak of a property boom in 2008.

Meanwhile, a faltering economy combined with stubbornly high unemployment drove loans in default to an all-time high of 102.5 billion euros ($143 billion) in August.

"It's going to be a very long haul," said Neil Smith, banking analyst at WestLB. "They (Spanish banks) are probably facing another few quarters of declining asset quality."


Some of this has already been priced in. The Spanish banking index is trading at its lowest levels since June, when hedge funds sold bank shares as a proxy for Spain on fears the euro zone's fourth largest economy debts were unsustainable.

Spanish banks have underperformed the European sector by around 20 percent since the start of the year. And analysts believe valuations could continue to wane as high funding costs eat into profit margins.

"We believe the recent pick-up in domestic margin pressure has further to run and is not adequately reflected in consensus estimates," Barclays Capital said in a recent note.

Spanish banks were frozen out of the money markets during the summer after fears about Spain's burgeoning debt levels. The markets have opened up again since August, but they have been left paying more than their European counterparts.

For instance, savings bank La Caixa priced a 3-year 1 billion euro senior unsecured bond in October at a spread over mid-swaps 65 basis points greater than a 5-year bond for Denmark's Nykredit, despite having the better rating.


Banks (SBK.NX - news) have turned to retail depositors to fill the gap left by erratic wholesale funding, but in doing so have exacerbated the problem by getting into a pricing war. They are offering rates of up to 4.5 percent on one-year fixed term savings accounts in a drive to secure liquidity. That's more than double the 1.85 percent offered on 12-month Spanish Treasury bonds.

And there's a huge disconnect with what banks are charging on loans, with the one-year Euribor rate -- the interest rate most commonly used to calculate mortgage payments in Spain -- at around 1.5 percent.

"It's really started to kill them this quarter," said one UK-based banking analyst who asked to remain anonymous. "It doesn't make any sense, lenders have to lend with a margin versus their deposits, otherwise it's uneconomical."

Spain's second biggest listed bank, BBVA (931474.EX - news) , has warned this price war could cost the sector up to 7 billion euros. And it could get worse.

A repricing of the total deposit book for the top six Spanish banks by 50 basis points could cut 2011 estimated net income by 15 percent on average, Barclays Capital estimates.

And the Bank of Spain requirement that lenders put aside more reserves to protect against losses from property on their balance sheets as of the end of September is also hitting profits.

Spain's biggest bank Santander (Madrid: SAN.MC - news) said in October

profit for 2010 would miss its expectations after taking a one-off charge for bad Spanish assets under the new rules.

While Santander and BBVA have less than half their business in Spain, the trends are even more brutal for the other banks.

"You wouldn't own any of the pure domestic Spanish banks," said Royal London Asset Management fund manager Andrea Williams.


Across the sector -- including the unlisted savings banks, or 'cajas' which account for around half the banking sector -- unpaid loans as a proportion of total loans crept up to 5.62 percent in August, their highest level since Spain's housing bubble burst.

And debt owed by property developers has stuck at around 320 billion euros since 2008.

Analysts expect the proportion of unpaid loans, which lag the economic cycle, to keep on rising into 2011.

Some, such as ESADE Business School economist Robert Tornabell, say the non-performing loan ratio could reach 9.5 percent, fuelled by 20 percent unemployment.

Spain's economy crawled out of a year-and-a-half long recession at the beginning of the year, but economists expect it to contract for the year as a whole as strict austerity measures smother tentative growth and depress asset prices.

One of Spain's top five retail banks, Banco Popular, values its assets available for sale, including repossessed real estate, at almost half their peak value two years ago. There are widespread expectations of further price declines.

"We hold those assets at close to 50 percent discount to peak, and nobody wants to buy," Chief Financial Officer Jacobo Gonzalez-Robatto said last month.

The Bank of Spain puts the potentially troubled exposure of the banking sector to construction and real estate, including doubtful assets, sub-standard loans and loan write-offs, at 181 billion euros in June 2010, up from 166 billion at end-December.

The collapsed property market is at the root of the funding problems for Spain, RBS (LSE: RBS.L - news) believes, and with austerity measures starting to take effect and an unemployment rate more than double the European average, that is not likely to recover soon.

Source: Yahoo Finance

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