Spain's bill to bail out its banks may yet rise, some bankers and analysts fear, as a worsening economy hampers the government's early attempts to sell off nationalized lenders and threatens the "bad bank" housing their rotten property deals.
Spanish banks say the worst is behind them after steep losses last year and they are now recovering - a view broadly shared by authorities such as the European Commission, backer of a 41 billion euro ($54 billion) rescue of ailing lenders.
But while Madrid is on schedule with demanded industry reforms and banks are better protected against losses from a sunken real estate market, a growing number of bankers argue in private that more state funds may still be needed to help sell rescued lenders and keep "bad bank" Sareb ticking over.
Sareb was used to clean the balance sheets of state-rescued banks by taking on 50.7 billion euros worth of foreclosed properties and troubled loans to real estate developers.
The assets are matched by 50.7 billion euros in senior debt and backed by 4.8 billion euros in capital, more than half of which was contributed by Spain's healthy lenders to reduce the burden on state books.
The 8 percent capital cushion may however be too thin to withstand losses without a top-up, which could be hard to source from the private sector, said several senior Spanish bankers and investment bankers who have worked with the government.
"It was a big mistake. The government is going to have to take over the entire vehicle sooner or later," said a Spanish banking executive, on condition of anonymity, echoing a view from three other senior bankers.
Spain took 41 billion euros of a 100-billion-euro European credit line to bail out its banks last year. The bill added the equivalent of 3.5 percent of gross domestic product to a deficit that was already higher than allowed under EU rules.
The bailout came after several failed government efforts to clean up the financial sector, crippled by more than 300 billion euros in bad loans after a housing bubble burst in 2008.
If the liabilities of the bad bank, known by its Spanish-language acronym Sareb, were to be put on the state's balance sheet, it could add up to another 5 percentage points of GDP to the country's debt, pushing it to more than 100 percent of annual output. Spain's economy ministry declined to comment.
Worries at the Bad Bank
The real estate parked with Sareb was already written down by an average of 63.1 percent and the loans by 45.6 when the assets were transferred to the bad bank, but four bankers argued that further losses could still deplete its capital.
Of its loans, only 22 percent are considered "normal"; 34 percent are rated "substandard" and 45 percent "doubtful".
Most of the loans are linked to finished properties, for which it might be easier to find a buyer, but 4.3 percent are for unfinished developments and nearly 10 percent are for empty lots, for which there is little or no demand.
Nearly all of the foreclosed properties in its portfolio are empty, including apartment blocks far outside big cities. Only 6,000 of nearly 83,000 housing units have tenants.
Bankruptcies and defaults are on the rise in Spain, and the fall in housing prices accelerated in the first quarter. The bankruptcy of property developer Reyal Urbis , which now counts Sareb as one of its major creditors, underlined the problem.
Meanwhile, Sareb is just beginning to comb through its assets.
"This (structure) could be a problem if the vehicle starts making losses and needs more equity, something very likely to happen in our view once it reappraises its assets," JPMorgan analyst Jaime Becerril said in a recent note.
One source familiar with Sareb said it was aware of the risk it might need more capital, but believed "that would only happen under an extremely distressed economic scenario."
A stress test of Spanish banks last year by consultant Oliver Wyman, which served as the basis for some of Sareb's calculations, defined a worst case scenario as a 2.1 percent economic drop in 2013 and a 0.3 percent contraction in 2014.
Spain expects its economy to shrink 1.3 percent in 2013, further than initially forecast, while growing 0.5 percent in 2014.
Sareb does have a contingency plan for shoring up capital, which involves restricting eventual dividend payments to shareholders, the source said. Otherwise fresh capital will have to come from investors - the state, or sound banks, some of whom had came under pressure from the government to invest.
A spokeswoman for Sareb said "the contingency plan is the sales plan", which entails selling almost half of assets over the next five years and paying down half of the debt.
That would bolster Sareb's capital position, she said, adding that the vehicle had enough capital at present to see its strategy through and relative to the assets it has.
Spain has already had to fork out more funds to help sell rescued banks.
After failing to sell nationalised lender CatalunyaBanc in February as bidders demanded greater guarantees against future losses, the government was forced last month to pump 245 million euros of extra capital into small nationalised Banco Gallego to clinch its sale to Sabadell for one euro.
While a small amount relative to the billions already poured into the system, the need for a capital hike exposed worries about the risks still attached to bailed-out lenders.
Spain still fully owns three banks, including Bankia , controls another, Banco Mare Nostrum, and could yet end up controlling a fifth, Banco CEISS, if its sale to Unicaja falls through.
These banks and healthy ones alike are increasingly vulnerable to rising bad loans, especially among small company borrowers, as the Spanish economy worsens. For now, that is mainly seen as a threat to earnings.
While most banks maintain they have stocked up on enough capital to counter growing provisions for losses, a handful of analysts still believe some will have to do more to ward off problems outside the real estate realm.
The Bank of Spain on Tuesday tightened the rules on how banks classify bad debt in cases of refinancing, in a move that could force lenders to recognise more bad debt.
Ratings agency Moody's had forecast last October that banks had a 100 billion euro capital gap, rather than the 54 billion euros projected by Oliver Wyman in its stress test.
"Despite all the developments, it's difficult to see that all of that 100 billion euros is cancelled out," Alberto Postigo, analyst at Moody's, said.