Small companies struggling to repay loans in Italy and Spain signal bigger problems on the horizon for the euro zone after the dust has settled on Cyprus's last-ditch bailout this week.
Defaults by small and medium-sized enterprises (SMEs), easily the biggest employers in Spain and Italy, are rising at a worrying clip, spelling trouble for the banks and two countries at the heart of Europe's debt crisis.
"You can be sure that if these companies' bad debts rise, you're going to see more bad loans to families, and credit card bills that won't be paid," said Javier Santoma, finance professor at Spain's IESE business school.
The ability of Italy and Spain, which account for 28 percent of the euro zone economy compared with Cyprus's 0.2 percent, to pull themselves out of crisis and avoid full-blown bailouts depends on the health of their banks; weak banks conserve capital rather than lend to get the economy moving.
Profits at Spain's top three lenders Santander, BBVA and Caixabank fell an average 60 percent in 2012 due to steep government-enforced provisions for property losses. Writedowns of nearly 24 billion euros at state-owned Bankia led to a record 19.2 billion euro loss.
In Italy, the two biggest banks, Intesa Sanpaolo and UniCredit, set aside a combined 14 billion euros in 2012 to cover bad loans. Smaller lenders also had to increase provisions after the central bank conducted simultaneous audits of around 20 institutions.
Banco Popolare, Italy's fourth biggest, issued a profit warning after the audit prompted 684 million euros of loan loss provisions in the fourth quarter, more than the total it set aside in the first nine months of the year.
The Italian banking association has said the pace of growth in bad loans, which has been climbing at an annual rate of 16-17 percent in recent months, should ease later in the year, based on economic recovery in the second half. That looks remote after the government this month said GDP would shrink 1.3 percent this year, adjusting a previous forecast for a 0.2 percent fall.
"Consumption levels, retail sales, industrial activity have gone back to pre-euro levels, and the banks still have not fully taken into account the fall in the property market. I doubt that if they foreclose today ... they would get much of their money back," said Ronny Rehn, analyst at Keefe, Bruyette & Woods.
"So I think we will see a lot more provisioning for many years. Also, there is a lot of non-competitive companies that will end up exiting the market and defaulting, entailing more losses for the banks."
Spanish banks are better protected against SME losses after Madrid used 41 billion euros of a total 100 billion euros of European aid to prop up its weakest lenders.
The government has ruled out another round of special provisions, and analysts said if more capital was required it would be covered by the remaining European aid.
"It could be that one bank here or there needs more capital, but it probably won't be a system-wide issue," said Erwin Van Lumich, a banking analyst at Fitch ratings agency.
"Bad debts could peak in the course of this year, or slightly into 2014, as there is always a delayed effect for these types of statistics."
Spanish banks face 25 billion euros of losses from 2012-2014 on non-property-related SME exposure of 237 billion euros on a base case scenario set by consultants Oliver Wyman last year.
On an adverse scenario, that hits 39 billion euros, compared with losses of 65 billion and 97 billion euros in base and adverse scenarios on real estate exposure of 227 billion.
No Safety Net
Behind the figures are struggling people.
Raffaele Balzano faces eviction in days from his two-star hotel in Pistoia, Tuscany, which was forced to close last year. Power and water were cut off when he couldn't pay the bills.
"In 2011 it all came to a head. I had a debt of 26,000 euros with the bank, and they would not give me any new credit lines to try and stay afloat, plus I also owed some 50,000 euros to suppliers which I could not pay," Balzano told Reuters.
"No one has helped me, not the government, the banks or any trade unions. We, the small businessmen, have no safety net whatsoever. I've lost everything."
One in 10 Spanish loans was in arrears for three months or more in December, and research firm Axesor said February was the worst month since 2008, with more than 1,000 companies filing for creditor protection, up 82 percent on a year earlier, even though banks roll over debt for many struggling borrowers.
Around 1,000 companies a month went bust last year in Italy, and as of January, 7.4 percent of loans were non-performing, the highest in nearly 13 years and much worse than France's 4.1 percent and Germany's 3 percent. At the other end of the scale, the Greek bad loan ratio was 22.5 percent at end-September 2012.
With Italy and Spain expected to contract by 1.3 percent and 1.5 percent this year under the weight of government austerity programmes, SME bad debts are set to climb, meaning defaults are more likely in consumer credit and mortgages.
Unemployment, already a record 26 percent in Spain and 11.7 percent in Italy, the worst since the current statistical series began in 1992, will also climb as small firms fire staff.
No Marriage, No Mortgage
Fed up being ignored by banks and the Italian government, Giuseppina Virgili set up an association called the "Invisible Small Entrepreneurs" to advise businesses in trouble.
"The banks have turned off the credit tap for us small entrepreneurs. They don't give us money, they don't trust us. We are no longer welcome customers," Virgili told Reuters.
"They are scared that we can't pay them back, so they treat us as if we were the cause of the economic crisis, even when we should be part of the solution."
In Spain, a breakdown of the country's regional savings banks, which overextended themselves in the property boom, has left many of their small clients without financing.
"We want to lend, but those that really need the funding are the SMEs that used to borrow from the savings banks. We don't know their track record, and for now these companies are isolated, which has created a shock in terms of lending," a senior Spanish banker said, on condition of anonymity.
The government is trying to get various state-backed credit schemes going, including 45 billion euros in SME financing, plus tax breaks for these companies.
But bankers complain of a lack of "solvent demand".
"We have not seen a healthy demand for new credit," Victor Massiah, CEO of Ubi Banca, said this month after Italy's fifth biggest bank by branch numbers reported a nearly 40 percent rise in loan writedowns for 2012.
"Unemployment is rising, young people are living with their parents, they are not getting married, and they are not buying a house - the demand for private mortgages has halved."