Spanish Banks' Borrowing Up; Recapitalization Coming?

Spanish banks' borrowing from the European Central Bank almost doubled in March from February to 316.3 billion euros ($415.9 billion) as the question whether Spanish banks need to be recapitalized hangs over the sector like the sword of Damocles.

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Worries about the country's housing sector and a recent spike in government bond yields have rattled investors' nerves over the past two weeks and last Tuesday, Spanish central bank Governor Miguel Angel Fernandez Ordonez said "if the economy worsens more than expected, it will be necessary to continue increasing and improving capital as necessary in order to have solid entities.”

Marco Troiana, analyst at Berenberg Bank in London, told that the central bank governor didn't specify which Spanish banks would need additional capital. However, he added" I wouldn't believe that big banks like Santander and BBVA will need to raise capital from investors as they are focusing on boosting the capital levels by scrapping dividends and debt to equity swaps"

On Thursday, Spanish lender Banesto kicked off the first- quarter Spanish bank reporting season, posting an 88 percent slump in profits as it set aside 475 million euros in provisions for potentially non performing property loans - only 50 percent of the total provisioning needs it expects for the full year.

In January the Spanish government introduced reforms under which Spanish banks must increase their provisions for property assets by 52 billion euros. This will also weigh on earnings from the rest of Spain's banking sector, including the country's biggest banks BBVA and Santander.

However, according to Troiano the effect of the provisions will be more diluted for these big lenders as they have very profitable operations elsewhere in the world, such as Brazil, Mexico, the US and the UK.

But will an additional 52 billion euros in additional provisions be enough?

Spanish banks are sitting on 300 billion euros of property loans. According to the Bank of Spain, more than half are already classified as troubled loans. Citigroup said in a note that Spanish house prices could fall a further 20-25 percent before hitting a floor. And Banesto's CEO Jose Antonio Garcia Canteria told analysts on Thursday that the "underlying bad loans trend will keep worsening this year."

As Citigroup's Willem Buiter wrote in his famed note in March, “New property and real estate-related losses are likely to come their way as a result of further property price declines. The Spanish banks are unlikely to be able to absorb these losses."

But who is ready to help the beleaguered Spanish banks?

Private Sector to the Rescue?

The Spanish government has said it is not willing to inject more capital into the sector after it has already offered funds and deposit guarantees to the banking sector at the start of the crisis.

Meanwhile, officials from both the European Commission and the Spanish government have reiterated that there were no plans to ask the EU for funds to recapitalize the banking sector. This leaves only one candidate: the private sector.

However, this can come at a considerable cost for the bank and existing investors - as Wednesday's announcement of the share issue by Portugal's Banco Espirito Santo has shown, in which shares were sold at a 66 percent discount to Wednesday's closing price.

But the exposure to the property sector isn't the only worry for Spanish banks.

On Wednesday, Fitch warned that the funding pressures encountered by Spanish banks were unlikely to ease soon, as they "face high funding costs and have patchy access to the market."

Even if the ECB steps in to buy Spanish bonds to bring down the yield, as indicated by an ECB governing board member on Wednesday, Eric Wand, from Lloyds Banking, pointed out: "The SMP [Securities Markets Program, the ECB's bond-buying program] provides a first line of defense at markedly higher yield, but its usefulness is likely to be questioned."

"This leaves the prospect of another LTRO – though it's not desirable given the amount of funds already injected," Wand added.

Since the ECB's first 3-year loan in December, analysts estimate that Spanish banks have increased their exposure to the country's sovereign debt by 79 billion euros. Given that the yield on the Spanish 10-year paper has spiked by almost 1 percent since the beginning of March, the sovereign debt holdings have lost in value - if marked to market.

Analysts at Deutsche Bank believe that the recent spike in yields could stem from the fact that Spanish banks simply have no more LTRO money to spend on sovereign bonds. That's why it says that "Italian banks are better situated to support their domestic bond market this year than the Spanish banks are."