Spanish Banks’ Tale of Woe to Drag On

There is still more agony to come for Spanish banks.

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The Madrid government has duly released the much anticipated results of “stress tests” by two consultancies, showing that Spanish lenders will need somewhere between 16 billion euros ($20 billion) and 62 billion euros of new capital.

Publication of these broad assessments has cleared the way for Luis de Guindos, economy minister, to make a formal request on Monday to his euro zone partners for a credit line of as much as 100 billion euros.

This money—a partial bailout for the crisis-stricken Spanish state—will be used to recapitalize needy banks, including Bankia, the merged group of seven savings banks that has called for 19 billion euros of emergency capital support and is being nationalized.

From Madrid to London, however, skeptical analysts say much more needs to be done, and done more quickly, to restore confidence in Spanish banks so they can revive lending to businesses and help to end a crippling economic recession.

The next stage in Spain’s bank restructuring is for four accounting firms—Deloitte, PwC, Ernst & Young and KPMG—to complete a comprehensive analysis of loan portfolios by the end of July. That will provide the basis for another, more detailed stress test by end-September to work out how much capital each bank needs. Then banks must prepare recapitalization plans by mid-October, and will have a maximum of nine months to carry them out.

For many critics of Spain’s belated and piecemeal approach to bank reform since the economic and financial crisis began in 2008, even the latest recapitalization drive is too small and too slow.

“It’s something that is always hanging there, with the government behind the curve and reacting to events,” says Emilio Ontiveros, chairman of Analistas Financieros Internacionales, a research group.

To break this vicious circle, he says, regulators and officials should “take advantage of the summer and at the end of it spell out once and for all what is needed in new capital for each bank”.

Spanish officials and regulators say the latest stress tests, each conducted independently by Oliver Wyman and Roland Berger using Bank of Spain data, showed that the three biggest banks—Santander , BBVA and Caixabank—did not need outside help in the form of new capital, even in the difficult economic conditions of the “stressed” scenario.

Most of the capital, they said, was needed for banks already on government life support: Bankia, NovaCaixaGalicia, CatalunyaCaixa and Banco de Valencia. However, a third group of middle sized banks with varying business models and loan qualities—one that includes quoted companies Banco Sabadell and Banco Popular—has been left in an uncomfortable state of doubt.

The two stress tests did not provide a bank by bank breakdown of capital needs. But analysts at Barclays extrapolated the modelling to conclude that among Spain’s original commercial banks, under the so-called “adverse scenario”, Popular would have the?biggest?capital?hole—of 6 billion euros.

The Barclays analysts said that if the exercise mimicked the requirements of an earlier stress test for Ireland conducted?by?BlackRock —including a 10 percent post-stress core tier one capital ratio rather than Oliver Wyman’s 6 percent for Spain—then even Santander and BBVA would have had to raise 8 billion euros-9 billion euros apiece.

There have also been questions about the assumptions made on the quality of Spanish portfolios—not only on the loans to real estate developers, but in other areas such as home mortgages and consumer loans.

While BlackRock’s Irish stress test modelled for losses on 12 percent of retail mortgages, Oliver Wyman’s Spanish scenario is for a 3-4 percent loss rate. On other consumer lending the Irish model forecast that more than a quarter of credit would go unrecovered, compared with only 16-18 percent in Spain under the Oliver Wyman test.

Defenders of the Spanish banks say there are good reasons for the discrepancies. Mortgages in the country, for example, still account for only 62 percent of the value of the homes they are secured on, compared with an equivalent figure of 100 percent in Ireland.

Sceptics retort that Spanish banks have often failed to mark property values to market prices, and point to the common practice of restructuring loans, extending them over longer periods with lower interest rates without recognising that forbearance in accounts. That has made mortgage books look better than they really are, and kept alive “zombie” property developers to spare banks the financial hit of a default.

“Everyone is underestimating the next wave in Spain,” said one bank chief executive who knows the Spanish market well. “And that will come from the fallout from the economic problems and rising unemployment on consumer loans.”

The Oliver Wyman report refers to the problem of loan forbearance—and to the incorrect classification of underperforming real estate loans as “regulator corporate loans”—but its analysis is more optimistic than international banks that reckon Spanish recapitalisation needs exceed 100 billion euros.

Spain’s authorities, says Edward Hugh, a Barcelona-based economist and bank expert, are “still in denial”. He suggests a US-style solution of forcing banks to take extra capital now while the audits are being prepared, in order to jump-start the economy. He also supports the idea of a “bad bank” structure.

“They need to do something to remove the short-term doubts,” Mr. Hugh says.