EBA stress test to spotlight asset quality at Spain’s banks

David Brierley and JahanZaib Mehmood Chaudhary - Miercoles, 27 de Julio

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Spain's banks are benefiting from an economic recovery, but the glare of imminent EU-wide stress test results could expose capital and asset quality problems. Figures from S&P Global Market Intelligence show that, among the largest Spanish lenders, capital has generally strengthened in recent years, and nonperforming loans declined significantly. The Spanish banking system reached a common equity Tier 1 ratio of 12.5% in 2015, up from 11.6% in 2014. Problem loans as a percentage of gross customer loans declined to 7.6% in 2015, down from a peak of 12.9% in 2013, and there is a clear trend of total NPLs falling at most large banks since 2013.

The general economic situation is good and appears sustainable for 2017, according to Bankia Bolso bank analyst Javier Bernat, with GDP growing above 2%, implying employment growth. "The outlook is much better than the last two or three years; property prices are rising by 2% and 3% year over year," he said in an interview. Commerzbank is predicting GDP growth of 2.9% in 2016 and 2.5% in 2017.

But profitability and returns are under pressure from muted loan demand, low interest rates and increasing competition.Banco Santander SA and Banco Bilbao Vizcaya Argentaria SAposted net interest margins of 2.48% and 2.39%, respectively, for the first quarter, but the purely domestic Spanish banks are achieving less impressive figures of between 1% and 2%. CaixaBank SA, Bankia SAand Banco Popular Español SA reported figures of 1.36%, 1.21% and 1.58%. Bernat said he expected this to persist, and the net interest margin in Spain to decline, resulting in returns of between 7% and 9% for the international banks and about 5% for the domestic banks.

Further, the resilience of asset quality and capital in a downturn will be challenged by the European Banking Authority's stress test, the results of which are due to be released on July 29. The picture for foreclosed real estate is murky; the total has ticked up at Santander, BBVA, CaixaBank and Popular since 2013. And Texas ratios remain high — at several major lenders including Banco de Sabadell SA, which, along with those banks mentioned above, will also be stress-tested, NPLs still represented more than 100% of common equity plus reserves in 2015.

The stress test's adverse macroeconomic scenario implies a deviation of EU GDP from its baseline level by 3.1% in 2016, 6.3% in 2017 and 7.1% in 2018, as well as "a shock in residential and commercial real estate prices."

Asset quality already forced a €2.5 billion capital raise at Popular in May. It was the third in less than four years and represented around half of its market capitalization, as Citi analysts observed in a May 26 note. At the end of 2015, Popular had €19.6 billion in nonperforming loans and €10.1 billion in foreclosed real estate, equating to some €29.7 billion in nonperforming assets and resulting in a 169% Texas ratio. The new equity is intended to cut NPAs to below €20 billion in 2018.

Sabadell, with a Texas ratio of 115%, could fall foul of the stress test, given that it had €6.6 billion in loan reserves, equating to 33% of NPAs at the end of 2015. Among the smaller Spanish banks that are not participating in the stress test, Liberbank SA, with a Texas ratio of 166%, looks notably weak although it recently emphasized its high collateralization and coverage ratios. Banco Mare Nostrum SA, Grupo Cooperativo Cajamar and Ibercaja Banco SA also could be challenged should growth falter. All of these banks have improved their Texas ratios since 2013, but the question is whether the European authorities regards this as sufficient.

A bank equity analyst, who preferred not to be named, cautioned that, although the trends are improving, the issue of so-called restructured loans is "definitely a key issue." Such loans are identified in most EU jurisdictions as "exposures modified due to difficulties of the debtor."

"It could be seen as an area of risk in Spain if the economic outlook deteriorated and unemployment trends do not continue to improve," the analyst said in an interview. He observed, though, that the migration of restructured loans appeared not to be happening at present, and that much of the real estate and developer loans are already included in the banks' NPL book.

Property sales, which are critical to improving bank balance sheets and Texas ratios, are proving a challenge, Bernat said.

"There are quite a lot of banks selling assets," he said. "Who is going to take them? Last year Bankia, Sabadell and Popular had to scale back the size of their deals. A great deal of the real estate is being sold to foreign investors. [Spanish politics] make this a volatile situation."

A stable government in Madrid has yet to emerge from the recent election.

Spanish banks received a potentially very important boost on July 13 when a non-binding opinion from the European Court of Justice indicated that they will not have to repay homebuyers excess mortgage interest charged before May 2013. The banks imposed floors on mortgage interest rates, preventing them following central bank rates downwards. On the whole, banks have set aside money for excess interest paid since May 2013 but not before.

According to SocGen analysts, writing in a May 12 note, the banks (excluding Santander) have provisioned 1% of tangible equity but could end up paying up to 6% of tangible equity. A definitive judgement is still expected, but the opinion of Advocate General Paolo Mengozzi of the Court of Justice has encouraged markets to think the banks' exposure could be limited to current provisions.

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