Domestic banks stuck with pain in Spain

©Reuters

As they scrutinise the full-year results of Spain’s leading banks over the next two days, investors will be looking to answer a crucial question – is the worst finally over for the crisis-ridden Spanish banking sector?

Market sentiment has certainly turned more positive since the start of the year. The shares of Spain’s three biggest lenders – Santander, BBVA and Caixabank – have all edged higher over the past month, as have the shares of weaker financial groups. January bond auctions by Santander and BBVA were unusually well-received. Another sign of confidence is the readiness of Spanish lenders to repay some of the cheap emergency loans provided by the European Central Bank last year.

However, Santander’s results on Thursday were not welcomed, with Spain’s largest bank by assets reporting that net profits – after it booked €18.8bn in provisions for last year – tumbled 59 per cent to €2.2bn, sending its shares down by 3.4 per cent.

Spanish politicians and regulators claim that the banking crisis that engulfed the country last year – and that forced the government to seek a €100bn EU bailout – is now well on the way to being solved. Mariano Rajoy, the prime minister, has declared himself “absolutely convinced” that Spanish banks will not need additional capital beyond the €40bn injected by the government and the EU so far.

Senior officials at the Bank of Spain also sound a confident note: “I am not claiming that we are totally out of the woods,” says one. “But the basic work of restructuring has already been done.”

The upbeat tone is being reflected by Spain’s bank chiefs as most follow their peers by announcing they have paid back part of the three-year loans taken from the ECB last year. Santander said it had paid back €24bn to the ECB, with BBVA expected to follow suit.

“I believe we are now entering a new phase,” said Emilio Botín, Santander’s 78-year-old chairman, at the bank’s year-end results conference.

However, worryingly for Mr Botín, the international units that his bank boasts will protect it against problems in Spain did not perform well, with pre-provision profits in the fourth quarter in the UK down by 20 per cent, by 25 per cent in the US and by 3 per cent in Brazil.

Investors, meanwhile, have been watching closer to home for signs of a slowing in non-performing loans in the Spanish market.

BBVA, which follows Santander, its main domestic rival, when reporting Friday is expected by analysts to have completed the last parts of the provisions lenders were required to make by the Spanish government.

Caixabank, Spain’s third-largest bank by assets, which does not enjoy the international diversification of its bigger rivals, is expected to report an increase in bad loans, which rose to €1.14bn in the third quarter.

Meanwhile, last week Banco Sabadell, a medium-sized lender, frustrated analysts by not including a detailed breakdown of its non-performing loans in its year-end results.

Analysts agree that Spain has made progress towards cleaning up its banking sector. However many warn there are further pitfalls ahead and few foresee a rapid return to the kind of profits that were common before the crisis. “I don’t think that bank profits are going to be high, at least for those banks that operate mainly in the Spanish market,” says Juan José Toribio, a professor of economics at the IESE business school in Madrid.

Prof Toribio argues that profits will be depressed not least by the continuing need to retrench, both in terms of the branch network and the balance sheet. “The Spanish banking system has a loan-to-deposit ratio that is too high, at more than 200 per cent,” he says. “They have to reduce it. Reducing it means less credit to the economy but it also means less profit and less business for the banks.”

It is a challenge that will be made even harder by the continuing economic deterioration in Spain. The Spanish economy is expected to contract by about 1.5 per cent in 2013, the second consecutive year of recession. Unemployment has just breached 26 per cent, and is set to rise further.

The drumbeat of dire economic news has kept alive broader fears – at least in some quarters – over the health of Spain’s banks. Two areas of concern are retail mortgages and loans to small- and medium-sized companies. In both cases, the ratio of non-performing loans has crept up steadily, a trend that is certain to continue unless there is a rapid turnround in the broader Spanish economy.

Despite the recent rush of writedowns, doubts also remain over the banks’ exposure to Spain’s stricken real estate developers. In a study, Santiago Lopez, a bank analyst with Exane BNP Paribas, points out that lending to developers increased an “incredible” 27-fold in the years between 1995 and 2009.

Since then, despite the near-total collapse of the property market in Spain, the absolute level of loans has declined by only 14 per cent – and still stands at the same level as in 2007. Mr Lopez’s conclusion: “Additional deleveraging lies ahead.”

Investor sentiment may be improving and the immediate risk of another banking collapse may have receded. However Spain and its lenders still face a deepening recession, rising unemployment, falling house prices and a collapse in domestic demand. It is a reality that looks certain to mark the results of Spanish banks for some time to come.