BMI View: We expect loans from Spain's banking sector to continue declining in 2013, following 10.3% year-on-year (y-o-y) contraction in March, as deteriorating asset quality and sustained deposit flight weigh on banks' ability to lend. As negative loan growth will continue restricting banks' profitability , and the September reclassification of restructured loans will force banks to raise their capital provisions, we believe further government recapitalization of the sector will be required at some point in late-2013 or 2014.
Although concerns over Spain's banks culminated in the EU Commission backing a EUR41bn (3.5% of GDP) rescue of the country's four ailing national lenders in 2012, the bank recapitalization is failing to revive lending in the contracting economy . R ecently- released data from the Bank of Spain (BDE) sh owed that banking sector assets contracted by 5.4% year-on-year (y-o-y) in March 2013 , down from a 4.0% contraction in February. T he deteriorating lending environment has prompted us to downgrade our forecast for asset growth to -2.5 % in 2013, from 0.4% previousl y, while we expect declining asset quality through H213 to encourage Spain to draw down more fund s from the EUR100bn c redit line agreed through the European Stability Mec hanism (ESM) over the next few quarters.
While total banking sector assets contracted by 4.3% y-o-y in Q113, banks' loan portfolios have fared even worse, shrinking by 10.4% y-o-y in March, from a 7.6% fall in February. We revise our forecast for client loans to a 5.1% contraction in 2013, from a 1.0% fall previously , and expect lending to be restricted by private sector deleveraging and declining bank deposits . We believe the sharp slowdown in loans will we igh heavily on the sector's profitability in 2013. Indeed, the loan slowdown saw Banco Bilbao and Banco Santander's net interest earnings both contract by over 9.0% y-o-y in Q113 , while Banco Ceiss , BMN and Caja 3 , three medium-sized Spanish banks, recently reported losses of EUR2.5bn, EUR3.7bn and EUR1.0bn in 2012.
|Client Loan Growth To Continue Contracting|
|Spain - Client Loans|
As we expect slowing loan growth to continue restricting the retained earnings of Spanish banks, we see banks capital buffers suffering over the next few quarters. While capital provisions have improved modestly due to more stringent regulatory thresholds forcing banks to increase their proportion of capital holdings (the Bank of Spain stipulated that banks' have capital adequacy ratios of above 9.0% from January 2013) and the recapitalization of the banks , we believe Spanish banks would have to become significantly more profitable to avoid further public sector assistance over the next few years. However, g iven that we see weak deposit growth weighing on Spanish banks' ability to boost lending, and therefore profits in 2013 and 2014 , particularly in light of the regulatory environment, we believe this outcome is unlikely. Bank deposits have contracted for eight consecutive months, accelerating to a 7.0% y-o-y contraction in March, and we see low wages and falling disposable incomes weighing on household s ability to boost savings over the next few quarters.
|Bleak Outlook Restricting Bank Deposits|
|Spain - Deposits|
Alongside weak client deposits, we expect asset quality to deteriorate further, weigh ing heavily on the sector ' s profitability. While the proportion of non-performing loans (NPL) fell to 10.4% (EUR161.9bn) of total loans in February 2013 , down from 10.8% the previous month , the modest fall was due mainly to the transfer of part of the sector's real-estate assets to SAREB , a bad bank established to clean the balance sheets of state-rescued banks .
W e believ e the impact of the ongoing real estate crisis, the recessionary economy and record unemployment (27.2% in Q113) will drive up the proportion of underperforming loans going forward . In 2012 people were already struggling to repay their mortgages ( an average of 80 families a day had their mortgages foreclosed ), and we expect increasing numbers of people to have difficulties over the next few quarters, a s we forecast unemployment to rise to 27.5% by end-2013 and see real GDP contracting by 1.7% over the course of the year . A sset quality is unlikely to improve anytime soon, and we caution that the sector is estimated to be sitting on over EUR100bn of 'risky' mortgages.
While Spanish bank s ' tier 1 capital adequacy ratio was 11.0% at end-2012, we believe this figure fails to adequately recognise the level o f risk stemming from the sector s declining asset quality. Rather than recognise many of the non-performing loans on their books, Spain's banks have ext ended or refinanced them, even in situations where borrowers are unlike ly to be able to pay them back. Spanish banks have refinanced 14 .0% over total loans ( EUR202.2bn ) , with over 37% of these restructured loans classified as 'doubtful' and 21% as 'substandard'.
|Turning Away From Client Loans?|
|Spain - Selected Components Of Banking Sector Assets, EURbn|
However, with the Bank of Spain (BDE) announcing in May that banks will have until September to reclassify all restructured loans according in accordance with tougher guidelines, we believe the NPL ratio will rise significantly in H213. The rules will see banks reclassify some of these currently performing loans as substandard, which we believe will force the banks to take on fresh capital provisions. T he extra capital provisions are likely to weigh further on loan growth and retained earnings , implying that some further public money is likely to be needed to help the nationalized ban ks in late-2013 or 2014.
Risks To Outlook
A key risk to our outlook is the government's willingness to secure a state bailout in either 2013 or 2014. While bond yields have been driven down by the ECB's offer to buy sovereign debt through its Outright Monetary Transaction (OMT) programme, a sharp change in investor sentiment and higher borrowing costs would make a full blown sovereign bailout likely , as servicing the country's hefty public debt burden (81.1% of GDP in 2012) becomes increasingly expensive. In such a scenario, we believe the promise of the ECB buying bonds would help modestly stabilise finan cial markets and the country's banking sector , which could requir e upward revisions for our asset and client loan growth forecasts .