Spanish banks on the mend as bad loans subside

The financial crisis of 2007-2009 has left a lot of collapsed Spanish castles in its wake, hitting Spanish banks hard.

Pictures of Spain’s ghost towns were splashed across the world’s newspapers at the beginning of the eurozone debt crisis. True, they weren’t as impressive as the Chinese ghost cities, but they show what excess debt and an inflated real estate sector can do to a country – and to its banks.

However, more than five years on since the crisis, the story is slowly changing.

Spanish banks are digging themselves out of the hole, with non-performing assets (NPAs) falling due to economic growth.

Scope Ratings, the European credit rating agency, estimates that NPAs will continue to fall but warns that many factors on which the economic recovery depends are cyclical – so Spain is not out of the woods yet.

In March this year, system-wide NPAs were 211 billion euros ($236 billion). That’s 16% below their December 2013 peak of 251 billion euros, according to Scope Ratings’ analyst Marco Troiano.

He estimates that if the pace of decline in bad loans registered in the first four months of the year continues, total NPAs will be cut by 15% year on year by the end of the year to 190 billion euros.

If the higher rate of decline in NPAs, seen in April, is extrapolated instead, they could see an even deeper decline of 22% to 173 billion year on year in December.

Spanish Banks Recover

Spanish banks NPLs’ decline accelerated in April. Source: Scope Ratings.

The stronger economy should make the sales of foreclosed assets and portfolio sales of non-performing loans easier.

Troiano looked at data on real estate asset sales from SAREB – Spain’s “bad bank” – and says they signal improved demand and bode well for the future.

SAREB was created in 2012 as part of a 100 billion bailout of Spanish banks and has 15 years to dispose of the bad assets it holds. SAREB acquired bad property loans from banks in exchange for government bonds.

Scope rates two Spanish banks, BBVA and Santander. The rating agency says their diversified revenue models have made the banks resilient to the deep domestic recession.

“We believe the reported financial performance of both banks should improve over the coming years, as losses on real estate legacy assets gradually decline. As a matter of fact, we have already seen a sharp reduction in Spanish real estate assets earmarked for run-off at both banks,” says Troiano.

“A further acceleration in the clean-up of legacy assets, coupled with improving financial performance, would be positive for the rating of these banks, although we note that our current forecasts already partly incorporate the anticipated improvement,” he adds.

However, Troiano warns that many of the factors that support the recovery are cyclical, such as cheap credit due to record low interest rates and a boost to exports given by the weak euro.

Spanish banks should therefore make the most of cleaning up their balance sheet while the going is good.