Rating agency Standard & Poor’s on Tuesday issued a comprehensive and downbeat note on the Spanish banking sector, something of a hot topic here on FT Alphaville.
Below are extracts from the note, any emphasis ours:
Standard & Poor’s Ratings Services anticipates a high level of credit losses for the Spanish financial system over the next three years, owing to the magnitude and length of the current recession, the high level of debt accumulated by the Spanish private sector (both corporates and households), and the rapid pace of lending growth in the years preceding the downturn. We believe, under our base-case scenario, that the Spanish financial sector, as a whole, should be able to absorb these losses due to loan loss reserves accumulated during the economic boom and Spanish financial institutions’ comparatively sound level of recurrent earnings with respect to those of many of their European peers. Nevertheless, we expect the system’s financial strength to weaken over the three-year period. Profitability and internal capital generation capacity will likely suffer over the 2009-2011 period as Spanish financial institutions struggle to meet demanding provisioning requirements with lower earnings. At the same time, loan loss reserves built up prior to the downturn are likely to be depleted. More importantly, because loss absorption capacity differs from one financial institution to another, and given our expectation that asset quality performance will also vary widely, we believe that a number of institutions (mostly savings banks) will suffer meaningful financial stress and will probably not be able to survive without state financial support.
Our credit loss assumptions refer exclusively to the domestic private sector’s lending exposures and therefore represent the lion’s share of most Spanish institutions’ loan books, except for those of Banco Santander S.A. and Banco Bilbao Vizcaya Argentaria, S.A. (both rated AA/Negative/A-1+), which have significant lending operations abroad.
Under our base-case scenario–which assumes two consecutive years of economic recession, a meaningful increase in unemployment, and a sharp decline in property values--we expect cumulative credit losses on the year-end 2008 portfolio of domestic private-sector loans to reach 4.4% (or €81.6 billion) of the total over the 2009-2011 period. This compares with almost 7% (€130.6 billion) under our downside scenario. These levels do not, however, represent the total credit losses we expect over the full course of the downturn, since they exclude those losses that we believe already materialized in 2008. Including such losses, credit loss levels would rise to 5.2% (€96.5 billion) in our base-case scenario and almost 8% (€147.5 billion) in our downside scenario.
Although only limited public information is available on the magnitude of credit losses during Spain’s previous economic recession (1993), we believe that the current downturn should prove more severe. We expect to see the highest credit loss rates in the real estate and consumer lending portfolios, as well as in residential mortgages granted to immigrants and other non-Spanish residents (for example, retired foreigners from other European countries who have taken up residence in Spain).
We believe that the wide disparity in asset quality performance that we have seen thus far among Spanish financial institutions will continue, resulting in variations in credit loss rates for individual players with respect to the levels mentioned above for the financial system as a whole. The weight of domestic lending in Spanish institutions’ balance sheets, as well as these institutions’ loan portfolio composition, risk management practices, and recent credit track records, will, in our opinion, explain the different levels of problem assets across the system. In general, we believe that savings banks are set to suffer more than commercial banks in the current recession. Within the savings bank sector, we expect wide disparities as well. Similarly, we also expect to see different levels of loss absorption capacity across the system, from one institution to another.
As a result of our stress test exercise we raised our estimate for the Spanish financial system’s cumulative gross problematic assets (GPA) over the full course of the recession to 10%-20% of total domestic private-sector credit from 5%-15%.
And here, for your enjoyment, are some tables:
The full report, including an analysis of the distribution of expected losses throughout the downturn, is available as a PDF.
Related links:
Scrutiny of Spain’s potential banking pain increases – FT Alphaville
Are Spanish banks hiding their losses? – FT Alphaville
Surprise! Spanish banks are not hiding their losses! – FT Alphaville
Spanish banks are hiding their losses – Round 2 – FT Alphaville