Spanish banks: Irish levels of losses would take down 'Cajas'

Finally, Madrid has taken action on the problems plagueing the Spanish banking sector.

The solution brought forward Sunday by Economy Minister de Guindos looks fine on paper, but what if plan B if losses mounts up and banks need additional capital?

The plan seems to be based on a naïve view of the Spanish economy, particularly the housing market. If Spain is becoming Ireland, almost half of the correction is left in the housing market and likely the Spanish banks will then face a doubling of bad loans. Shareholders’ will be reluctant to bring put in more capital as there is recovery in sight for the Spanish housing market and credit quality, chart 1 and 2.

More madness ahead
As we mentioned in a previous analysis, currently 8.2% of the total loans in Spain are non-performing, equal to € 144bn. The total amount of “problem assets”, non-performing, write-offs, substandard put together, vary a lot between the bank, varying between 5-20% of total loans. Banco Santander and BBVA are in the 10-12% range in terms of “problem assets”, the Cajas however in general have larger relative amounts. Investors should bear in mind that this reflects the expectations on credit losses not actual.

The unluck of the Irish
The Irish experience tells us that recovery levels on large “asset rescue projects” get smaller than normal when countries enter a surrender phase in their crises, a phrase where prices are in free fall and the supply is enormous. When the Irish National Asset Management Agency (NAMA)  was created, the haircut was 50% across the board of all troubled credits transferred from the banks. Is this the likely outcome for Spain? We are not that far from that level as many might think.

An crisis of Irish magnitude will most likely wreck the Spanish banking system. Using Irish levels of mark-to market on the Spanish banking assets, the picture already looks scary, table 1.

Note: The Spanish loan book adjustments are based on the general credit exposure of Banco Santander and BBVA. Non-performing loans are estimates for 2012 and weighted for these two banks given their relative credit exposure. Reservations on loans is not taken into account.

Conclusion
The base scenario -  applying Irish levels of losses - would take down many of the Cajas, and in our study Banco Popular and Banco De Sabadell would be in serious trouble. Looking at a further fall in housing prices and losses, the picture quickly turns really nasty. The five largest Spanish banks alone would need to raise at least Euro 50bn to stay afloat. In my book, the uncertainty and magnitude of the various outcomes does not provide a healthy risk reward for investing in Spanish banks right now.

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