June 25, 2015
Spanish asset quality problems: a legacy
of the past and a challenge for the future
Following a massive real estate boom-and-bust cycle, Spanish banks’ financial
performance, as well as their credit risk profile, remains negatively impacted by large
portfolios of non-performing assets (NPAs). These include both non-performing loans and
foreclosed assets, built up largely in the past five years.
Analysts
Marco Troiano (author)
[email protected]
Cautious welcome for Spain’s recovery
Ilona Dmitrieva
At present, the outlook for Spain is positive: the European Commission forecasts continued
GDP growth in 2015 and 2016. Lower energy prices, better and cheaper availability of
credit, as well as improved competitiveness, should support domestic consumption and
investment, and boost employment.
[email protected]
Sam Theodore (team leader)
[email protected]
Scope takes a cautious approach to recovery in Spain, which partly reflects cyclical factors
such as cheaper cost of credit and energy, and the weak euro. In particular we highlight
structural macroeconomic imbalances built-up in the years before the crisis, which may
weigh on recovery in the medium term.
Benign environment accelerates fall in NPAs
The positive macro backdrop should help banks’ asset quality by lowering new entries into
NPLs and boosting NPL recoveries. It should also facilitate NPL transactions as well as
foreclosed real estate assets sales, a trend that has already gained momentum in recent
quarters.
According to the Bank of Spain, Spanish banking’s non-performing asset (NPA) ratio peaked
at the end of 2013, and after levelling out for some months, started declining more markedly
in the second half of 2014. As of March 2015, we estimate that system NPAs stood at EUR
211bn, 16% below their peak of EUR 251bn in December 2013 including SAREB assets,
Spain’s bad bank. Our expectation is that NPAs will continue to decline, and even gain
downwards momentum, supported by the ongoing macroeconomic recovery. If the pace of
decline of the first four months of the year is sustained, we estimate that NPAs will stand at
EUR 190bn by year end – a 15% year on year decline and 25% below their peak. If we
instead extrapolate the higher rate of decline in NPAs in April, we project NPAs of
EUR 173bn in December, a 22% y-o-y decline and 31% below their peak.
Stronger underlying asset quality will likely translate into lower need for P&L provisions for
banks, as well as cleaner balance sheets, which will generally be supportive for banks’ credit
profiles.
Low interest rates present banks with opportunity for a clean up
In Scope’s view, the current ultra-low interest rates environment limits the negative impact
on net interest income from having to fund large portfolios of NPAs. While it is difficult to
foresee an early tightening of monetary policy, prudent bank management should assume
this environment is temporary and take advantage of the positive cycle to clean up balance
sheets. We note that while Spain’s large international banks are already advanced in this
process, it could take longer at the more exposed domestic banks.
NPAs pose future risk if not dealt with
In our view, given the macroeconomic imbalances weighing on the medium term outlook for
Spain, the pace of reduction in NPAs is important as a high level of NPAs would be a heavy
burden to carry through the next recession, when this comes. In other words, recent data
seems to indicate that the asset quality problems are a legacy of the past. However, until
such legacy is appropriately dealt with, it also remains a potential challenge for the future.
25 June 2015
Scope Ratings AG
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www.scoperatings.com
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Spanish asset quality problems: a legacy of the past and a
challenge for the future
Positive macro outlook for Spain, with downside risks.
The economic outlook for Spain is positive with GDP expected to expand in 2015 and 2016. However, macroeconomic
imbalances – largely accumulated before the crisis – pose downside risks to the recovery.
Following the long recession, the Spanish macroeconomic environment improved markedly in 2014, and is expected to continue
in 2015 and 2016. According to the European Commission, GDP should expand by 2.8% in 2015 and 2.6% in 2016, a substantial
acceleration from 1.4% in 2014. In Scope’s view, the acceleration will be driven by domestic private sector demand in the form of
consumption and investment, supported by:


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Lower energy prices boost households’ discretionary income available for consumption as well as lowering businesses
production costs (Spain imports oil and gas).
Better availability of credit at lower costs, thanks to ECB’s ongoing support to SME lending (TLTROs) and quantitative easing
suppressing market yields.
Improved competitiveness following several years of internal devaluation and the recent euro depreciation.
Ongoing macro recovery is expected to have a positive impact on employment, with the unemployment rate continuing to decline
after having peaked in 2013, but remaining one of the highest in the EU.
Chart 1: Spanish GDP growth is expected to accelerate in
the coming years
Chart 2: Unemployment declining but remains high
compared to the EU
Source: European Commission, Scope Ratings
Source: European Commission, Scope Ratings
While acknowledging the positives, Scope takes a cautious approach to the recovery, which is partly due to cyclical factors such
as cheaper cost of credit and energy and a weak euro. In particular we highlight structural macroeconomic imbalances, built-up
before the crisis, which may weigh on the recovery in the medium term. Among these, the fiscal drag will likely continue to weigh
on the recovery as Spain’s debt/GDP remains high and is set to increase further, despite strong projected GDP growth.
We also note the large negative net international investment position (the stock of foreign assets minus foreign liabilities), at
93.5% of GDP, the result of accumulated current account deficits in the past decade that will require several years of surplus to be
reduced.
Finally, we highlight uncertainty related to the political shake-up that emerged from the latest administrative elections, with new
parties Podemos and Ciudadanos presenting themselves as credible challengers to the established PSOE and PP for the
upcoming general elections due in December 2015.
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Spanish asset quality problems: a legacy of the past and a
challenge for the future
Chart 3: Government debt/GDP will continue to increase
Chart 4: Net international investment position in
percentage of GDP, 2014
Source: European Commission, Scope Ratings
Source: Eurostat, Scope Ratings
In the absence of an early end to the ECB’s expansionary policy or an unwanted tightening of funding conditions, the environment
should remain supportive for bank’s asset quality, with declining unemployment boosting household finances and better liquidity
and a recovery in profitability for the corporate sector, at least in the short term.
Sector data points to turnaround in Spanish banks’ asset quality
The ongoing cyclical rebound is already evident in sector asset quality data. According to the Bank of Spain, Spanish banking’s
non-performing asset (NPA) ratio peaked at the end of 2013, and after levelling out for some months, it started declining more
markedly in the second half of 2014. We note that a previous peak in the Bank of Spain data series at the end of 2012 (see chart
5.a) reflected transfers of NPAs to SAREB, the country’s bad bank. In chart 5.b we add back assets transferred to SAREB (c.
EUR51bn at the time of transfer, c. EUR44bn as of year end 2014) to the series, to show how the underlying trend remains
negative until 2014, but reversed more recently.
Chart 5.a: Monthly evolution of the NPL ratio, Spanish
banks
Chart 5.b: Total NPAS of Spanish banks, adjusted for
SAREB transfers
Source: Bank of Spain, Scope Ratings
Source: Bank of Spain, SAREB, Scope Ratings
As of April 2015, we estimate that system NPAs stood at EUR 211bn, 16% below their peak of EUR 251bn in December 2013.
Our expectation is for the decline in NPAs to continue and possibly gain momentum, supported by the ongoing macroeconomic
recovery.
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Spanish asset quality problems: a legacy of the past and a
challenge for the future
If the pace of decline of the first four months of the year is sustained, we estimate that NPAs will stand at EUR 190bn by year end
– a 15% year on year decline and 25% below their peak. If we instead extrapolate the higher rate of decline in NPAs in April, we
project NPAs of EUR 173bn in December, a 22% y-o-y decline and 31% below their peak.
The stronger economy should support the dynamic of NPL net entries, as well as facilitate sales of foreclosed assets and portfolio
sales of NPLs. Aggregating comprehensive data on NPA disposals is beyond the purpose of this note, but we have compiled data
on real estate assets sales from SAREB accounts as well as quarterly data disclosed by selected domestic Spanish banks. In
both cases, we note a marked increase in sales of real estate assets, signalling improved demand and boding well for the future.
SAREB data also allows us to observe the increased demand for wholesale transactions in the second half of 2014, which signals
improving informed demand for such assets.
Chart 6.a: Sales of Real Estate assets by SAREB, retail vs
wholesale channel
Chart 6.b: Sales of Real estate assets by Popular,
Sabadell, Caixabank.
Source: SAREB, Scope Ratings
Source: Banco Popular, Caixabank, Banco Sabadell, Scope Ratings
In our expectation of improving asset quality trends for Spanish banks, we take comfort from sectorial data on non-performing
assets, which shows the improvement is broadly based, ranging from household mortgages, non-performing debt – which peaked
at around 6% in March 2014 – to various sub segments of banks’ corporate books, and including real estate related activities (see
Chart 7 for details).
Chart 7: Corporate NPL ratios have stabilised and are starting to improve across sectors
Source: Bank of Spain; Scope Ratings
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Spanish asset quality problems: a legacy of the past and a
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Improved macro situation helping banks’ asset quality and results since 2014
The supportive macro environment has already affected Spanish banks’ reported results in 2014 and in the first three months of
2015. Indeed, while the P&L performance of Spanish banks was mixed during the year, the stabilisation in NPL ratios has been
the dominant and defining feature of 2014 results, both for international and domestic banks.
The peak quarter in NPL ratios for most banks was Q4 2013, and was also the reference quarter for the ECB’s Comprehensive
Assessment. At some banks, we believe the increase in NPLs in 2013 may have been driven by a desire not to be found lacking
in the classification of impaired assets by the new supervisory authority. Since then, quarterly results invariably show a decline in
NPL ratios.
Chart 8a: Quarterly NPL ratios, International banks
Chart 8b: Quarterly NPL ratios, domestic banks
Source: SNL, Scope Ratings
Source: SNL, Scope Ratings
Note: Sabadell data exclude APS from Q1 2014
A closer examination of results shows that in some cases the decline in NPLs was accompanied by higher foreclosures, partly
explaining the continued high need for P&L provisions to be booked. In any case, starting from the second half of 2014, the
decline in reported NPLs rests on more solid grounds, with much lower migration from performing to non-performing loans and
higher recoveries. In recent quarters, the evolution of foreclosed assets is also more encouraging, helped by portfolio sales, as
explained above.
We expect the recovery to facilitate the clean up of legacy assets for rated banks BBVA (A, Stable)
and Santander (A+, Stable)
For the two Spanish banks we rate publicly, we have witnessed encouraging trends both on reported domestic asset quality
metrics and on profitability in recent quarters. However, we highlight that while Spanish losses have depressed profitability and
hindered capital formation during the crisis years, the diversified revenue models of BBVA and Santander have proven resilient to
even a deep domestic recession. We consider such diversification to be a key strength of these two banks, which is reflected in
our rating assessment. Nevertheless, 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.
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.
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Spanish asset quality problems: a legacy of the past and a
challenge for the future
Chart 9a: Santander RE loans and assets expected run off
Source: Santander, Scope Ratings
Chart 9b: BBVA Spanish Real Estate total assets expected
run off
Source: BBVA, Scope Ratings
The pace of clean up is important, as tail risks are back ended, especially for domestic banks
We believe it is important for domestic Spanish banks with a larger NPA stock to take advantage of the positive leg of the cycle
and the easy access to cheap funding from the monetary authority to dispose of unproductive assets. Indeed, these assets would
represent a more serious drag to revenues if interest rates were to rise and could in some cases pose a challenge to banks’
business models. Although an early tightening of monetary policy is highly unlikely, it would be a risky management choice to
assume funding costs of NPAs remain negligible for years.
In addition, given persistent macroeconomic imbalances and the potentially unsettling political dynamics, we believe the mediumterm growth outlook for Spain remains uncertain, and a high level of non-performing assets may be too great a burden to carry
through the next recession.
In other words, recent data seems to indicate that the asset quality problems are a legacy of the past. However, until such legacy
is appropriately dealt with, it also remains a potential challenge for the future.
25 June 2015
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Spanish asset quality problems: a legacy of the past and a
challenge for the future
Scope’s Bank Rating Team
Lead Analysts
Jacques-Henri Gaulard
[email protected]
Pauline Lambert
[email protected]
Marco Troiano
[email protected]
Macro and Public-Sector Analyst
Ilona Dmitrieva
[email protected]
Associate Analysts
Juan Villalobos
[email protected]
Chiara Romano
[email protected]
Junior Associate Analyst
Quentin Courant
[email protected]
Team Leader
Sam Theodore
[email protected]
Disclaimer
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