Outlook for Spanish banks remains negative — Moody’s

The fundamental credit outlook for the Spanish banking system remains negative, reflecting the impact of the ongoing economic recession and severe asset quality deterioration on domestic banks' risk absorption capacity, Moody's Investors Service said in its new Banking System Outlook on Spain.
"Over the past 12 months, the pressure on Spanish banks has broadened, resulting in an accelerated deterioration of asset quality; a further weakening of the existing cushions against losses, such as retained earnings, generic (anti-cyclical) provisions and unrealised capital gains; and a still challenging wholesale funding market and increased competitive pressure on the retail funding side," said Maria Cabanyes, Moody's lead analyst for the Spanish banking system.
On the face of it, Spanish banks have so far demonstrated remarkable resilience to these pressures, but Moody's remains concerned that many entities appear to be avoiding recognition of the true scale of the asset quality deterioration in their books, which could result in the banking sector remaining weak (and in continuing low standalone ratings) unless this is addressed more decisively.
However, the amount targeted by the government to support the banking sector (close to EUR 100 bln has been made available in a recapitalisation and restructuring fund) should provide sufficient funds to address the capital shortfalls of Spanish banks under Moody's base scenario, thereby supporting the current long-term ratings.
Extrapolating Moody's estimates of lifetime loan losses for rated banks in Spain to the entire Spanish financial institutions universe results in an approximate figure of EUR 108 bln of losses under the rating agency's base-case scenario, as of the end of 2008. Against this estimated loss number, system-wide (general and specific) loan loss provisions amounted to EUR 51 bln at the end of H1 2009, which means that constituted provisions provide a coverage of expected losses of 47%.
This in turn means that Spanish banks still need to fund provisions of EUR 57 bln on the basis of Moody's assumptions regarding the performance of key asset classes, earnings and available capital. Extrapolating the net loan loss provision cushions that have been built-up over the past six months (EUR 6.3 bln), it would take banks close to five years to fully provision Moody's estimation of losses. This would severely affect the capacity of many Spanish banks to generate profits in the coming years. Should the Spanish economy continue to deteriorate significantly, the rating agency's stressed scenario estimates substantially higher losses, of up to EUR 225 bln.
The deterioration of the Spanish banking industry's asset quality has not reached its peak and Moody's anticipates that a significant number of rated banks will report losses in the coming quarters. However, the mechanisms established by the Spanish government to ensure an orderly restructuring of the banking system should prevent insolvency situations; indeed, a number of savings banks are already in the process of discussing viability plans with the regulator. "The situation of exceptional systemic support is reflected in the fact that no Spanish bank is currently rated lower than Baa3 (i.e. they are all within the investment-grade category)," added Cabanyes.