The outlook for Spain's banking system is negative, as it has been since 2008, Moody's Investors Service said in a new Banking System Outlook, on the expectation that the banks will continue to operate in a recessionary economy, burdened by high levels on non-performing assets that are expected to significantly deteriorate further, with continued pressure on profitability and capital.
The outlook also takes into account still-restricted market access; banks' elevated reliance on ECB funding; and banks' sizable credit exposures to the Spanish government (Baa3 negative).
Moody’s added that improved bank capital levels, partly because of current recapitalisation efforts, do not fully offset these sources of rating pressure, especially if the economy does not improve notably during 2013. This results in an ongoing negative outlook for the domestic Spanish banking system.
The rating agency expects that domestic operating conditions for Spanish banks will remain difficult because of the recessionary economic conditions. Spanish GDP contracted by 1.4% in 2012 and Moody’s expects a similar contraction of 1.4% in 2013, with a bottoming-out or slightly positive growth towards the second half.
Furthermore, the sovereign's weakened credit profile will continue to weigh on the banking system, given the multiple linkages of bank and sovereign credit risk.
Moody's expects bank asset quality to deteriorate further from already weak levels over a 12-18 month period driven by the ongoing real-estate crisis, a recessionary economy and record-high unemployment. Non-performing loans (NPLs) fell to 10.4% of total loans at end-December 2012, from 11.4% at end-November 2012, due to the transfer of some banks' problematic real-estate related assets to Sareb, a government-initiated "bad bank". Excluding transfers to Sareb, problem loans remain on an upward trend that Moody's expects will continue.
Spanish banks' capital levels have improved due to more stringent regulatory thresholds and the ongoing recapitalisation effort. However, under Moody's stress test assumptions, most rated banks would still require additional capital to maintain regulatory requirements.
Moody's says that Spanish banks' access to market funding improved for the stronger banks in early 2013, but market access has not normalised yet and will likely continue to adversely affect banks' liquidity positions. Spanish banks remain the largest borrowers from the ECB, which reflects funding pressures, but also the low cost of these funds. Positively, retail funding has been resilient throughout the crisis, and remains Spanish banks' main funding source.
Moody's believes that the stability of retail funding reflects consumers’ view that deposits will be protected under any scenario, including restructuring and recapitalisations, while earnings are expected to remain weak.
Pre-provision income levels have contracted significantly for many banks, affected by low interest rates, growing non-earning assets, deleveraging of the private sector, as well as the recessionary economy. In addition, loan-loss provisions will continue to absorb a high portion of banks' pre-provision earnings.
