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Fitch Ratings says that under its updated base case, the Spanish banking system will need additional capital requirements of between EUR50bn and EUR60bn to cover potential stressed losses on the domestic loan portfolio. Under a more extreme scenario, based on what occurred in Ireland, these amounts rise to between EUR90bn and EUR100bn. In both scenarios, this arises from the taking of upfront stressed losses, net of taxes, and without taking into account pre-impairment profits.
Over the past few years, Spanish banks have been increasing provisioning and improving capital levels. The Spanish government has passed legislation in 2012 imposing more demanding coverage levels on banks' real estate (RE) exposures through income statement provisions and capital buffers (see "Higher Real Estate Coverage for Spanish Banks" dated 22 March 2012 on www.fitchratings.com.) This is in addition to the stricter capital requirements required in 2011 (see "More Stringent Capital Requirements for Spanish Banks" dated 1 March 2011 on www.fitchratings.com.). Fitch's base case and Irish stress scenarios capture these same concepts by stressing asset quality and calculating stressed losses for the different asset classes while achieving higher capital ratios.
The front-loading of stressed losses is likely to be viewed by the markets as prudent and appropriate in order to address declining market confidence in the sector. In Fitch's view, the probability of these severe losses materialising is growing and a near-term recapitalisation plan is increasingly likely to be needed for the more exposed banks in order to try to improve confidence.
The stress tests update previously published stress tests conducted in March 2011 and July 2010. While maintaining the same target equity-to-total assets ratio, Fitch has revised its stress scenarios to factor in the continued strained macro economic conditions in Spain, further asset quality deterioration (mainly in the RE sector), the ongoing eurozone crisis, which has contributed to heightened market risk aversion over Spanish debt, and the need for substantial support for a number of Spanish banks since July 2011. Of this support, the most important is the recent EUR19bn state rescue package requested by the Board of Directors of Banco Financiero y de Ahorros, S.A., the parent of Bankia, S.A.
In both the base case and the Irish stress case, Fitch estimates the amount of capital needed to reach a common equity-to-total assets ratio of 6.5% at end-2011 (equivalent to a core capital-to-risk-weighted assets ratio of 10% Fitch estimates), once stressed losses, net of tax and existing loan loss reserves, are deducted from equity (which includes mandatory convertible securities and EUR15bn of FROB funds already injected). The stresses assume probability of defaults (PDs) based on a multiple of non-performing loans (NPLs) and apply stressed loss given defaults (LGDs) to arrive at the stressed loss figure.
The stress tests are based on an aggregate loan portfolio of EUR1,783bn at year-end 2011 as reported by Bank of Spain statistics and EUR88bn in foreclosed assets. NPLs for the domestic loan portfolio grew by EUR32bn between end-2010 and end-2011 to EUR140bn. Given the sharp deterioration in asset quality and the worsening macro environment in Spain, Fitch has increased its NPL multipliers and its LGDs, particularly for the RE sector.
Fitch estimates that losses on the domestic loan portfolio would total EUR230bn under the base case and EUR295bn under the Irish case. Of these amounts, EUR160bn and EUR187bn, respectively related to the RE and construction sectors and included foreclosed property. A further EUR20bn and EUR40bn, respectively, related to residential loans (mainly mortgages) for individuals. The difference was corporate exposures, both large and small and medium-sized companies as well as consumer loans.
The multipliers and the LGDs applied are particularly severe on banks' RE exposures as these assets already reported very high NPL ratios at end-2011. By type of RE loan, Fitch estimates that the average NPL at this date was: land (36%), unfinished property (29%) and finished property (23%).
Banco Santander, Banco Bilbao Vizcaya Argentaria (including soon to be merged Unnim) and Caja de Ahorros y Pensiones de Barcelona (including the soon to be merged Banca Civica) fare better under the stress tests that some of the medium-sized banks and savings banks with high exposure to RE. These three large Spanish banks have sufficient pre-impairment profit generation, reserves and capital to withstand Fitch's stress scenarios and are therefore rated higher. However, they are not immune from negative ratings pressure due to the deteriorating economic situation and volatile market conditions in Spain. Fitch expects to publish a comment on its updated stress tests over the next few days and to review ratings in the near term where required.
