Spain's Banks Get Vocal Support But What They Really Need is Capital

Spain's economy minister, Luis de Guindos hit back at critics today after some suggested that the Spanish banking sector may have to receive a significant cash injection in order to stay afloat.

According to reports, De Guindos said at an event in Madrid that the country's banks do not need to be bolstered by European rescue funds, despite Spanish banks objectively having the largest shortfall in capital on their balance sheets, according to European Banking Authority (EBA) data, which is critical when it comes to creating a cash cushion in the event of a significant crisis in the markets.

The defence of his country's banking sector may be a noble, yet foolish exercise when looking at the cold, hard numbers.

Only three days ago, ratings agency Moody's cut the credit ratings of 16 Spanish banks and cut the debt rating on Santander UK, a subsidiary of the Spanish banking giant.

Moody's four main reasons for the downgrade illustrated the increasingly strained situation in Spain:

1.) Adverse operating conditions, characterised by the renewed recession, the ongoing real-estate crisis and persistent high levels of unemployment.

2.) Reduced creditworthiness of the Spanish sovereign, which weighs on banks' standalone profiles and affects the ability of the government to support banks.

3.) Rapid asset-quality deterioration, with non-performing loans to real-estate companies rising rapidly, and Moody's expecting other loan categories to deteriorate.

4.) Restricted market funding access, with the ongoing euro area debt crisis contributing to persistent investor concerns about Spanish banks and the sovereign.

But this is not a surprise.

Fitch Ratings started the year off with a negative outlook for Spanish banks, following intensification of the Eurozone crisis, increased market volatility, high unemployment and property sector problems.

"A further intensification of the Eurozone crisis, a deteriorating macro environment within Spain and across Europe, increased market volatility and risk aversion, could negatively affect bank credit profiles," said Maria Jose Lockerbie, Managing Director in Fitch's Financial Institutions group in January this year. "The weak economic environment in Spain, high unemployment and property sector problems will continue to constrain banks' business volumes, as well as eroding asset quality."

For 2012 and 2013, Fitch projected Spanish GDP growth of 0.0% and 1.0%, respectively, revised down from 0.5% and 1.5% previously. On May 17, Spain confirmed its formal slip back into recession, after its GDP fell 0.3% quarter on quarter, the same as in the earlier flash estimate. This is exactly the same pace of decline as recorded in Q4 last year.

Tying in with Moody's downgrade, Fitch cited the major Spanish banks continue to have varied drivers of credit worthiness and "purely domestic banks face significant challenges, the geographical diversification of the international banks."

Previous data from December 2011, from the EBA's benchmark capital requirements report, which comprised of its formal Recommendation and the final figures, related to banks' recapitalisation needs made for frightful reading.

It said that European banks must raise €114.7bn of additional capital buffers by June this year, which is 8 percent more than its initial estimate of €106bn.

Spanish banks pole-position for the worst set of results. According to the EBA, Spanish banks had a €26.1bn shortfall in banking capital requirements - the bufferzone needed to keep them afloat, in case of severe market conditions.

In a breakdown of EBA report results, Banco Santander made up for a substantial portion of the shortfall with €15.3bn needed.

Meanwhile, for comparative purposes, Italian banks have a shortfall of €15.3bn, Portugual €6.9bn while Germany apparently needs another €13.1bn and the UK has no shortfall.

Moving forward to this week, De Guindos said that recently nationalised Bankia will need an injection of around €7bn but rejected the need for European rescue funds.

So where does he think the money will come from?

That we don't know - but what we do know is that investors are already predicting a bailout.

According to an interview with the Independent newspaper in the UK, one of the industry's top fund managers Dominic Rossi, chief investment officer for equities at Fidelity Worldwide Investment, said he expects Spain to be bailed out shortly.

"I don't think it will be long before Spain will need to seek official assistance in the recapitalisation of its banks from both the European Central Bank and the International Monetary Fund," said Rossi to the Independent. "Spain has a lot of assets outside of the country which can be sold and certainly I suspect some of those assets will come on to the market in order to recapitalise the banks before this is all over."

Spanish banks are not only undercapitalised but they also possess major risk from real estate exposures.

Fitch illustrated that the non-performing loans (NPL) ratio for the entire sector stood at 7.2 percent at end-September 2011.

The Spanish Government named consultants Oliver Wyman and Roland Berger Strategy to assess the banking system's real estate loans in a two part process.

The Financial Times said Spain wants a "top-down" assessment of the difference between the book value of loans, their current value on a "mark-to-market" basis and their value under a more stressed scenario.

In the second three-month exercise, which will begin in a month's time, the groups are said to conduct "a "bottom-up" examination on a bank-by-bank basis of all loans, which should provide an even more accurate assessment of the true losses faced by Spanish banks."