Spanish banks' bad loans look set to weigh on the economy for some time

The Bank of Spain released its latest data on the level of bad loans held by Spanish banks today. For the first time since January 2013, the value of bad loans has dropped - falling from €195.2bn in Feb to €192.8bn in March. However, it has stayed roughly constant as a percentage of total loans (13.4%).

Symbolically, even a small drop in the headline value of bad loans may be seen as important, especially given that previous declines were down to the transfer of assets to the Spanish bad bank (SAREB), rather than any change in circumstances of the loans. If this is discounted, the value of bad loans has simply continued to rise.

That said, as the graph highlights, these loans remain at very high levels and well above the loss provisions held by banks. This continues to tell us that:

• Spanish banks will continue to deleverage for some time to come. This puts a dampener on any hopes that they will show any rapid increase in willingness to lend and take on more risk to help fuel any form of Spanish recovery. This thereby increases the risk that any recovery will be ‘creditless’, and therefore more likely to be limited and temporary.

• This data is quite timely, as it also highlights the obstacles which the ECB is going up against in these countries when it comes to encouraging banks to begin lending again, particularly to small and medium-sized enterprises (SMEs). With their balance sheets still weighed down by these loans, it seems likely that banks will continue to be reticent to take on significant new lending, even if the ECB does offer them cheaper long-term loans.

• Given that many of these loans still relate to the real estate and construction sector, they will continue to weigh on prices in these markets. This suggests prices could fall further (although this will vary significantly based on location and regional markets), while the political hot topic of evictions could return to the fore again in the future.

Could the decline in Spanish house prices be bottoming out? Not just yet...

A quick update on Spanish house prices, given that the latest quarterly statistics were released this morning.

As the graph highlights the second quarter of 2013 saw the smallest decrease in house prices quarter on quarter for some time. A few points to note here, though:

• Q1 2013 saw the largest decline for some time so the rebound could be impacted by the fact that the previous decline had been extraordinarily large. The rate of annual decline, at 12%, remains rapid.
• House prices, according to INE, have now fallen by 37% from their peak in Q3 2007. This is clearly a huge decline, but as we have pointed out before, a decline of up to 50% cannot be ruled out, meaning prices may still have some way to go before they bottom out.
• As with other statistics in Spain, there could be some seasonal impact which is yet to be accounted for.
  

• As the graph above shows there is also a wide range of regional variation with some of the richer areas beginning to fair better.
• The year-on-year decline, from Q2 2012 to Q2 2013 is seen to be around 8.8% by INE. However, recent statistics from Tinsa put the decline over the same period at 10.5%. It’s hard to say which is more accurate but this is a notoriously difficult area to accurately measure. There is some (fair) concern that the indices may fail to capture the true decline in house prices in Spain as they do not accurately reflect market transactions, so any data should be read with that in mind.
• Interestingly, it has also been suggested that that while domestic demand has continued to fall, 2013 Q2 saw a pick up in interest from foreign buyers. This could be a positive sign, although (as we have pointed out for the wider economy) foreign demand is not likely to be sufficient to offset a cratering in domestic demand.
• The growing difference between new and second-hand housing is also interesting, if not unexpected. The construction sector will likely continue to struggle as long as new buildings do. The slightly positive signs for second-hand housing could also be positive for the banks, since the majority of their mortgage portfolios will be linked to these properties – if they begin to show signs of recovery the mortgage books may begin to look less toxic (early days though yet). Clearly, as the decline continues and other factors (such as unemployment) continue to push up the level of bad loans that banks hold, they are likely to continue to struggle.
• All that said, the problems with prices of new houses do not bode well for the significant amount of unsold new housing stock floating around in Spain (though to be around 1 million properties) or the large swaths of un-developed land owned by the banks. Clearly these factors will drag on the economy for some time.

Housing, real estate and construction are likely to continue to be a drag on Spanish economy. The concerning point remains that the Spanish economy has been slow to adjust and rebalance towards new areas for growth. Meanwhile, with the ECB's asset quality review (aka 'stress tests') coming up at the start of next year, the attention to the state of bank balance sheets and their links to the housing crisis are likely to once again intensify.