UPDATE 2-Bad loans, deposits increase stress on Spain's banks

* Bad loans reach new record high at 9.9 percent
* Deposit fell 2.6 percent in July
* Deposit trend less worrying than it appears

By Jesús Aguado and Sonya Dowsett
MADRID, Sept 18 (Reuters) - Spanish banks, awaiting the
first funds from a 100-billion-euro European credit line, are
coming under increased stress as bad loans rose to a record high
in July and deposits from domestic companies and Spanish
residents dropped.
Although the poor data may not affect the European banking
aid, which is focused on cleaning up the toxic real estate
assets from the lenders' balance sheets, it adds concern to the
banking sector capacity to cope with a punishing recession,
massive unemployment and waning confidence.
Bank of Spain data showed banks' bad loans stood at 9.9
percent of their outstanding portfolios in July, the highest
level on record and up from 9.4 percent a month earlier.
Loans that fell into arrears increased by 960 million euros
($1.3 billion) from June, reaching 1.7 billion euros in July.

Bad loans could rise further in coming months should an
economic recovery fail to materialise, as many banks have
refinanced debt owed by struggling companies to prevent them
going bust.
Deposits by Spanish households and companies fell 2.6
percent in July from a year earlier to 1.1 trillion euros, Bank
of Spain data also showed on Tuesday. The figure does not
include financial sector deposits.
Overall, deposits, including non-residents, fell by 5
percent in July according to European Central Bank data
published on Aug. 28.

NO DEPOSIT WORRIES
The deposit flight data is however less worrying than it
appears, a Bank of Spain official told Reuters.
The central bank official, who asked not to be named, said a
lot of funds moved from deposits into commercial paper after the
regulator penalised high-interest deposits to stop a deposit war
between banks.
He also said banks must book a deposit to balance out
mortgage-backed securities and other securitised loans.
Many of those deposits, which are an accounting mechanism,
are now being cancelled out since the securitised instruments
are maturing and not being replaced by others after mortgage
lending has dried up in Spain.
The official said that the trend should progressively begin
to reverse because the central bank has removed the penalisation
on high-interest deposits over concerns that consumers'
investments in commercial paper are not guaranteed by the
government as deposits are.
The results of a final stress test on Spain's banks are due
on Sept. 28.
They will provide a basis for calculations as to which banks
should receive European Union funds and how much they should
receive to patch up the funding gap in the country's ailing
banking system, brought low by years of bad property investments
during a construction boom.