UPDATE 3-Spanish banks' profits drop, financial reform on track
* Popular 9-mth net down 38 pct to 251 mln euros
* Caixabank net down 80 pct to 173 mln euros
* Bankia reports 7.05 bln euro loss at end-Sept
* Bad loans grow at all banks
* Spain's financial reform on track-EC/ECB/IMF (Adds IMF/EC/ECB statements, Bankia earnings)
By Jesús Aguado and Sonya Dowsett
MADRID, Oct 26 (Reuters) - Three of the five biggest Spanish banks, pummelled by recognition of property losses from Spain's real estate crash, reported sharp profit drops and said loan defaults were creeping higher.
Banks in the euro zone's fourth-largest economy are belatedly recognising the effects of the bursting of a decade-long property bubble which forced a 100-billion-euro European bailout of the financial system and could now lead to a sovereign rescue package.
The reform of the financial sector is broadly on track but the country needs to keep up the momentum as more steps need to be taken, the European Commission and the European Central Bank said in a statement on Friday.
The International Monetary Fund also said the programme had been well implemented so far but non-viable banks should be promptly wound down and mergers that do not clearly generate value should be avoided
Popular, one of seven lenders identified as having a capital shortfall in a September independent audit, echoed the chief executive of Spain's biggest bank, Santander, saying a sovereign bailout would be positive for the economy, by lowering the cost of borrowing for the government and the banks.
"The spread must be reduced however possible, and asking for a credit line would achieve this in a reasonable way. The rescue could have a positive effect on the Spanish economy," Chief Financial Officer Jacobo Gonzalez-Robatto told reporters.
Popular's nine-month net profit fell 38 percent to 251 million euros ($325 million) due to government-forced writedowns on property assets.
Net profit at Caixabank, Spain's third-biggest lender, fell 80 percent to 173 million euros. For the first time, the Barcelona-based lender incorporated results from Banca Civica, the state-rescued lender it bought earlier this year.
Bankia reported a loss of 7.05 billion euros in the first nine months of the year after setting aside 11.485 billion euros to cover losses on real estate assets.
RIGHTS ISSUE BEFORE DEC. 6
Bankia and Popular are expected to book billions of euros more of property writedowns in the last quarter, linked to government demands and additional losses identified in the audit.
Popular made 3.9 billion euros of provisions during the first nine months to cover losses related to bad property investments, less than half the 9.3 billion euros of writedowns it must make this year.
Bankia said it had completed 75 percent of the property writedowns but will have to set aside more capital to cover potential losses on other assets.
Shares in Popular and Caixabank were unchanged. Bankia was down 2.56 percent.
Loan defaults have spread beyond the real estate sector in Spain's severe recession, made worse by Europe-imposed spending cuts and marked by a sky-high unemployment rate.
Unemployment hit a record high of 25 percent in the third quarter, data showed on Friday, a level unseen since the Francisco Franco dictatorship ended in the 1970s.
Popular reported bad loans at 7.8 percent of total loans at end-September, up from 7 percent at end-June. Caixabank at the same time saw the ratio rise to 8.4 percent from 5.6 percent while Bankia's ratio rose to 13.3 percent from 11 percent.
Popular's chief executive said the bank expected a recapitalisation plan to be approved by the Bank of Spain and Brussels in a matter of days.
The bank expects to set the terms and conditions of a share issue on Nov. 10 and complete it before Dec. 6. It said it expected the capital hike to be subscribed just by existing shareholders.
The rights issue is considered an important test of Spanish banks' ability to tap the market, and analysts expect the shares to be sold at a discount of 50 to 73 percent.