MADRID Spain's banking sector clean-up is about to enter a decisive new phase, with new rules forcing lenders to recognize yet more bad debts widely expected to be toughened up as time goes on.
Analysts and bankers say the rules released by the Bank of Spain last week are likely to hit earnings and dividends, and prompt asset sales and perhaps a new round of mergers. They may also require more government money to be pumped into the system.
Over the longer term, however, Spanish banks could end up ahead of the international curve by taking losses up front.
The banks booked heavy provisions last year to cover risks related to toxic real estate assets, but they have not yet properly acknowledged the dangers lurking in 208 billion euros of refinanced loans to companies and households.
The rules will force them to reclassify some performing loans as substandard by September, requiring extra provisions which bankers think the central bank will specify in due course.
This contrasts with other European regulators who largely responded to concerns by forcing their banks to hold more capital, Mike Lloyd, a partner at Deloitte's Banking & Capital Markets Audit Group, said.
While the move, pushed by the European Union, should restore confidence in the sector in the long run, it could at worst lead to an extra 8 billion euros in loan provisions across the sector, according to a Reuters analysis. <Link to FACTBOX>
Reuters spoke to more than 20 people, including banks, several people at the FROB, the Bank of Spain and the economy ministry and to analysts in assessing the impact of the changes.
They are expected to make Spain's banks appear worse than international peers who have not had to take loan loss hits upfront, with the exception of the Irish banks.
"Spain's banks will look more weakly capitalized in terms of their published financial accounts," said Lloyd.
Spain tapped 41.5 billion euros of a 100-billion-euro credit line for its financial system last year after the bursting of a decade-long property bubble, but the bailout failed to revive lending in a contracting economy, with record unemployment and high corporate and household debt.
"In many cases, difficulties that were deemed transitory have become structural," the Bank of Spain said when it announced the new rules.
Although the central bank insists the new rules will have a limited impact on the sector, it said in a separate report this week that it expected non-performing loans to rise in 2013 in a tough economic environment. Some analysts said they could reach 20 percent of total loans, up from 10.4 percent today.
Another immediate consequence will likely be an increase in corporate borrowers going bust as banks will now have less reason to refinance loans to "zombie" companies.
Data from the national statistics institute released on Wednesday showed the number of companies filing for insolvency already up 23 percent year on year in the first quarter.
Only time will tell whether banks will have to raise capital and perhaps call on the public purse.
A senior government source, speaking on condition of anonymity, acknowledged the rules would show a provision gap of up to 10 billion euros and trigger extra capital needs of between 3 and 4 billion euros at the banks, an amount the country could afford without tapping more EU funds.
While some public money could be needed to help the nationalized banks, the others would be expected to raise new capital on their own.
But at least half a dozen banks said they believed the new rules were only a first step that would later lead the government to enforce new provisioning rules, a method it already used last year to deal with real estate assets.
"This is the usual way the Bank of Spain acts. It first puts out an idea, and then you can bet they will later add details and clearer requirements," a banking source said.
According to Reuters calculations, excluding their real estate exposure, which was covered by heavy provisions last year, Spain's 15 biggest banks hold on their books refinanced loans worth 116 billion euros at the end of 2012.
Of this amount, 45 percent, or 52 billion euros, is accounted for as performing and will have to be reassessed because the new rules consider a refinanced loan to be substandard by default unless the bank can prove the contrary.
If all of them were recatalogued as substandard and assuming a 15 percent provision on these loans, a level widely considered in the sector as an average requirement, Spanish lenders would need to book provisions of up to 7.9 billion euros.
The data suggests some banks will cope with limited pain. Others will have to fight - again - for their survival.
At the bottom, a group of former regional savings banks or "cajas", including the nationalized Bankia (BKIA.MC), Catalunya Banc and Banco Mare Nostrum, could suffer losses and have to decide whether they can survive alone, need to merge with sounder lenders or seek public aid.
In the middle, a second group of lenders that did not need to be recapitalized by European funds last year, including CaixaBank (CABK.MC), Popular (POP.MC), Sabadell (SABE.MC) or Kutxabank, may also have to report losses, although they should still be able to get by without support.
And finally, at the top, three banks should easily cope with the requirements as they are diversified and generate higher profits than their peers, such as Santander (SAN.MC) and BBVA (BBVA.MC), or have low volumes of refinanced loans, such as Bankinter (BKT.MC).
Reuters has called the 15 banks analyzed. All of them but Bankinter and Bankia declined to comment.
"Our calculations tell us that we can absorb the impact of the new rules and maintain the profits," a spokesman for Bankia said. He would not comment on whether the 800-million-euro profit target in 2013 for its parent group BFA still stands.
A Bankinter spokesman said it was too soon to make an estimate of the impact but said preliminary figures showed it would be lower than at other lenders.
Spain has always taken its own route when it comes to provisioning. Madrid's pre-crisis approach of imposing mandatory reserves on domestic banks was praised for cushioning Spain's fall during the early phases of the financial crisis.
While the International Accounting Standards Board (IASB) is now moving towards a more Spanish-like model, the rules, because they were not applied very strictly, did little to protect a banking system which shrank from more than 40 banks four years ago to just 15 now.
Senior bankers think seven to nine more will disappear before the clean-up ends.
While the fate of several lenders will largely depend on how the rules, which allow some wiggle room, will be clarified and implemented, most of the banking sources Reuters spoke to said they would have a positive impact in the long term.
"This casts more doubt on the banks, especially now that the horizon seemed to be clearer. But if it helps to clarify the situation, we see it positively," one banking source said.
Analysts say banks' earnings and share prices will benefit from the increased transparency, which will help re-open the wholesale funding markets for the sound banks and eventually help credit flow in the country.