UPDATE 1-Spanish bank profits to be hit by bad debt -cenbank

(Adds analyst comment)

By Andrew Hay

MADRID, Nov 5 (Reuters) - Spanish banks' results will suffer in coming quarters as they are forced to increase provisions for rising bad debts amid the global financial crisis and domestic economic slowdown, the Bank of Spain said on Wednesday.

Spain's retail-focused banks have felt no direct impact from U.S. subprime problems but will not escape a sharp rise in defaults as the collapse of a decade-long housing boom coincides with credit market turmoil, the central bank said.

"Higher bad debt will hit income statements due to higher provisioning needs," it said in a report on the Spanish financial system.

Soaring Spanish unemployment, which hit a 12-year high in October and is expected to rise further over the next year, has a direct link to levels of debt defaults, say analysts.

"Unemployment and non-performing loans are highly correlated and the recently reported unemployment numbers lead us to believe that the fast acceleration in non-performing loans is here to say," Credit Suisse said in a research note.

Banks have been obliged to use generic provisions, or rainy-day funds, as they attempt to fill the gap on their books left by unpaid loans, though some have been hit harder than others.

Spain's leading banks Santander (SAN.MC) and BBVA (BBVA.MC) diversified out of domestic property years ago and are expected to take advantage of knock-down asset values to buy rivals.

Smaller institutions and savings banks have higher real estate exposure and financing problems which have raised expectations for mergers.

BAD DEBTS

Wholesale credit markets remain practically blocked to Spanish banks and institutions will continue to cut lending and experience rising bad debt in coming quarters, the Bank of Spain said.

Spain's bad debt ratio tripled in the past year to reach 2.5 percent of outstanding loans in August, marking the highest rate since 1998, but still below the euro zone average.

"In coming quarters we will see bad debt coverage ratios converge with historic average levels more in line with those seen in other banking systems in our region," the central bank said.

Banks will focus on capturing greater deposits and gain some financing relief from a government plan to buy long-term, asset-backed debt they cannot sell to markets or the European Central Bank, the Bank of Spain said.