Spanish Bad Loans Hit New Record in August

Spanish households and companies defaulted on their debts in record numbers in August, hurting the country's lenders and highlighting the need for an aid package and bad bank to help the economy out of recession.

A property crash left banks with billions of euros in bad debt from real estate developers on their balance sheets but the problems have spread to small businesses and other sectors. Loans that fell into arrears in August increased by 5.3 billion euros ($7 billion) from July, reaching 178 billion euros, Bank of Spain data showed on Thursday. Spain is setting up a bad bank to siphon property assets off lenders' balance sheets and banks are preparing to receive the first funds from a 100-billion-euro credit line agreed with the European Union.

But the record loan data raises the question of whether consumer loans should also be transferred to the bad bank and if Spain will take too little of the European cash. The government estimates it only needs 40 billion euros.

"The most obvious thing from this data is that the Spanish government should aim for a greater recapitalisation exercise,'' said Gilles Moec, economist at Deutsche bank. "There is a risk of undershooting with the recapitalisation plan as it stands today.''

The setting up of a bad bank is a condition of receiving the European aid, alongside an independent audit of the country's lenders completed in September which pointed to seven banks needing capital in a severe downturn.

Spain is also expected to ask for a sovereign aid package in the next few weeks which would open the door for the European entral Bank to start buying its debt to bring premiums down.

CONSUMER QUESTION 

Spain is suffering its worst economic downturn in half a century, marked by high unemployment and deep spending cuts. This has hurt consumers who are now defaulting on their loans in increasing numbers and this also makes the bank problems worse. The country has raised the possibility of including defunct consumer loans in the bad bank, although only in the worst cases, Economy Ministry sources said on Wednesday.

Bad consumer loans will not be transferred into the bad bank in the first instance, a source with knowledge of the matter said, but the bad bank has been designed so that non-real estate assets could be included in the future.

"At some time in the future they may be included, but it may never happen,'' the source said. ``What you need to cut out is the cyst of the real estate sector, that's what the bad bank has been set up for, that's what has destroyed the banking system.'' The bad bank will be designed to hold up to 90 billion euros of assets, but the government expects the final size to be much smaller. It will be up and running by the end of the year.

The Bank of Spain must determine the price at which assets are transferred to the bank, using input from independent auditor Oliver Wyman. The price will be set in the week following Nov. 19 when the legislation governing the formation of the bad bank is passed.

Prices must be low enough to attract private investors, meaning the bad bank will be profitable over its 15 year lifespan, but not so low as to precipitate bigger losses for Spain's banks.

WRITEDOWNS SQUEEZE EARNINGS

Economists say getting the banks back to a healthy position is crucial to Spain climbing out of recession. Most independent forecasts are looking for a drop of 1.5% in economic output next year, far worse than the government's forecast for a 0.5% contraction.

Spain's lenders have already made massive write downs on their property investments under two government laws passed this year. The government has forced lenders to set aside 137 billion euros on 307 billion euros of real estate exposure.

Write downs on property are expected to continue to squeeze banks' profits in nine-months results. Bankinter, the first Spanish bank to report results this season, posted a halving of 9 month net profit due to writedowns made in the first half. Santander and BBVA, which passed the independent audit with flying colours, still have more writedowns to make to comply with the government legislation.