Fitch Ratings says in a newly-published report that the new coverage levels for real estate (RE) assets required by the Spanish government is a big but necessary step forward and there are significant challenges ahead.
"These challenges include the need to build up coverage levels under adverse economic prospects for Spain, balancing higher coverage with the need to meet stricter capital requirements and restoring investor confidence," says Carmen Munoz, Senior Director in Fitch's Financial Institutions group. "In addition, deterioration in other asset classes such as SMEs and residential mortgage loans can be expected, funding will remain under pressure and there is execution risk as stronger institutions merge with weaker ones given that, in recent years, the risk profile of the latter has deteriorated and their franchises have debilitated," adds Ms. Munoz.
Imposing more demanding coverage levels on banks' RE exposures through income statement provisions and capital buffers is one of the measures taken by Spain's new government to stimulate credit and promote economic growth. These requirements will place significant pressure on banks' stretched income statements and capital management strategies at a time when Spain enters into recession. This, together with the short time frame for complying with the new requirements will stimulate consolidation.
In terms of rating implications, from the information available to date, Fitch believes that there are a number of institutions, mostly the larger entities including the two largest international Spanish banks, which are able to meet both the new provisioning and capital buffers, without any impact on their ratings, given the one-off nature of the reform in 2012.
Smaller banks, particularly those with capital injections from the state's Fund for Orderly Banking Restructuring (FROB), will face difficulties in complying with requirements in just one year, given their low revenue generation capacity and tighter capital, and will be forced to merge. For the stronger institutions that merge with weaker institutions, there is downward rating pressure as a result of the potential weakening of their risk profile, additional provisioning and capital needs and execution risks.
Fitch expects the larger players to report lower earnings, while some of the smaller and domestically focused institutions could report losses in 2012, unless they register capital gains. Internal capital generation at institutions is already burdened by narrower margins and lower volumes due to adverse macroeconomic trends, limiting scope to make provisions without affecting net income.
According to Bank of Spain data, total exposure to the RE sector for the entire banking sector at end-June 2011 was around EUR323bn, of which EUR175bn were potentially problematic. The new requirements will bring coverage for the entire RE portfolio to around 30%, which Fitch views as a more appropriate level for the higher risk profile of these assets.
Banks will have to ensure that, in addition to having a sufficient capital buffer to comply with coverage levels, they must also be in compliance with the harsher regulatory capital requirements in place as well as with the European Banking Authority's 9% core capital requirement. Fitch observes that addressing higher provisioning needs and capital raising, at the same time, has become a challenge for management at most institutions.
SOURCE Reuters