Bad Loans Continue to Rise in Spain and Italy

Spain and Italy reported today that the share of bad loans have continued to rise. There is nothing to suggest that this is the peak. In fact, further deterioration is likely.

Bad loans at Spanish banks rose to 10.87% in April from 10.47% in March and 8.73% in April 2012. These doubtful credits rose to 167.1 bln euros. Spain's problem stems from the housing market boom. Prices have not bottomed. 

S&P, for example, warns that a further decline in house prices is needed. No sector has emerged to replace the housing related industries as an engine of growth for the Spanish economy. The contracting economy and high unemployment rates, even if it is mitigated in part by the cash economy, warn of additional distress.  

Spanish banks had raised deposit rates to attract and retain savings. The higher deposit rates squeezed Spanish banks earnings. The central bank has successfully gotten the banks to reduce deposit rates. The yield on 1 year deposits, for example, have been almost halved to 1.5% from nearly 3% at the end of last year. The decline in deposit rates led investors to pour savings into mutual funds. Spanish investors have invested almost 7 bln euros into local mutual funds in the year through May. 

Italy also reported its bad loan situation today and it is getting worse.  The total amount of non-performing loans at Italian banks rose to a 2-year high in April.  They are 22.3% above a year ago, a tad lower than Spain's 24.5% increase.  

The country's banking association reported that the gross non-performing loans stood at 133.3 bln euros.  Italian banks have made provisions to cover about half of this, leaving net NPLs at about 66.5 bln euros.   The central bank has encouraged banks to make more provisions.  Net NPLs did decline slightly in the first two months of the year as banks made provisions.  However, they rose again in March and April to a new two-year high. 

Italy did not have a housing market bubble like Spain.  It has been the chronic poor growth and high debt servicing costs that have taken a toll.    Although the PMIs suggest that pace of economic contraction may be slowing (in both Italy and Spain), it is likely to be insufficient to stem the rot. 

If new loans were growing, it would also help stabilize the nonperforming loan ratios.  However, this is not the case.  The Italian banking association data shows that last month, loans to households and businesses fell by 3.1% (though deposits increased by 7.3% to 1.21 trillion euros).   

Five years into the crisis and Europe has still not addressed it banking problems.   Yes, the European Investment bank can help facilitate new loans to small and medium sized businesses.  This  bypasses the private sector banks without expediting the resolution of their problems.   

European bank issuance of senior debt has fallen to the lowest level in a decade.  Thus far this year, EU banks have issued 132 bln euros of senior debt compared with 158 bln in the same 2012 period.  The ostensible cause is the fear the creditors will be held accountable going forward in a way they have not, for the most part up until now.   That is what "bail-in" involves.  

Senior debt holders have been typically treated as sacrosanct in the default or restructuring situation.  However, new rules may place senior debt holders after depositors.  The lower interest rate associated with the senior status seems less attractive.  European banks have quadrupled their subordinated debt offerings this year compared to the same period a year ago.