Two Giant Spanish Banks Could Tumble Hard

Last August, an article I published on DailyFinance highlighted that something seemed amiss with two international banking giants headquartered in Spain: Banco Santander (STD) and Banco Bilbao (BBVA) were buying up foreign banks, even as conditions in their home country worsened dramatically. Instead of buckling down to face an inevitable spike in loan losses on existing business, the banks expanded their balance sheets through acquisitions and became more leveraged.

But after a string of relatively benign months for equity markets, investors have recently grown skeptical of these two companies and sent shares down sharply. Santander shares have dropped 17% since the end of August, and Banco Bilbao shares are off 26% over the same period.These stock price declines come on the heels of earnings releases from the banks, both of which made special "one-time" loss provisions of nearly $3.5 billion in addition to their regular provisions. Banco Bilbao said its special provision was primarily driven by a reevaluation of loans to real estate developers and consumers in Spain and Portugal, while Santander's special provision was described as taking advantage of one-time earnings gains to generally strengthen the company's balance sheet.

All Is Not Well

As the big share-price sell-offs might indicate, Spanish banks still have plenty of question marks surrounding their ability to handle unemployment approaching 20% in Spain. Despite what management teams try to depict using selected data and charts, all is not well. At Banco Bilbao, growth in nonperforming assets (NPAs) more than doubled on a quarter-over-quarter basis. The big jump in NPAs for Banco Bilbao in Spain and Portugal should lead investors to ask whether Santander is being equally judicious in assessing the likelihood of repayment.

Because NPAs include nonperforming loans (NPLs) as well as other assets like repossessed real estate, NPA numbers will be higher than NPL numbers alone. Banco Bilbao talks about NPAs in its reports, while Santander focuses on NPLs. Looking deeper into Banco Bilbao's reporting reveals that the difference between its NPAs and its NPLs is essentially negligible. However, comparing those results with Santander's reported troubled loan book shows a fairly sharp divide in several regions where both banks have operations.

In Mexico, Spain and Portugal, Santander's NPLs are strikingly lower than Banco Bilbao's NPAs (which, remember, roughly equate to NPLs per that bank's breakdown of the numbers). Given that both banks are market leaders, the law of large numbers would suggest that the outcomes of their loans will be roughly equal over time. The increase in loss reserves by Banco Bilbao, then, could be a sign that Santander has not fully dealt with its bad loans -- which could mean another multibillion dollar hit to management's optimistic earnings targets.

"They Have No Idea"

Of course, banking executives aren't the only people in Spain beset by optimism in the face of a potential bout of deflation. The phenomenon actually is gripping the entire country, as has been clearly described by Edward Hugh. Spain's version of the consumer confidence index is being strongly buoyed by its "expectations" component, which is close to an all-time high, even as factors like "unemployment" and "current situation" remain depressed.

Hugh writes: "My contention is not that there is anything wrong with this finding, but rather that this is how Spanish people actually think at the present time. They have no idea of the actual economic reality, or of what the future has in store for them. They are virtually being kept in the dark. This is the worrying part, and I fear that all this may well now end badly, very very badly."

Spain's banks have been racing to diversify abroad, and the market's actions suggest their problems are growing increasingly severe. While Greece is attracting the largest share of worried attention regarding developed national debt issues, Spain is close behind. And with two banks having market capitalizations totaling $150 billion and significant exposure to the Spanish consumer and real estate, this situation could be even more difficult to digest.

James Cullen edits and writes at He has no personal position in the stocks mentioned above.
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