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Why Spain’s Rising Bad Loans Are Actually a Good Thing

Investors see Spain’s growing nonperforming loans figure as evidence of a new culture of transparency.

Bad loans in the Spanish banking sector are rising amid a recession, yet there is growing optimism among investors that the country is now at least coming to terms with the scale of its problems. Bank of Spain data released on August 17 show that bad loans rose to €164.36 billion ($206 billion) in June, representing 9.42 percent of total lending, the highest level ever recorded in Spain compared to 8.95 percent in May.

The government, led by Mariano Rajoy, has already negotiated €100 billion of European Union support for his country’s banks, but there are fears of a full-scale sovereign bailout as the country struggles to borrow at sustainable rates. On August 17, the mayor of Madrid, Ana Botella, a member of Rajoy’s party and the wife of former prime minister Jose-Maria Aznar, said it was inevitable Spain would have to seek more international aid.

Investors, however, see the growing nonperforming loans figure as evidence of a new culture of transparency. Cosimo Marasciulo, head of Government Bonds and Foreign Exchange at Pioneer Investments’ Dublin office, says: “It was hardly a surprise to see Spanish banks’ NPLs reach a new high today [of 9.42 percent] given the continuing weak macro picture in Spain and the Bank of Spain’s stricter provisioning rules. Provisioning levels are starting to look credible and a framework will soon be in place to provide capital to those institutions that need it. And this is good news for the economy over the medium term”.

Galina Abalatchka, co-founder and managing partner of distressed debt trading platform IlliquidX in London, says, “I think the rising figures show greater recognition of problems that already exist rather than a deterioration.” IlliquidX is aiming to step up activities in the nascent distressed debt trading market of Spain after hiring Ignazio Munoz-Alonso, a former head of European corporate and investment banking at Madrid-based bank BBVA, as a senior adviser. The firm says it sees potential in the Spanish market since Spanish have barely begun selling distressed assets. “Eventually billions of euros of assets will have to be sold,” says Abalatchka, but against a backdrop of a more optimistic market.

Spain’s sovereign borrowing costs have dropped markedly in recent weeks following the announcement by the European Central Bank in July that it had plans to buy short-term Spanish debt. Yields on the 10-year bond had dropped to 6.44 percent by August 17 after spiking to the dangerous level of 7.62 percent on July 23. But the macroeconomic in Spain is worsening as the economy contracted by 0.4 percent in the second quarter, while unemployment is running at 25 percent.

An initial stress test of Spain’s banks by management consultants Roland Berger and Oliver Wyman suggested that a maximum of €62 billion would be needed to bolster the country’s banks rather than the full €100 billion allocated, but a full audit is due in September. The markets are not expecting any decisive action until then. “The crisis is on holiday at the moment,” says one banker, “with all the politicians away.”

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