Bad debts are coming back to haunt Spanish banks, with debt problems likely to build up towards the end of 2020 and next year, analysts say.

In the midst of COVID-19, businesses will have difficulty repaying their loans and bankruptcies will increase, especially for small and medium-sized businesses which, according to Moody’s, account for 42% of Spanish bank loans.

And a second coronavirus-related foreclosure, if it were to occur, would be particularly damaging for major Spanish banks, whose capital levels are the lowest among European lenders.

The economic impact of the crisis is hitting as lenders move forward in unraveling the vast amounts of toxic debt inherited from the global financial crisis.

The country’s bad debt rate stood at 3.14% at the end of 2019, against 6.74% in Italy and 6.14% in Portugal, two other European countries affected by high bad debts following the crisis.

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Gross NPLs and advances as a percentage of total gross loans and advances fell to 3.14% in the fourth quarter of 2019, from 7.67% in the first quarter of 2015, aBased on data from S&P Global Market Intelligence.

Elena Iparraguirre, credit analyst at S&P Global Ratings, said she expected non-performing assets, including non-performing loans and real estate assets, to peak at 9.5% in 2021, from 8.5 % expected in 2020.

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Spanish banks will release their second quarter results in the week of July 27, but Iparraguirre said the full impact on bad debt ratios will become clearer in the coming months, as borrowers are currently being bolstered by loan holidays and tax and government measures.

“We will know how much damage the borrowers actually suffer, how much will get there and continue to operate, and which will have the most problems,” she said.

Spain has been one of the European countries hardest hit by the virus, with 28,429 deaths as of July 24, according to John Hopkins University. The government launched a 100 billion euro loan guarantee program at the start of the crisis to help businesses, while banks have granted loan leave.

NPLs of the largest Spanish banks – Banco Santander SA, Banco Bilbao Vizcaya Argentaria SA, CaixaBank SA, Banco de Sabadell SA and Bankia SA – declined slightly in the first quarter as the impact of the crisis has not yet materialized . At Santander, the ratio for the first quarter fell to 3.66% from 4.03% in the first quarter of 2019, while at CaixaBank it fell from 5% to 3.97%. At BBVA, it fell to 3.98% against 4.35% over one year. For Banco de Sabadell and Bankia, the ratio fell to 4.02% and 4.89% from 4.37% and 6.13% respectively.

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Banks take three months of non-payment to declare a non-performing loan, so there will be a lag in reporting non-performing loans, said Santiago Carbó, professor of economics and finance at the Catedrático de Economía y Finanzas, a university based in Madrid. He predicts that the bad debt rate will rise to 9% by 2021.

Despite the sale of bad debt stocks, banks still hold significant numbers that could weigh on profits and cause problems in the future, he said. Current market conditions will make it difficult for banks to get rid of the remaining debt, he added.

Spanish banks are likely to increase their provisions in the coming months to take into account expected loan losses. BBVA has already announced significant provisions in the first quarter.

“BBVA was the exception among Spanish banks because it took the more conservative approach and a big provisioning effort in the first quarter”, said Iparraguirre. Other banks will record new provisions in the second quarter and potentially the third, she said.

The European Banking Authority predicts that the entire European banking sector will face an increase in bad debts, with credit losses amounting to 3.8% of risk-weighted assets, which determine the capital that a bank must hold.

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Spanish banks have the lowest capital levels among major European lenders, according to data from S&P Global Market Intelligence. BBVA has the lowest, not having been able to cancel its dividend payment for 2019 because it held its shareholders’ meeting before the ECB recommended banks not to distribute dividends to raise capital. Santander is second from the bottom.

“They have bigger capital reserves and are in better shape than 10 years ago, but there is some murky water ahead”, Carbo said. Provided there is no second wave and subsequent lockdown, they should be able to cope.

In the event of a second confinement, SMEs already in difficulty, particularly in the tourism sector which represents around 15% of Spanish companies ”,will not survive; they may survive the first blow, but not the second, “he said.

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