An uncertain economic outlook, a potential delay in the all-important tourism sector recovery and a slower pace of higher credit risk recognition than European peers will require Spanish lenders to recognize higher provisions in 2021 than they anticipate, according to analysts.

The coronavirus pandemic has raised concerns about rising bad loans at Spanish banks as corporates face difficulties in repaying loans in a challenging economic and health context.

Spain is the 10th-most affected country globally by COVID-19 in terms of mortality, with more than 69,140 deaths as of March 1, according to U.S.-based Johns Hopkins University. The Spanish economy has also taken a bigger hit than most European countries in the fourth quarter of 2020, with GDP contracting 9.1% in the period, compared with a contraction of 5% on average in the eurozone, according to the EU statistics office.

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Cost of risk — the main metric for calculating loan loss provisions — rose sharply for the largest five Spanish banks by assets in 2020 from 2019, according to S&P Global Market Intelligence data. At the country's two largest banks, Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA, cost of risk rose to 135 basis points from 99 bps and to 162 bps from 102 bps, respectively, as the lenders frontloaded expected losses from coronavirus-related loan defaults.

Both banks said during earnings presentations that they expected cost of risk to decline in 2021, but warned of uncertainties. CaixaBank SA, which is acquiring Bankia SA, predicted loan loss charges in 2021 would be "well below" 2020 levels, while Banco de Sabadell SA estimated 2021 cost of risk to be lower.

"Given the economic environment, I wouldn't rule out a higher cost of risk this year," Pablo Manzano, vice president for global financial institutions at DBRS Morningstar, said in an interview. "To see some kind of normalization we need to see, maybe not a full recovery, but to be in the path of a full recovery. This is not the current situation. We are still in a very uncertain economic environment."

Loans

Citing the European Banking Authority Risk Dashboard report, Manzano said there were signs that banks in Spain are lagging European peers in recognizing stage 2 loans — loans for which credit risk has increased significantly. According to the report published Jan. 13, the stage 2 loans of Spanish banks rose by 20 bps in the first three quarters of 2020.

ECB data also shows that Spanish banks' gross nonperforming loans and advances as a percentage of total gross loans and advances stood at 2.95% at the end of the second quarter of 2020, compared with 6.32% in Italy and 2.33% in France.

As the coronavirus outbreak unfolded in Spain, the government responded with a €100 billion loan guarantee scheme in March 2020 then another €40 billion in July of the same year, while banks offered loan holidays. According to the Bank of Spain, banks had granted loan moratoriums of €54.11 billion as of Jan. 31, 2021.

Tourism

Spain is a global tourist destination, with tourism accounting for 12.3% of the country's GDP. The coronavirus-induced economic shutdown led to a slump in visitors in 2020, cutting off vital revenues for tourism-related small and medium-sized enterprises, and Prime Minister Pedro Sanchez announced Feb. 24 an additional support plan of €11 billion for the tourism sector, restaurants, hotels and small businesses.

If the 2021 tourist season is delayed or even canceled, that could be a negative for banks' cost of risk outlook, analysts said.

"If you are a restaurant or hotel owner in Spain and the moratoria helped you survive last summer, if there is no tourist season this summer to speak of either, a second year is going to be much more difficult," Jefferies analyst Benjie Creelan-Sandford said in an interview. Banks' cost of risk predictions are "dependent on a reopening happening sooner than much, much later to justify that more upbeat outlook on provisions."

"If you are thinking the tourism sector is completely written off in the summer of 2021, that is going to have a detrimental impact on corporate asset quality," he said. "There is going to be a more knock-on impact on employment and that will put pressure on other parts of the loan book."

While government support measures as well as loan moratoriums and furlough schemes are supportive for asset quality and acting as a "safety net" for loan losses, Creelan-Sandford said they are "are simply a way of buying time."

"It is dependent on getting back to normal or something closer to normality but if that doesn't happen you would expect the loss experience to be worse," he added.

Nonperforming loans at Spanish banks as a percentage of loans held at amortized cost fell to 3.84% in the fourth quarter of 2020 from 3.96% the year before and from 3.86% in the previous three months.

In terms of capital, Spanish banks have the lowest capital adequacy ratio of 12.56% at the end of the second quarter of 2020 among European lenders, ECB data shows.

However, measures to ease regulations as well as a recommendation from the ECB to suspend dividend payments boosted banks' capital in 2020, with the common equity Tier 1 ratios — a sign of capital strength — rising for the top five lenders.

Although they have low capital levels compared to peers, they "have room for maneuver," Manzano said. "They can absorb losses without breaching capital requirements."

Lenders need to take advantage of their capital buffers to deal with the risk and then focus on new lending, he added.

Banks may be waiting to see what the final bill is to have a clearer picture, but it would be better for them to address the issue now.

"The sooner they do that, the better for the Spanish economy and for the Spanish banks," Manzano said.