Spain's largest banks had the weakest capital positions among EU lenders at the onset of the coronavirus outbreak, leaving them little room to maneuver in the event of a capital crunch during the pandemic, according to S&P Global Market Intelligence data.

Banco Santander SA ranked bottom among Europe's 40 biggest banks, with its common equity Tier 1 ratio — a key measure of capital strength — standing at 11.41% at the end of the 2019 fourth quarter. Banco Sabadell SA was second from the bottom at 11.71%, and Banco Bilbao Vizcaya Argentaria SA next at 11.74%. CaixaBank SA was fourth from the bottom at 12.03%. State-controlled Bankia SA fared better, taking the 12th-from-last place, having rebuilt its capital following a €22 billion government bailout in 2012. By contrast, Finland's OP Financial Group topped the list, with a ratio of 19.50%.

Spanish lenders were also the worst performers in terms of aggregate capital, which stood at 12.2% for the whole banking sector at the end of the third quarter. This compared with 14.5% in France, 14.8% in Germany and 13.7% in Italy, according to S&P Global Market Intelligence data.

Daniel Lacalle, chief investment officer at fund manager Tressis Gestión, predicted "a massive rise in nonperforming loans" both domestically and in the banks' overseas operations, which would "definitely hurt" capital ratios. Even in the most benign economic scenario, core capital ratios are "going to be heavily impacted for sure," he said.

"In Spain there is going to be a very drastic — and legally enforced — reduction in payments," Lacalle said, adding that the Spanish government is offering mortgage holidays to households in financial difficulty.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Like many global governments, Spain has taken steps to mitigate the impact of the pandemic on the economy, offering €200 billion in financial aid in the form of loans, credit guarantees, benefits and direct aid. This includes €100 billion in guarantees and loans for companies, especially small and medium-sized enterprises.

But Lacalle said the loan package could potentially backfire over the longer term.

"It's all on the balance sheet of the banks and that can cause severe strains going forward, even if there is an acceptable type of recovery, because it is virtually impossible to believe that the increase in nonperforming loans is going to be reverted quickly," he said.

"In general, capital is dissolving," Lacalle said. "If governments don't stop this insanity of shutting down the economy in order to contain the virus they are going to create a much larger problem down the line."

Stress tests

While Spanish banks generally have higher profitability levels than the European average, their capital levels will limit their capacity to manage bad loans, said Javier Santacruz, an economist at the Instituto de Estudios Bursátiles in Madrid who specializes in the Spanish banking sector.

Return on tangible equity — a measure of profitability — was 11.9% at BBVA end-2019, compared with 7% at its European peers, according to the bank. Santander had a 2019 underlying ROTE of 11.9%. Among Spain's smaller lenders, CaixaBank's ROTE was 7.7%, Sabadell's 7.4% and Bankia's 4.3%.

Santacruz likened the current crisis to the worst-case scenario in the European Banking Authority's 2018 stress tests, in which Spanish banks' capital levels "decreased a lot," but not to critical levels.

Under the adverse scenario of those stress tests, Sabadell's common equity Tier 1 ratio falls to 7.58% at the end of 2020, while BBVA's stands at 8.80%, CaixaBank at 9.11% and Santander at 9.20%. Bankia was not tested.

Their business diversification and global presence means Spain's two largest banks, Santander and BBVA, are the best placed to weather the crisis, Santacruz said. Santander generates a large chunk of its earnings from South America, and has a presence in the U.S., the U.K. and Poland, among others. BBVA's biggest market is Mexico, where it owns the country's largest bank, BBVA Bancomer SA Institución de Banca Múltiple Grupo Financiero BBVA Bancomer, and it has operations in Turkey.

But Santander's target of a 11% to 12% CET1 ratio was "not enough", analysts at Berenberg said in a March 26 research report, in which they forecast the lender would have an €8 billion capital shortfall.

The group's Executive Chairman Ana Botín told shareholders on April 3 that she was "comfortable" with the bank's capital position, even before taking into account regulatory measures to relax capital requirements. Dividend cancellations will boost the bank's lending capacity to €90 billion, and represent 80 basis points of pro forma capital, based on 2019 underlying profits, she said.

For BBVA, Berenberg analysts forecast €6.7 billion of loan losses in 2020, up from €4.2 billion in 2019.

A BBVA spokesperson said the lender had a "comfortable" capital position, with its CET1 ratio at 247 points over minimum requirements. ECB measures to relax capital requirements have raised that level to 294 basis points, he said. The bank's leverage ratio at the end of 2019 was the highest of its European peer group at 6.7% versus an average 4.9%, which "demonstrates the high quality of the group's capital and its capacity to absorb losses." In European stress tests, BBVA "has stood out for the resistance of its results and its capital in potential economic recessions," the spokesperson said.

A spokesperson for Bankia underlined the bank's "solid" capital position and referred to a speech to shareholders by the bank's Chairman José Ignacio Goirigolzarri who noted that the bank had the highest capital levels among Spanish banks, and its strong capital position would help it support corporate and private customers during the crisis. The 13.02% ratio means the bank's capital levels are €3 billion above requirements, he said.

Mid-sized lenders

The capital levels of medium-sized lenders such as CaixaBank will depend on how corporates fare during the crisis. They will likely see further margin erosion and face a loss of business for several months as small and medium-sized enterprises and mid-to-large corporates struggle to maintain their activity.

A CaixaBank spokesperson pointed to a March 26 statement where the bank underlined its "solid liquidity and solvency position." The bank's end-2019 capital ratio of 12% represents a buffer of 325 basis points over supervisory requirements, it said. The lender lowered its CET1 target to 11.5% amid a softer regulatory stance.

Sabadell, another midsized mainly domestic lender, may also come under pressure, analysts said.

"Obviously domestic banks have less financial muscle," Lacalle said. "Santander and BBVA can erase the dividend and survive the slump, but for the domestic banks [like] Sabadell ... it is not as if they are coming from multidecade highs with very strong margins and huge corporate profits." Sabadell did not respond to a request for comment.

Like many of their European peers, the profits of Spanish lenders have been hit by negative interest rates, and 2019 net income was down at all but one of the largest five lenders, S&P Global Market Intelligence data shows. Sabadell was the exception, rebounding from a steep drop in 2018 profits after a bungled IT migration at its U.K. subsidiary TSB Banking Group plc.

Smaller former savings banks such as Liberbank SA, long considered as one of the weaker Spanish lenders, will likely be the most affected and may rely on ECB support, Santacruz said. They may also have to step up cost cutting measures such as letting employees go and closing branches, he added.