This reform could see Banco Santander, Spain's biggest lender take a 42 percent hit on its 2012 profit, and BBVA take a 52 percent hit on 2012 earnings, according to a new Societe Generale report.

At €26 billion, Spanish banks had the widest capital shortfall in Europe, based on the European Banking Authority's capital requirements. They managed to cover this gap without any capital increase. According to SocGen Santander was the most active, followed by BBVA, in making themselves compliant through changes in dividend policy, asset disposals etc. Banco Popular needs to accrue 1 billion in capital to meet the target.

Now, SocGen estimates that these extra provisions would come to €48 billion to €58 billion for the system, implying a capital shortfall in a range of -€25 billion and -€30 billion, on top of the EBA capital shortfall.

Moreover, this time around banks are unlikely to get much help from the government. Earlier this year Spain's economy minister Luis de Guindos said that the government would not set up a bad bank. Spanish banks would have three priorities namely, cleaning up balance sheets, streamlining capacity, and
minimizing the cost for Spanish Treasury. This would mean that the shareholders would take the hit for the clean-up.

Just how big is the problem?

Total real estate exposure amounts to €338 billion, or €406 billion including construction loans, which represent 23 percent of all loans, and 41 percent of GDP. Mortgages account for 34 percent of the loan book, or about €612 billion. From SocGen:

"More than half of the Spanish bank loans tied to property and construction, amounting to €176bn, or 18% of GDP, are classified as “problematic” in the latest Financial Stability Report (FSR) a Bank of Spain report published every six months."

As the chart from SocGen shows, real estate and construction loans account for the largest share of non-performing loans.

 

Spanish banks chart

Societe Generale

 

Banco Santander, has said its Q4 profit fell 98 percent as it expected tougher regulations on covering its real estate losses, according to Bloomberg. The bank reported net income of €47 million, from €2.1 billion a year ago.

Meanwhile, Spanish officials are hoping these measures will boost confidence in the country's banking sector and its economy.

Note: SocGen prefers BBVA to Santander, for its business and geographical mix, low leverage, asset quality and high fully diluted profitability. Santander’s lower exposure to Spain vs BBVA and its larger excess capital after the additional provisions and potential actions to restore it may mean that Santander could be involved in a more sizeable deal in a consolidation scenario.