EUROPEAN BANKS ARE FACING MORE PAIN IN SPAIN / THE WALL STREET JOURNAL ( VERY HIGHLY RECOMMENDED READING )

BUSINESS
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June 27, 2012, 6:25 p.m. ET
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European Banks Are Facing More Pain In Spain
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By SARA SCHAEFER MUÑOZ And LAURA STEVENS

Spanish-owned banks aren't the only ones under pressure to fortify themselves against Spain's crumbling economy. Foreign banks with big Spanish operations also find themselves in a tough position—and with few options.

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Three European banks—Barclays BARC.LN -15.53%PLC, Deutsche Bank AG DBK.XE -4.49% and ING Bank NV—have large Spanish units. They already have pumped in billions of euros of capital to shore up those businesses, but as the Spanish government conducts a wide-ranging review of the sector's health and the economy continues to struggle, they could demand even more, according to bankers and analysts.

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Making matters more difficult, Spanish regulators, like their counterparts elsewhere in Europe, are encouraging banks to transform their local subsidiaries into financially self-sufficient entities, according to people with knowledge of regulators' efforts. In other words, instead of relying on funds transferred from the parent companies, the local subsidiaries would need to develop the ability to raise funding locally.

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The combination of Spain's worsening economic outlook and the mounting government pressure further threatens to make Spain a less attractive place for the banks to do business.

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"The big problem is that they can't get out," Christopher Wheeler, an analyst at Mediobanca Securities in London, said of Deutsche Bank and Barclays, which both acquired Spanish banks in the 1980s. "They have a pretty big footprint there, but they can't sell the branches because you'd just be giving them away."

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To be sure, banks such as Barclays, Deutsche Bank or ING are large institutions, their Spanish units account for less than 5% of their overall balance sheets. But the businesses will eat away at future profits, analysts say.

Mr. Wheeler noted weak earnings from Deutsche Bank's overall retail banking business segment in the first quarter, some of which he said could be attributed to slowdowns in areas such as Spain.

Barclays, which over the past year has scouted out possible acquisition targets in Spain, has put the search on pause, according to people close to the bank.

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Barclays had £25.8 billion ($40.4 billion) of gross assets in Spain as of the first quarter and announced last year it would funnel an additional €1.3 billion to shore up its Spanish business in order to meet new rules set by Spanish regulators. According to analysts at Citigroup, C-3.73%,76% of Barclays's €2 billion ($2.5 billion) in loans to real-estate developers are past due or otherwise problematic. The bank has set aside enough funds to cover some 62% of the portfolio.

The London-based bank has been more conservative than many Spanish peers in flagging worrisome property-developer loans, analysts say. But Spain's deep economic downturn will increase pressure on other areas of lending, as well.

Barclays also has some £5.4 billion in corporate loans, and Spain's souring economy means that the country "will be a drag on Barclays corporate business for an extended period," said Ian Gordon, an analyst with Investec Securities in London.

A Barclays spokesman said the bank is "focused on generating a return despite challenging conditions."

Deutsche Bank had a total of €29.1 billion in exposure to Spain at the end of March, including €6.4 billion in exposure to financial institutions such as loans to banks.

Exposure in Spain is "principally to highly diversified, low risk retail portfolios and small and medium enterprises," Deutsche Bank said in its first-quarter report.

Following Spain's request to the European Union for up to €100 billion in bank rescue money, it will launch a sector-wide audit of the Spanish banks, to be carried out by international firms and completed in July. The findings of the audit could have implications for foreign banks in Spain, analysts say, causing lenders such as Barclays, Deutsche Bank and ING to set aside further buffers against losses even on mortgage books and on other portfolios that had been considered relatively low-risk.

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Bloomberg News

Banks such as Barclays, Deutsche Bank or ING are large institutions, their Spanish units account for less than 5% of their overall balance sheets. But the businesses will eat away at future profits, analysts say. Above, a Barclays branch in Madrid.

Barclays has some £14.3 billion in residential mortgages, while Netherlands-based ING has €9.2 billion.

In a recent investor presentation, ING said its client base is healthy, and the majority of the loans were issued before the crisis. The Dutch bank's credit exposure in Spain totals €37.6 billion, nearly half of it through covered bonds issued by Spanish banks that it bought up in the past and is now slowly getting rid of.

Covered bonds have been a favorite fundraising tool of Spanish banks. They are bonds backed by collateral—usually residential mortgages—and are usually considered low risk because if a bank defaults on the loan, the creditor receives the collateral. In the case of Spain, with the real-estate market continuing to decline, that collateral likely would be worth less, say analysts and people familiar with the fixed-income market, leaving the lender with a loss.

A spokesman for ING, which has launched a successful deposit campaign through ING Direct, said that the bank's position in Spain is strong, in part due to the large degree of Spanish customer funding it holds.

Collectively, German lenders have the highest exposure to Spain at $146.1 billion—of which $53.1 billion alone is exposure to banks, according to the Bank for International Settlements.

Germany's so-called Landesbanks rushed in and invested heavily in European sovereigns and banks through such bonds, along with mortgage-backed securities and other risky assets, in the early 2000s.

—David Enrich and Eyk Henning contributed to this article.

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