Banks' rising bad loans add to Spanish troubles

MADRID (Reuters) - Spanish banks' bad loans rose in March to their highest in 18 years, underscoring the problems facing the government as it drafts in independent auditors in an attempt to reassure investors it can clean up the sector.

The Bank of Spain said bad loans rose to 8.37 percent of banks' outstanding loans, the highest since August 1994 and up from 8.3 percent in February, which was also revised higher.

The data was released before Spain names auditors on Monday to assess how bad the losses are likely to get, and how much cash banks will need to rebuild their balance sheets.

The audit will start with a one-month stress test followed by a deeper analysis of assets in the financial sector, Deputy Prime Minister Soraya Saenz de Santamaria said.

Financial sources have said fund manager BlackRock and management consultancy Oliver Wyman would probably be named to conduct the deep audit. But a government source said six funds and management consultancies have placed bids for the work, while a different government source said BlackRock may have a conflict of interest.

The Bank of Spain figures, released hours after a mass bank downgrade by credit ratings agency Moody's, showed losses from loans made in Spain's housing bubble are still rising.

The Moody's move had been expected, however, and Spanish bank shares rebounded on Friday after a grim week. Shares in part-nationalized Bankia leapt by a quarter to cut recent losses.

Troubled banks, along with overspending in indebted regions, are the two biggest risks for Spain's public finances. Investors believe Spain needs to aggressively address these two issues to avoid an Irish-style bailout.

Banks expect bad loans to continue to rise this year as the economy contracts and the jobless rate remains painfully high at almost one in four of the workforce, the highest in the EU.

Against that backdrop, analysts estimate bad loans could rise to nearer 15 percent of loans.

"The challenge is the non-performing loans portfolio that sits on their books and the direction of that (level)," Johannes Wassenberg, managing director of banking at Moody's, told Reuters on Friday. "The key is getting to the bottom of that, whether in a single entity or a consolidated basis."

BORROWING COSTS

A more immediate worry is if savers start to withdraw deposits. A report that Bankia had lost more than 1 billion euros ($1.3 billion) in deposits sparked a 30 percent crash in its shares on Thursday, before denials of an exodus.

On the streets of Madrid there were no signs of panic about savings, but some are wary and are checking with branch managers and friends and relatives to discuss their concerns.

"I'm very worried. I have a fixed-term savings account, I can't take it out, but if I could I would," said Josefa Oset, 78, who has a Bankia account. "For the interest I get on it, I might as well keep it under the mattress, that way no-one's going to take it. Who knows if in a year's time I'm going to get my money back."

Spain's borrowing costs hit euro-era highs this week, prompting the government to ask Europe for more backing.

Prime Minister Mariano Rajoy will press for the European Central Bank to step up its defense of the euro zone in a meeting on Sunday with German Chancellor Angela Merkel, on the sidelines of a NATO summit in Chicago, and at a lunch with French President Francois Hollande on Wednesday in Paris.

Spanish officials say Spain has done its job with reforms to make its economy more competitive, such as making it cheaper for companies to hire and fire, with measures to shore up the banking system, and with harsh spending cuts.

They say ECB bond buying is necessary to back up Spain's efforts. Rajoy has pledged to continue with austerity measures even though they have aggravated the economic contraction.

REAL ESTATE LOSSES

The government has also hired Goldman Sachs to carry out an independent valuation of Bankia, the ailing bank taken over by the state last week, two sources said, one from the government, one from the financial sector.

Bankia's financial hole may reach 8 billion euros ($10.2 billion), on top of the 10 billion it needs to set aside to cover potential losses on real estate assets, newspaper Expansion said.

Moody's on Thursday downgraded 16 Spanish banks, citing the recession, real estate crisis and unemployment, and the government's reduced ability to support troubled lenders.

By 1300 GMT shares in Santander and BBVA were each up 3.7 percent, outperforming a flat European bank sector.

Bankia shares were up 25 percent, but have still tumbled 28 percent in the last two weeks. Santander and BBVA have both dropped 6 percent this week as the crisis has rattled investors in the bigger, stronger lenders too.

The cost of insuring the banks against default has also risen. By 1000 GMT Santander's five-year credit default swaps (CDS) were up 9 basis points at 452.25 bp and BBVA rose 12.5 bp to 499 bp. This means it costs just under $500,000 annually to buy $10 million of protection against a BBVA default using a five-year CDS contract.

Insurance costs have risen across the sector this week, with the iTraxx Senior Financial index breaching 300 bp on Thursday for the first time since December.

Bankia - due to present a restructuring plan next week - has said it would need 4.7 billion euros in capital to comply with the last banking reform.

The government last week forecast banks would need to find about 35 billion euros more to cover potential losses, marking its fourth attempt to deal with a 2008 property market crash.

($1 = 0.7869 euros)

(Additional reporting by Paul Day, Sarah White and Catherine Macdonald in Madrid and Steve Slater and Jean-Marc Poilpre in London; Editing by Fiona Ortiz and David Holmes)

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