Spanish Home Prices, Bank Asset Quality Fall

Spanish home prices fell in the second quarter at a faster rate than anticipated, falling to lowest levels since the peak of the housing market in 2008. The fall in home prices could further weaken the already struggling banking sector and make the bank recapitalization plan (already a staggering $125 billion) potentially larger.

The Spanish home price index fell 8.3 percent from a year ago in the second quarter, a much larger drop than the rate of decline in the first quarter. Home prices had fallen at a 7.2 percent annual rate in the first quarter. Economists had expected home prices to decline at a 7.5 percent annual rate.

The steep drop in home prices to five-year lows has hit the struggling banking sector as well as homeowners. The Bank of Spain reported that bad loans as a percentage of total loans at Spanish banks rose to 8.95 percent in May from 8.72 percent in April. As bank asset values continue to deteriorate and losses mount, the future of the Eurozone could be called into question.

Spanish banks lent heavily to the real estate sector in the previous decade as home prices rose. However, once prices peaked in 2008, the loan performance started to deteriorate in a similar dynamic that has plagued U.S. banks. As loan values fall, banks need the government to help aid in recapitalization. The Spanish government has struck a deal with European officials to receive European support for the bank rescue plan, but further falls in asset values could jeopardize this deal.

As asset values fall, banks record losses, which affect the financial statements in the shareholder's equity section. The recapitalization is aimed at replenishing the banks' equity with fresh capital. Thus, further losses on bonds would make any required bailout larger than previously anticipated. Because German, Finnish, and other Northern European officials have been reluctant to help at this current stage, asking for more funds would be extremely difficult and would be politically tough for the creditor nations to allow. If the broad Spanish economy contracts further and home prices fall further, Spanish banks could be in trouble.

Some Spanish banks are traded in U.S. markets. For example, Banco Santander (NYSE: SAN) has shares listed in the U.S. and so does BBVA (NYSE: BBVA). Traders can express opinions over the health of the Spanish banks through these two stocks and can express broad, Spanish economic views through the iShares MSCI Spain ETF (NYSE: EWP).