Defaults by small and medium-sized enterprises (SMEs), easily the biggest employers in Spain and Italy, are rising at a worrying clip, spelling trouble for the banks and two countries at the heart of Europe's debt crisis (see background).
"You can be sure that if these companies' bad debts rise, you're going to see more bad loans to families, and credit card bills that won't be paid," said Javier Santomá, finance professor at Spain's IESE business school.
Profits at Spain's top three lenders Santander, BBVA and Caixabank fell an average 60% in 2012 due to steep government-enforced provisions for property losses. Writedowns of nearly €24 billion at state-owned Bankia led to a record €19.2 billion loss.
In Italy, the two biggest banks, Intesa Sanpaolo and UniCredit, set aside a combined €14 billion in 2012 to cover bad loans. Smaller lenders also had to increase provisions after the central bank conducted simultaneous audits of around 20 institutions.
Banco Popolare, Italy's fourth biggest, issued a profit warning after the audit prompted €684 million of loan loss provisions in the fourth quarter, more than the total it set aside in the first nine months of the year.
Bad loans forecast to ease in 2013
The Italian banking association has said the pace of growth in bad loans, which has been climbing at an annual rate of 16-17% in recent months, should ease later in the year, based on economic recovery in the second half. That looks remote after the government this month said GDP would shrink 1.3% this year, adjusting a previous forecast for a 0.2% fall.
"Consumption levels, retail sales, industrial activity have gone back to pre-euro levels, and the banks still have not fully taken into account the fall in the property market. I doubt that if they foreclose today ... they would get much of their money back," said Ronny Rehn, analyst at Keefe, Bruyette & Woods.
"So I think we will see a lot more provisioning for many years. Also, there is a lot of non-competitive companies that will end up exiting the market and defaulting, entailing more losses for the banks."
The Spanish government has ruled out another round of special provisions, and analysts said if more capital was required it would be covered by the remaining European aid.
"It could be that one bank here or there needs more capital, but it probably won't be a system-wide issue," said Erwin Van Lumich, a banking analyst at Fitch ratings agency.
"Bad debts could peak in the course of this year, or slightly into 2014, as there is always a delayed effect for these types of statistics."
Spanish banks face €25 billion of losses from 2012-2014 on non-property-related SME exposure of €237 billion on a base case scenario set by consultants Oliver Wyman last year.
On an adverse scenario, that hits €39 billion, compared with losses of €65 billion and €97 billion in base and adverse scenarios on real estate exposure of €227 billion.
Going bust
One in 10 Spanish loans was in arrears for three months or more in December, and research firm Axesor said February was the worst month since 2008, with more than 1,000 companies filing for creditor protection, up 82% on a year earlier, even though banks roll over debt for many struggling borrowers.
Around 1,000 companies a month went bust last year in Italy, and as of January, 7.4% of loans were non-performing, the highest in nearly 13 years and much worse than France's 4.1% and Germany's 3%. At the other end of the scale, the Greek bad loan ratio was 22.5% at end-September 2012.
With Italy and Spain expected to contract by 1.3% and 1.5% this year under the weight of government austerity programmes, SME bad debts are set to climb, meaning defaults are more likely in consumer credit and mortgages.
