OREANDA-NEWS. A better economic outlook, less exposure to real estate and construction, easier access to credit, and legal changes are producing an improved performance for SME loans in Spain, Fitch Ratings says. We recently reduced the annual average default expectation on typical Spanish SME loan portfolios in our SME CLO analysis to 5.0% from 6.25%.

The reduction reflects the falling default rates in loans to SMEs in the real estate and construction sectors, and that these borrowers constitute a lower percentage of a typical portfolio than in previous years. We expect the average annual default rate for real estate and construction SMEs to drop to 8% from 10%, while we have maintained the 3.75% annual default rate for all other sectors. The difference reflects the still-weak outlook for Spain's residential property market, chiefly due to the large overhang from before the financial crisis.

The 5% Spanish benchmark for a typical portfolio is higher than in most European jurisdictions, including core eurozone countries (e.g. Germany 2.5% and France 3.5%) and the UK (3%). But it is lower than in southern peers Portugal (6.5%) and Italy, where our benchmark of 5% for a 180 days-past-due default definition would represent a worse performance than Spain, which uses a 90dpd definition.

Spain's economic recovery and a revival in bank lending should benefit SMEs across all sectors. We forecast Spanish real GDP to grow by 2.0% in 2015 and 2.3% in 2016. New bank credit to SMEs was positive in 2014 for the first time in six years, growing at an annualised rate of 8.6% according to Bank of Spain data. SME financing costs have fallen significantly since 2H14, with the risk premium to German SMEs below 100bp. We expect these trends to continue as the economy grows and the ECB pursues its expansionary monetary policy.

The performance of Spanish SMEs that are active in export markets will be supported by a weaker euro and improving external demand. Although export volumes tend to be concentrated in larger, internationally-orientated businesses, a significant proportion of Spanish SMEs are exporters.

Fitch expects fewer defaults among Spanish SMEs as the implementation of Law 17/2014 facilitates more debt restructurings. The law provides for refinancing and restructuring agreements between highly indebted SMEs and financial creditors. The total for restructured SME loans in Spain is estimated at 24% of outstanding credit at end-1H14, according to Bank of Spain data, of which 60% is classified as doubtful. The new regulation may reduce recoveries for secured claims, for example, if dissenting secured creditors are forced to accept haircuts and maturity extensions approved by a majority of creditors.

These and other developments in the Spanish SME sector are discussed in our report 'Spanish SME Market Review', published today. The report is available at www.fitchratings.com, or by clicking the link above.