OREANDA-NEWS. The 2016 outlook for Spanish bank ratings is positive, based on improved fundamentals, says Fitch Ratings. This is in stark contrast to 2015, when 40% of ratings were on Negative Outlook, weighed down by the impending removal of sovereign support for banks. Standalone creditworthiness now drives bank ratings and we are expecting improvements. One-third of ratings assigned by Fitch to Spanish banks are currently on Positive Outlook, supported by the better economy.

We forecast GDP growth of 2.5% in 2016 and expect the housing market to stabilise. In many respects, the worst seems to be over and we maintain a stable outlook for the banking sector. However, Spain will hold a general election on 20 December 2015 and political developments may create additional risks.

New lending is picking up but the level of net loans outstanding is likely to remain relatively flat. Persistently high unemployment means that many households are continuing to cut back on borrowings and companies are still deleveraging. Pressure on profitability is unlikely to lift until we see an improvement in margins. But prospects for boosting margins are limited, reflecting low interest rates, tough competition and the potential removal of interest floors on certain retail mortgages. Positively, lower loan impairment charges and cost containment should alleviate some pressure on earnings.

Asset quality is improving, albeit slowly. But impaired loans plus foreclosed assets still represented an average 12.8% of gross loans for Fitch-rated banks at end-June 2015. This is better than the 13.8% reported at end-2014 but we are not expecting a short-term solution because banks still have to work through a stockpile of foreclosed assets totalling EUR81bn. This is likely to prove both slow and uncertain as demand for distressed assets is unsteady and prices are volatile.

In our view, the Spanish banks are reasonably well capitalised considering their rating levels. However, solvency remains vulnerable at some banks that hold unreserved problem assets. We expect banks to continue selling problem exposures and non-core assets in 2016 to free up capital to support business growth.

Once amendments to the corporate tax law are passed, the European Commission's state aid concerns regarding the inclusion of certain deferred tax assets (DTA) in bank regulatory capital should be dispelled. This is positive for banks holding large amounts of DTAs and, in particular, those which either received state aid directly or acquired troubled banks that had benefited from aid because it will remove some uncertainties undermining their reported solvency ratios. This comes with a cost because fees will be charged in exchange for state guarantees provided on DTAs.

Net new funding needs are likely to remain modest until credit demand firms up and proves to be more sustainable. Spain's resolution framework, legislated in June 2015, introduced contractual subordination by creating a new class of debt class ('senior subordinated' or 'Tier 3'), specifically to be bailed-in during resolution and ranking behind retail deposits and senior debt. Market appetite for this type of debt remains to be seen. Banks will also have to contribute 1% of their deposits annually towards a new resolution fund.