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59. The outbreak of the financial crisis in summer 2007 has severely affected the operating model of the Spanish banks. With wholesale funding drying up, Spanish banks have started restructuring their balance sheets. On the asset side, credit institutions have slowed lending growth and tightened credit standards. On the liability side, they have tapped more extensively ECB refinancing facilities by doubling access from a??22 billion in the pre-crisis period to a??49 billion recently. Since other banking systems also expanded their recourse to the ECB, Spain' access has remained broadly in line with that of Euro-area total assets (Figure 11). Banks have also competed fiercely for customer deposits, largely at the cost of redemptions from mutual funds.
60. Banks' operating environment has deteriorated more rapidly and severely than expected. Given their retail-oriented nature, Spanish banks have not been directly affected by the US subprime crisis and its ramifications.60 Nevertheless, they have to face with the bleak economic situation. Domestic economic slowdown and banks' deleveraging have been mutually reinforcing. Households and the corporate sector are highly indebted. Unemployment is rising. The housing market is rapidly cooling off. The corporate sector is facing increasing cash-flow and liquidity problems. Several large real estate developers have filed for bankruptcy. Against this environment, NPLs have increased rapidly but from a very 60 Spanish banks' total direct gross exposure to Lehman was estimated at US$700 million, with BBVA having the largest exposure with US$100 million. However, both Santander and BBVA were caught off guard by the Madoff fraud scandal. While Santander's direct exposure was reportedly minimal (a??17 million), Santander's clients who invested in the bank's Optimal Strategic hedge fund, had an exposure of a??2.3 billion. BBVA reported a?? 300 million losses from its activities related to Madoff Investment Securities.
low base.61 Loans to the construction and real estate sectors have witnessed the most marked deterioration (Figure 12). As a result, savings banks have been most affected owing to their large exposure to the real estate sector. While banks' provisions are still at a comfortable level, the extra cushion provided by dynamic provisioning is falling rapidly.
61. As a consequence, and despite broadly positive results in 2008, market sentiment on Spanish banks has turned mixed. While Santander and BBVA continued to record high net income in line with market expectations, their stock prices have declined significantly, reflecting generalized market risk aversion and in anticipation of very difficult market conditions yet to come (Figure 13). When the financial turmoil heightened in the autumn, their CDS spreads trended above those of (retail) peers (investment banks fared much worse), 61 As of end-2007, NPLs amounted to less than 1 percent of total loans; half of the EU average. mainly owing to the sharp deterioration in the Spanish economic outlook and their large exposures to emerging markets, especially in Latin America. Since then, however, CDS spreads have returned in line with those of retail peers, in part helped by the two institutions' successful market-based ca