OREANDA-NEWS. September 07, 2015. The slowing in the pace of credit contraction at Spain's banks reflects their generally improving prospects, says Fitch Ratings. The sector is benefiting from the gradually accelerating recovery of Spain's economy, with improved profitability and management of problem assets. We forecast GDP growth in Spain to reach 2.8% in 2015, supported by improving domestic demand. This is likely to be the strongest growth rate among large eurozone members. We expect the improvement in Spanish banks' credit profiles to continue in 2H15, but new lending is still insufficient to offset a decline in the stock of outstanding loans to households and companies.

Bank of Spain data published on 1 September shows household borrowings contracting by an annualised 2.8% in July 2015, an improvement on loan shrinkage of 3.7% for 2014 and 5.1% for 2013. A similar trend is reported by companies, with annualised loan contraction of 2.7% in July 2015, an improvement on 2014 (4.3%) and 2013 (6.6%).

Outstanding volumes of retail mortgages, which have halved since 2009, contracted by only 2% in 2Q15. This is good news for banks because mortgages represent the bulk of consumer spending in Spain. Stabilisation is a sign of consumer confidence, spurred by brighter job prospects, indicated by a fall in unemployment to a still very high 22% in August. The downward trend in average mortgage rates, in line with a steady reduction in 12-month Euribor, also supports demand for new mortgage borrowing.

Spanish banks' new lending focuses primarily on the most profitable areas, particularly SMEs and consumer loans, where growth potential is fuelled by increased credit demand due to the economic recovery. Bank lending remains the dominant source of financing for Spain's SMEs, which have more limited access to capital markets than mid to large corporates. This is positive for banks because margins on this type of business remain attractive. But Fitch-rated banks warn of heightened competition, which is putting pressure on new loan spreads.

Spanish banks reported improving profitability at the operating level in 1H15. A gradual recovery in key retail and SME businesses, savings on funding costs, particularly on retail deposits, reducing loan impairment charges, cost containment and some one-off gains from government bond sales all contributed to an upturn in performance trends.

Asset quality continues to improve, albeit from poor levels. The stock of impaired loans to domestic borrowers reduced by 15% in 1H15 and we believe volumes of repossessed properties are also stabilising. Impaired domestic loans represented 11% of total loans at end-June 2015, an improvement on 13% at end-June 2014.