Spanish banks are up between 34 – 63% since the summer, outperforming the rest of the periphery, and the market seems to pricing in a lot of optimism even though Spanish banks still have weak loan growth and a high level of non-performing loans. But this optimism comes from making some fairly strong assumptions about next year’s performance, says Citi analyst Stefan Nedialkov.

Spanish banks performance

“Spanish banks are up 34-63%, outperforming the ESTX BANKS PR.EUR (INDEXSTOXX:SX7E) by 5-35%. What strikes us is that this stellar price performance seems to have been driven almost exclusively by multiples rerating rather than consensus estimate upgrades,” writes Nedialkov. “We argue that the market is pricing in a very healthy dose optimism as it, we believe: gives the shares full credit for above average carry trade levels; assumes some of the banks would report very low credit loan loss provisions and/or writebacks; and assumes a cost of equity lower than that for some of the Eurozone’s larger banks.”

Spanish banks market implied cost of equity

But Spanish banks are the most dependent on ECB funding with about 10% of assets (aside from Greek and Cypriot banks, whose level of reliance varies), while the rate of NPLs continues to climb. It’s up 160 basis points year on year, and while growth of NPLs is slowing, the total volume hasn’t even started to contract.

periphery ECB funding

spanish bank npl ratios

Mortgage growth in Spain

Domestic loans continue to contract at double-digit rates, if slightly lower double-digit rates than at the beginning of the year, and the rate of mortgage growth has flattened but is still quite negative. Nedialkov doesn’t expect loan growth to turn positive until 2016, and even then only barely so, around 0.4%.

spain system mortgage growth

spain yoy loan growth

In all of these cases you could argue that the Spanish banks are showing signs of a recovery, in the sense that they are doing poorly instead of spiraling downward, but the level of optimism being expressed by price growth seems hard to justify. There has been a move to increase exposure to periphery countries, mostly Greece but also Spain with Bill Gates’s large investment in Spanish construction firm Fomento de Construcciones y Contratas SA (MCE:FCC) (OTCMKTS:FMOCF) just yesterday, and the market’s optimism could be signaling a related sentiment.