Editor’s note: This publication will continue to feature a number of commentaries from wealth strategists, fund managers and other financial professionals about unfolding events in the eurozone. The French and Greek elections, recent Dutch political machinations and now the debt plight of Spain promise to make for a turbulent summer. The comments here are from Barry Norris, partner, Argonaut Capital Partners and manager of the Ignis Argonaut European Alpha Fund. As always, the views expressed are not necessarily endorsed by this publication.

Last week it was confirmed that Spain had returned to recession, joining Italy, Ireland, Belgium, Portugal, Slovenia and the UK amongst European countries in a “double dip” economic contraction (Greece is excluded from the list as its economy has yet to come out of its first recession). Only the IMF programme countries (Greece, Portugal, Ireland) will likely post worse growth than Spain during 2012, while Spain’s unemployment rate – though inflated by generous welfare benefits and a black economy – at 24.4 per cent is the highest in the eurozone.

Spain is sometimes referred to as the Florida of Europe, with its sunny climate attracting millions of northern European visitors, second home owners and retirees. Like Florida, Spain has historically - before the euro came into existence - experienced boom and bust real estate cycles, in 1979, 1991 and, most recently, in 2007. Between 1998 and 2007, the Spanish population increased from 40 to 50 million; new housing starts increased from 300,000 to 750,000 per annum, average house prices doubled and Spain created half of all jobs in the EU (with its unemployment rate falling from 18 per cent to 8 per cent).

With Spanish export activity surprisingly robust, much of today’s economic woes relate to the hangover from this property boom, with construction activity having fallen from a peak of 12.5 per cent to 6.5 per cent of gross domestic product today. Since 2007 house prices have fallen by 27 per cent on average according to the government - 10 to 30 per cent in Madrid or Barcelona, but 50 to 70 per cent on the Mediterranean coast where most of the development over the last decade took place.

There are now 5.6 million unemployed in Spain. Although it is often pointed out that Spanish unemployment among 18 to 24 year olds is a staggering 48 per cent at 900,000, it is a less well-known fact that there are 1.3 million foreign workers unemployed (most of whom were previously in construction-related jobs) or that there are 1.3 million unemployed in the populous sunshine region of Andalusia alone. Spain’s economic problems are more regional and industry specific than commonly acknowledged.

Banking sector

This can also be seen in the banking sector. Out of €1.763 trillion (around $2.28 trillion) of domestic Spanish loans, it is the €423 billion of developer and construction loans which are most problematic, where 21 per cent are currently categorised as non-performing. The same ratio for the €650 billion of residential mortgages is just 2.8 per cent (helped also by mortgage interest costs having halved since 2008). The market shares of the savings banks or cajas were higher in the coastal areas where much of the risky lending took place. It is amongst these banks that concerns over solvency are most acute.

At the end of 2011 Spanish banks had taken €108 billion in bad loan provisions against their real estate assets. At the behest of the government this is currently being increased to €160 billion, which compares with €180 billion of real estate loans the government deems to be problematic.

It is difficult to accurately gauge an overall figure for provisions which would provide comfort for financial markets given likely further economic deterioration, or how these provisions would be funded given concerns over the government’s solvency and the context of pre-provision profits of the Spanish banking system of just €30 billion per annum. It is surely here that perhaps €100 billion of the theoretical EFSF and ESM firewall can have the biggest bang for its buck.

Ultimately, market confidence in Spain is only likely to be re-established when a clearing price for property and property loans has been established. The market already anticipates this price to be lower than official current valuations. Should Spanish banks be able to sell real estate loans onto third party investors this would give the market greater confidence in the system as a whole and free up capital for new lending. This process can only be accelerated by a banking sector sufficiently capitalised to realise losses.

It is estimated that there is currently unsold inventory of between 800,000 to 1 million housing units in the Spanish market. With housing starts of 100,000 per annum and normal demand for 250,000 per annum, this excess inventory is likely to take a number of years to clear if it was solely dependent on domestic demand. Once prices have fallen sufficiently, external demand from northern Europeans seeking bargain second or retirement homes will fill the gap.

This will reinvigorate the coastal economies. Spain may be an economic and stockmarket laggard in Europe but it still has one significant natural advantage: it’s sunnier in Malaga than Munich.