By Jesús Aguado

ONTINYENT, Spain (Reuters) - The patient had made an appointment to see the surgeon at his consulting room in the local hospital, but when he arrived, he told Dr Antonio Carbonell he wasn't actually unwell. He wanted to talk about his mortgage.

Carbonell works as a surgeon in the small Spanish town of Ontinyent near the Mediterranean coast. He also happens to be chairman of the town's tiny savings bank, Caixa Ontinyent.

"He wasn't sick. But we are so close to our clients here that he had booked an appointment at the hospital to see the banker, not the surgeon," said Carbonell, relating the story as an example of the extreme localism that kept Caixa Ontinyent alive.

Out of more than 50 small savings banks in Spain, known as cajas, Ontinyent is one of only two that survived the country's banking collapse of recent years.

It did so by retreating from wholesale funding markets, withdrawing efforts to attract new business, focusing on its existing client roster of mostly small savers in its home town, and ploughing its profits back into covering for bad loans.

Today, Ontinyent is thriving. Profits were up 24 percent in the first quarter of this year after growing 13 percent last year. Though its network of 49 branches would barely be noticed by a giant competitor with thousands of branches like Santander <SAN.MC>, it has slowly begun opening more.

Now, with Spain's banking trouble being repeated in Italy -- a bigger country with an even bigger problem of bad loans and an even larger proliferation of tiny local banks -- Caixa Ontinyent's success is drawing new attention from those wondering whether its formula can be repeated.

It has a simple message for bankers at small Italian lenders in a similar predicament: stay local, serve your clients and act quickly to fix your balance sheet.


Italy is in much the same place now that Spain was a few years ago, trying to reform a fragmented banking sector weighed down by bad loans, in Italy's case totaling some 360 billion euros, compared to Spain's 2014 peak of 200 billion euros.

The Italian government wants to shrink a large network of co-operative banks, similar to Spain's cajas, by persuading small banks to merge. But progress has been slow, with no major merger in the sector yet to be completed. Economists say Italy's small banks, often with murky ties to local government and business, have been slow to open their books and reveal the extent of their problems.

But Caixa Ontinyent shows why such steps are necessary. Vicente Ortiz, adviser to the board and the visible face of the bank, said the secret behind its rebound was to react quickly and decisively when it became clear that a decade-long property bubble would burst.

"Until 2007, our plan was sell, sell and grow. But in 2008, we saw we had to quickly get the balance sheet under control," Ortiz told Reuters in an interview from the lender's recently refurbished headquarters on a shady central square of Ontinyent.

Unlike rivals which kept attracting new clients with artificially low rates on loans and high returns on deposits as they slipped deeper into trouble, Caixa Ontinyent scrapped all commercial offers. Instead, it focused on keeping its relationships with existing small savers, most with less than 15,000 euros in the bank, Ortiz said.

The result was that an ongoing client and deposit flight stopped and was reversed. Today, Caixa Ontinyent has around 100,000 clients, compared to 90,000 before the crisis. It manages 800 million euros in deposits, compared to 700 million euros in 2009 and a low of 600 million euros during the slump.

Although back in 2008 the Bank of Spain and many Spanish banks were denying any threat of a lending crash, Caixa Ontinyent became obsessed with boosting its financial ratios.

Between 2008 and 2012, when Spain's banks were eventually bailed out with 42 billion euros of European money, Ontinyent set aside as much as 100 percent of its profits in some years to boost an insurance fund against losses.


That was key to its survival, as in the meantime bad loans had grown five-fold to more than 10 percent of its total portfolio, boosted by the excesses of the boom years and mirroring the trend that brought down most Spanish lenders.

Like most Italian and Spanish lenders, Caixa Ontinyent still has a big stock of bad loans at around 12 percent. But unlike others it enjoys 74 percent coverage on them, compared to 45 percent on average for Spain's and Italy's financial sector.

According to Santiago Carbo-Valverde, professor of Economics and Finance at Bangor Business School, the turnaround was helped by the bank's small size, community ties and focus on domestic retail clients rather than international wholesale markets.

"For four years, it was 'for god's sake let's hope nothing happens," said Ortiz, also the longest serving employee with 43 years at the lender. "But then came the tipping point and people stopped asking if we were going to disappear and instead began inquiring how they could become clients."

Still, learning the lessons of Ontinyent might not be enough to save small banks in Italy, where bad lending is more complicated to untangle than in the wake of Spain's comparatively straightforward property boom, said Nicolas Veron, a research fellow at economic think tank Bruegel.

"The main problems in Spanish lenders were their high exposure to the real estate business, whereas Italian banks are more exposed in lending to businesses and households. And that makes it more difficult to address the problems," he said.

Italy’s notoriously Byzantine legal system creates particular hurdles, with long and uncertain court procedures making it hard to quickly recover collateral for non-performing loans, Veron said. Italian labor law makes it hard to lay off workers and shrink a bank’s business to save it.

For now, the Italian government is mainly focused on saving its big banks, rather than the little ones, which it has failed so far to persuade to merge. But time is running out, and Ontinyent's example shows the importance for small banks of acting quickly to identify problems if they hope to survive.

"Italy may have some small strong banks too but at some point there is obviously a need for more transparency," Veron said. "One clear lesson to be learned from Spain is that you cannot wait forever."

(Editing by Julien Toyer and Peter Graff)