Spanish, Italian Bank Funding Squeeze Risks Triggering European Recession

Spanish and Italian banks may have to curtail lending, threatening the European economy, as funding markets freeze amid the region’s sovereign debt crisis.

Yields on the two nations’ government bonds have climbed to records this week amid speculation European Union leaders will struggle to avert the euro area’s first default. That’s pushed up the cost of borrowing for banks including UniCredit SpA (UCG), Italy’s biggest, and Banco Santander SA (SAN), Spain’s largest.

The five biggest banks in each of the two countries have about 240 billion euros ($340 billion) of debt maturing by 2013, according to data compiled by Bloomberg. They haven’t sold bonds since June, and money market rates show the interbank lending market is freezing. That may force banks to curtail lending, which could tip the region’s economy into recession just as governments are struggling with record deficits.

“It may create a slowdown in economic activity,” Jean Pierre Mustier, head of corporate and investment banking at UniCredit, said in an interview. “There’s a disconnect between the markets and human ability to solve the crisis. We need to buy time.”

Banks across western Europe sold about 7.3 billion euros of euro-denominated debt last month, down from 13.8 billion euros in June and 33 billion euros in May, Bloomberg data show.

Lenders in Spain and Italy have been unable to sell bonds: the last sale of more than 500 million euros was June, when Santander sold 1 billion euros of covered bonds backed by loans to local governments. In Italy, the most recent sale was a 750 million-euro offering of senior notes by Mediobanca SpA (MB) in June.

Euribor

Signs of stress in the interbank funding market are worsening. The difference between the three-month euro interbank offered rate, or Euribor, and the overnight indexed swap rate, a gauge of banks’ willingness to lend, climbed to 0.558 percentage point yesterday, the widest spread since June 2009. It was at 0.548 percentage point today and was at 0.360 a week ago. A wider spread indicates greater reluctance.

Firms are wary of lending to each other and are increasing the amount they deposit with the European Central Bank. Europe’s lenders deposited 12.2 billion euros in the ECB’s overnight deposit facility on Aug. 3, the most since February.

The cost of insuring European bank debt against default surged to a record today. The Markit iTraxx Financial Index linked to senior debt of 25 European banks and insurers rose to 211 basis points today.

“At some point this does start feeding back into the real economy if it goes on for too long,” John Raymond, an analyst at CreditSights in London, said in a telephone interview.

‘Huge’ Pressure

The ECB yesterday said it would offer euro-area banks as much money as they need for six months and extend its existing liquidity measures through the end of the year in a bid to stop the crisis spreading.

“Banks will simply have to go to the ECB for funding,” said Ronny Rehn, bank analyst at KBW Inc. in London. “They will also face huge amounts of pressure from smaller banks which have been entirely cut-off from wholesale markets.”

The surge in borrowing costs also means banks may become less willing to make new loans as their own funding costs rise, Raymond said. Santander allowed its domestic loan book to shrink by 7 percent in the year through June. UniCredit said on an Aug. 3 it’s being choosier about to whom it lends and charging customers more to borrow.

“Banks will pull many levers to adjust,” Morgan Stanley analysts led by Huw Van Steenis said in an Aug. 3 report to clients. They could “constrain credit availability further, issue at wider spreads which will hit earnings power, delever or sell asset pools to reduce funding needs.”

‘Real Economy’

The pressure on government and bank funding costs in Spain “could feedback to the real economy” the International Monetary Fund said in a July 29 report, while the Bank of Spain today warned that “possible repercussions of market tensions” are the real “main threat” to growth.

To be sure, the larger banks did raise funding in the first part of the year. Santander sold 32 billion euros of medium and long-term bonds in the first half to replace 21 billion euros of bonds maturing. The lender could tap 100 billion euros from central banks, the lender said in a July 27 presentation to analysts. The bank needs to refinance as much as 37 billion euros next year, according to Bloomberg data.

A spokeswoman for Santander, who asked not to named in line with company policy, declined to comment on funding.

Unicredit Chief Executive Officer Federico Ghizzoni told analysts on Aug. 3 the lender had already raised 85 percent of the 32 billion euros it requires this year. The bank needs to refinance a further 32 billion euros in 2012.

Banks may also resort to other sources of financing, said Rehn. Unicredit can still raise funds through its units in Germany, Poland and Austria and could also offer bonds with retail customers in Italy.

“It will be more expensive and margins will be hit, but there may not be another choice,” said Rehn. “The central bank will not sit back idly and allow the banks to falter. It will say ‘If you have to pay up, pay up.’”

To contact the reporter on this story: Charles Penty at cpenty@bloomberg.net Liam Vaughan at lvaughan6@bloomberg.net Elisa Martinuzzi at emartinuzzi@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net Frank Connelly at fconnelly@bloomberg.net

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