Rajoy Bid to Avoid Full Bailout Risks Falling Short: Euro Credit

Rajoy Bid to Avoid Full Bailout Risks Falling Short
Visitors take photographs inside the Madrid stock exchange. Photographer: Angel Navarrete/Bloomberg

Spanish Prime Minister Mariano Rajoy’s bid to restrict any rescue package to the nation’s banks may not be enough to avert a full-blown bailout as European finance ministers plan to hold weekend talks on the issue.

Rajoy is pushing the European Union to allow its rescue funds to recapitalize lenders directly. Spain would channel any such aid, which may reach 100 billion euros ($126 billion), through the country’s bank-rescue fund, European People’s Party Secretary General Antonio Lopez Isturiz said yesterday. Spain’s 10-year government bond yield climbed as much as 18 basis points today to 6.27 percent.

“Once funding for the banks has been clarified, I think we can breathe a sigh of relief,” said Andrew Bosomworth, a money manager at Pacific Investment Management Co., which oversees the world’s biggest bond fund. “But we don’t know if there are other skeletons in the closet, ones that will be revealed as the credit tide goes out. So it might be a short period of relief.”

Rajoy says Spain risks losing access to capital markets, as some banks and regional governments already have, and data show the Treasury is increasingly dependent on domestic banks for funding. The economy is shrinking, threatening the goal of slashing the deficit by two-thirds in two years, and limiting Spain’s ability to grow its way out from under its public and private debt load.

European finance ministers will hold a conference call as early as tomorrow to discuss a possible aid package for Spain, according to a German government official, who declined to be identified.

Recession Deepens

Lending is contracting by the most on record, crimping demand as the economic slump approaches its fourth year. Retail sales fell almost 10 percent from a year earlier in April, the most since the reports started, and the EU expects unemployment, the highest in the Europe at 24 percent, to rise further this year.

Spain wants to cut the deficit to 3 percent of gross domestic product next year from 8.9 percent in 2011. The International Monetary Fund predicts the country will miss those targets as the economy contracts 1.8 percent this year, adding to the issuance needs.

Given the depth of the recession and the size of the country’s debt, bailing out the banks “isn’t going to be enough,” Stuart Thomson, who helps oversee $120 billion at Ignis Asset Management in Glasgow, U.K., said in a telephone interview. “We expect this not to be the last bailout for Spain. There would be a sovereign bailout further down the line.”

Funding Squeeze

Fitch Ratings downgraded Spain three levels late yesterday to within two steps of junk as it increased its estimate for the cost to the government of shoring up banks to as much as 100 billion euros. The economy will remain in recession through 2013, the company said.

Fitch said government support of 60 billion euros for the banks would help push the nation’s debt load to 95 percent of gross domestic product in 2015. Spain went into the crisis with a debt-to-GDP ratio of 36 percent in 2007.

The Treasury is increasingly dependent for financing on domestic banks, which in turn rely on the European Central Bank. Foreign investors reduced their holdings of Spain’s outstanding debt to 37 percent in April from 50 percent at the end of last year, while Spanish banks increased their share to 29 percent from 17 percent, Treasury data show.

Bank Pressure

If foreign investors decide not to reinvest in Spanish debt, domestic banks will have to pick up an additional 15 billion euros of issuance, which is “doable,” Gilles Moec, co-chief economist at Deutsche Bank AG in London, said in a telephone interview.

“If non-residents continue to reduce exposure at the same pace they did in the first quarter, then we’d be talking about a shortfall of 50 billion euros and there’s not enough liquidity right now for that without a drastic compression in lending to the private sector,” he said.

The Treasury said yesterday it has satisfied 58 percent of the country’s gross financing needs for 2012 after meeting its issuance goal at a bond auction. It paid 6.044 percent to sell 10-year debt yesterday, the highest since November.

Spanish bond rates declined after the auction, with the difference between the nation’s 10-year yield and Germany’s narrowed to 468 basis points, the lowest close since May 22. Today’s the gain widened to 482 basis points as of 10:05 a.m. in Madrid trading.

‘Problematic’ Assets

Spain’s main source of weakness is its banking industry, which has more than 180 billion euros of assets that the Bank of Spain says have become “problematic” since the collapse of the nation’s once buoyant real estate market. The yield on 10-year sovereign bonds has climbed above 6 percent from as low as 4.83 percent in March.

To keep down borrowing costs, which this month approached the 7 percent level that heralded bailouts in Greece, Portugal and Ireland, an aid package for the banks would have to be “generous,” said Ben May, a European economist at Capital Economics in London. “It’s not about whether it’s enough, but whether it’s perceived to be enough,” he said.

Banco Santander SA Chairman Emilio Botin said June 4 that 40 billion euros of European funds for four lenders seized by the state would be enough. Budget Minister Cristobal Montoro said the next day that banks don’t need “excessive” amounts as he called for support from European institutions.

S&P Estimates

Standard & Poor’s said yesterday that its “base-case scenario” estimates Spanish banks’ loan losses in 2012 and 2013 at 80 billion euros to 112 billion euros. The EPP’s Lopez Isturiz said an aid package may be between 80 billion euros and 100 billion euros.

“The number should be easily around 100 billion euros or more,” said Rinse Boersma, a fund manager at The Hague-based Aegon Asset Management, which manages 220 billion euros of assets.

Spain has made at least four attempts to clean up its banks since 2009, when it created the FROB rescue fund. The previous government tightened capital rules and encouraged banks to merge. Since the current government came to power in December, Economy Minister Luis de Guindos has implemented two decrees to toughen provisioning rules.

Rajoy said yesterday he was talking to European colleagues over how to shore up the nation’s lenders and he’ll put a figure on the industry’s capital needs once he has received stress-test reports from two international consultants this month.

“They have missed numerous occasions to sort out the banks,” Deutsche Bank’s Moec said.

IMF Funds

Should Spain need a full EU and International Monetary Fund bailout that covered funding needs through the end of 2014 and included 75 billion euros to recapitalize banks, the total package would amount to about 350 billion euros, David Mackie , the chief economist at JPMorgan Chase & Co. in London, wrote in a May 30 report. Spain’s economy is about twice the combined size of Greece, Ireland and Portugal, which received rescue loans in 2010 and 2011.

“The Europeans have a very strong track record of underestimating the scale of the problem,” said Charles Dumas, chief economist at Lombard Street Research in London.

Download: Bosomworth Says Markets `Sense’ Spain Solution


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