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Spanish Bondholders May Rank Behind Official Loans

Spain's Prime Minister Mariano Rajoy
Spain's Prime Minister Mariano Rajoy speaks to reporters in Madrid today. Photographer: Angel Navarrete/Bloomberg

Investors holding bonds issued by Spain and its banks will probably rank behind official creditors in the queue for payment after the nation asked for a bailout of as much as 100 billion euros ($126 billion).

The funds will be channeled through the state-run FROB bank-rescue fund and Spain will “retain the full responsibility of the financial assistance and will sign” the agreement with the other partners, according to the statement issued June 9. The document did not make clear whether the European Stability Mechanism, the region’s permanent support fund, which is likely to start operating in July, or the temporary European Financial Stability Facility, will make the loan.

“This is state financing, and the risks of an equity injection into the banks will stay with Spain,” said Alberto Gallo, head of European macro credit research at Royal Bank of Scotland Group Plc in London. “Spain needs a systematic restructuring of its banking system, which could entail haircuts to subordinated bank debt. Official lenders on the other hand are likely to demand seniority.”

Spanish Prime Minister Mariano Rajoy has been forced to abandon his attempt to recapitalize the nation’s banks without outside help as the country’s descent into recession obliged lenders to own up to spiraling losses. While Rajoy said yesterday the agreement was “the opening of a credit line,” rather than a bailout such as those received by Greece, Ireland and Portugal, and the conditions of the loan affected the financial industry, the sovereign is ultimately responsible.

Preferred Creditor

If the cash were to come from the ESM, its treaty provides it with preferred creditor status, junior only to the International Monetary Fund. The EFSF isn’t explicitly a preferred creditor, prompting Finland’s Finance Minister Jutta Urpilainen to demand collateral if the facility were used to advance the money. Even so, the Greek example showed that official lenders aren’t willing to accept losses, preferring to force private bondholders to take greater writedowns in a restructuring.

Euro-area leaders would prefer Spain’s financing to come from the ESM because the fund will have paid-in capital, German lawmaker Norbert Barthle, the budgetary expert in Merkel’s Christian Democratic Union caucus, told Stuttgarter Zeitung newspaper. The authorities should examine whether the ESM has sufficient capital, he was quoted as saying.

“The risk is now all Spanish bonds are inferior to the ESM,” Steen Jakobsen, chief economist at Saxo Bank A/S in Hellerup, Denmark, wrote in a research note. “Finland already declared that if this loan is coming from EFSF they want collateral.”

Bonds Rally

Spanish bonds rallied last week, with the 10-year yield dropping 31 basis points, or 0.31 percentage point, to 6.22 percent. The yield has declined from this year’s high of 6.7 percent on May 30 and was down 19 basis points at 6.03 percent at 8:20 a.m. in London today.

“This financial assistance will not only not undermine the present conditions of the current stock of Spanish public debt: it will also reinforce its overall solvency,” Spain’s economy ministry said in a statement today.

“Holders of Spanish government bonds have just been subordinated to bank recapitalization funding,” said Elisabeth Afseth, an analyst at Investec Bank Plc in London. “This helps with liquidity but I can’t see how it doesn’t undermine bondholders’ status.”

ESM Treaty

Article 12 of the ESM treaty requires government bond terms to contain collective action clauses from January 2013. These allow a set majority of bondholders to force minorities to take losses in a restructuring and were used in March to compel private investors to accept a writedown of 53.5 percent of the face value of their Greek debt.

Holders of the subordinated debt of banks that Spain has to rescue will probably have to accept losses, according to Gary Jenkins, director of Swordfish Research Ltd. in Amersham, England.

“Whilst Spanish politicians tried to claim that this was not a bailout it is of course a de-facto bailout of Spain itself,” Jenkins wrote in a note. “Considering that sovereign support for Greece required private-sector involvement it would be a bit of a turn up for the books if the equivalent for banks did not involve PSI.”

Irish banks raised capital by forcing holders of subordinated bonds to sell back their securities at a fraction of face value, generating a capital gain they used to increase their capital ratios. Senior bondholders of Irish banks weren’t affected amid concern lenders elsewhere would struggle to raise funds if such securities were written down.

Provisions making senior debt subject to so-called bail-ins aren’t due to become effective until 2018.

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