Spanish lenders face the prospect of needing as much as 12 billion euros ($15 billion) of extra collateral for their central bank loans, raising pressure on the banks as they negotiate a 100 billion-euro bailout.
The additional security will be required on about 245 billion euros of sovereign and government-guaranteed debt pledged by Spanish banks should DBRS Inc. become the fourth ratings company to downgrade the nation to the cusp of junk, according to JPMorgan Chase & Co. Bonds of Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA are the worst performers in the Bank of America Merrill Lynch EMU Financial Corporate Index this month.
The European Central Bank will demand deeper discounts on Spanish debt should DBRS cut its A High rating to match grades from Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, according to JPMorgan. Spain is seeking a rescue for its banks after they were shut out of credit markets amid concern bad loans will escalate as the recession deepens.
“People are already asking if the 100 billion-euro bailout will be enough for their needs, and having to raise another 12 billion won’t help,” said Olly Burrows, a London-based credit analyst at Rabobank International. “It’s too much pressure on Spanish banks that are already squeezed.”
The cost of insuring against default on Spanish government debt implies a rating three grades below junk, according to Moody’s Analytics.
Credit-default swaps on the nation surged to a record 633 basis points on June 18, implying a 40 percent chance of default within five years, up from 352 basis points on Feb. 8, according to prices compiled by Bloomberg. The contracts fell back to 590 basis points today.
As Spain’s creditworthiness deteriorates, bondholders are speculating they’ll be subordinated to European Union agencies demanding priority repayment for supplying aid to the nation. Lenders to Greece lost more than 70 percent of their investments when the nation restructured its debts in April, while the ECB and other official lenders were exempt from the discounts.
Default swaps on Banco Santander, the biggest Spanish bank, were at 437 basis points today, Bloomberg data show. That’s approaching the record 474 basis points in November before the ECB flooded markets with 1 trillion euros of cheap cash under its longer-term refinancing operations. Contracts on BBVA were at 469, compared with a record 516 in May.
“Spain is facing several challenges, including the increase in its public debt from the announced bank recapitalization package and stresses in economy-wide funding conditions, which can affect the depth of the recession,” Pedro Auger, an analyst at DBRS in New York, said in an e-mail. “In our assessment, we stress the risks to the public debt burden.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. declined, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining by 0.37 basis point to a mid-price of 115.1 basis points as of 12:02 p.m. in New York, according to prices compiled by Bloomberg.
That’s the lowest level on an intra-day basis since May 22 for the index, which typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, rose 0.12 basis point to 24.75 basis points as of 12 p.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Mexico City-based Petroleos Mexicanos, or Pemex, are the most actively traded dollar-denominated corporate securities by dealers today, with 150 trades of $1 million or more as of 12:01 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Latin America’s largest oil producer sold $1.75 billion of 32-year debt yesterday.
The ECB applies discounts of 0.5 percent to 5.5 percent to government fixed-rate bonds with the seven highest investment-grade ratings, according to the Frankfurt-based central bank’s website. That rises to as much as 10.5 percent when the securities are cut to the three lowest investment-grade rankings.
Moody’s downgraded Spain to Baa3 on June 13, a week after Fitch cut the nation to BBB, two levels above junk. S&P lowered its rating on the country to BBB+, three steps above speculative grade, in April. DBRS has had Spain at A High, its fifth-highest investment grade, since May. Junk bonds are rated below BBB- by Fitch and BBB Low by DBRS.
The extra collateral requirement may total 13 billion euros, according to Harvinder Sian, senior rates strategist at Royal Bank of Scotland Group Plc in London.
“Some weak Spanish banks may have a problem if DBRS cut Spain to the BBB area,” Sian said. “The extra haircut may come on top of the hit to mark-to-market margins that Spanish banks already face on their holding of country’s debt.”
The banks were able to borrow through the ECB’s LTRO facilities at 1 percent and invest the proceeds in Spanish two-year bonds that yielded 3.65 percent on Dec. 22 and 2.19 percent on March 1. Those notes have since fallen in value and were yielding 5.1 percent today.
Banco Santander SA bonds declined 0.56 percent this month through June 18 and BBVA’s debt fell 0.46 percent, according to Bank of America Merrill Lynch’s EMU Financial Corporate Index, compared with an increase of 0.34 percent for the gauge as a whole.
Credit-default swaps on BBVA exceeds the average cost of insuring Europe’s 13 biggest banks by 178 basis points, near the record 185 set last month, and contracts on Banco Santander are 143 basis points more than the average, Bloomberg data show. The difference between both Spanish banks and the 13-bank average was about 40 basis points in January.
LCH Clearnet Ltd., Europe’s biggest clearing house, raised the extra deposit it takes from clients to trade most Spanish government bonds. The margin needed for securities due in 10 years to 15 years will be increased to 14.7 percent from 13.6 percent, according to a statement on LCH Clearnet’s website yesterday. The rate was also boosted on all Spanish debt due from zero months through seven years.
Spanish lenders’ net borrowings from the ECB jumped to a record 287.8 billion euros in May, the Bank of Spain said on its website June 14. Gross borrowing was 324.6 billion euros in May, up from 316.9 billion euros in April.
The International Monetary Fund said in a report on June 8 that Spain’s lenders needed at least 37 billion euros to cope with the weakening economy. Three days later, the country asked for a 100 billion-euro credit line to shore up its banking system and provide a cushion against future shocks.
“A downgrade won’t help the banks with their liquidity,” said Hank Calenti, London-based, head of bank credit research at Societe Generale SA. “The higher the pledged levels, the lower the unencumbered assets for senior, unsecured bondholders.”
The ECB may consider loosening collateral rules to avoid making the credit crisis worse, said Sebastian Paris-Horvitz, chief market strategist at HSBC Private Bank Suisse in Paris.
“You cannot stop funding Spanish banks -- they are too big to fail,” said Paris-Horvitz. “The ECB will need to ease the rules, any other strategy appears a quite risky road.”