Spanish Pension Raids Spell Bad News for Bond Sales: Euro Credit

Spain’s Treasury may find one of its best customers less eager to buy its bonds as budget woes lead Prime Minister Mariano Rajoy to raid a government piggy-bank for a second year.

Created in 2000 to guarantee pension payments in times of hardship, the 59.3 billion-euro ($78 billion) Fondo de Reserva was tapped for the first time in December for 7 billion euros to fund Christmas bonuses and a monthly increase for retirees. Further withdrawals will have taken an additional 4.5 billion euros by the end of this month, helping to pay for pensioners’ summer bonuses and tax refunds.

“The fund isn’t in a position to accumulate assets anymore, it may even have to sell,” said Jose Antonio Herce, a partner at consultancy firm Analistas Financieros Internacionales in Madrid. “There are more and more pensions to pay and less and less money coming into the Social Security, the fund will melt quickly now that we’ve started taking money out of it.”

Rajoy is increasingly dependent on the pension reserve fund as it reaps lower returns on Spanish sovereign debt, which comprise 97.5 percent of its investments. The 10-year yield has declined by more than 310 basis points from the euro-era high of 7.75 percent that it reached a year ago, and was at 4.67 percent at 2:23 p.m. in Madrid. The reserves were fully invested in Spanish government bonds until the fund started buying foreign securities in 2004.

‘Bad Sign’

Spain is more than six months late in overhauling its tax-funded pensions system. The social security system deficit widened to 1 percent of gross domestic product last year from 0.1 percent in 2011, and is forecast to reach 1.4 percent this year. Lawmakers are debating changes, with the government unlikely to draft a law and get it approved before a scheduled annual pension increase, as well as the next Christmas bonus.

“It would be a really bad sign if the government needs to use the fund in November since it would be the fifth time in a little over a year,” said Manuel Gil, a fixed-income trader at BCP Securities LLC in Madrid. “Spain really needs to accelerate its reforms in order to gain international markets’ confidence.”

The government said this week that social security needs more cash as contributions from companies and employees through June fell 1.57 percent as spending rose 3.85 percent. Whether it taps the pensions reserve again this year depends on cash flows, said a spokeswoman for the Labor and Social Security Ministry, who asked not to be named in accordance with government policy.

Rising Claims

The reserve, which was set up through social security surpluses, hasn’t received money since the tax-funded pensions system swung to a deficit in 2011. An economic slump that has entered its sixth year in the euro region’s fourth-largest economy is undermining the social security program as unemployment rose to a record 27.2 percent.

At the same time, the number of pensions paid out climbed to 9.06 million in June from 7.85 million in 2003. Monthly payments increased 5 percent from a year ago to 7.76 billion euros, an amount that would drain the Fondo de Reserva in eight months should it have to take on the full burden.

The fund’s situation “isn’t surprising given the depth of the recession Spain is going through and the deficit budgeted for social security,” said Justin Knight, a strategist at UBS AG in London. “They may have to sell securities to take money out. It’s a question of timing to eke it out.”

Investment Shift

The Fondo de Reserva’s margin of maneuver has shrunk since it started preparing for cash needs in July 2012, as evidenced by the description of the investment strategy in the annual report released in April. Last year, it cut the portion of non-Spanish securities in its assets to 2.5 percent from 10.2 percent in 2011 by selling debt from euro-area countries to buy domestic securities. It had 1.53 billion euros of French, Dutch and German debt remaining on Dec. 31.

“Spain’s pension fund has moved to buying mostly its own government debt and it obviously can’t accumulate more,” said Luca Jellinek, the head of European fixed-income strategy at Credit Agricole Corporate & Investment Bank in London. “In so far as they are a good buyer, this money has got to be raised somewhere else.”

Treasury Debt

Bank of Spain data show government administrations held 13.9 percent of the Treasury’s 658 billion-euro debt stock in May. The Economy Ministry said the breakdown of the holdings isn’t public. It compares with domestic banks’ share of 31.5 percent. Foreign investors held 36.9 percent, down from 50.5 percent in 2011.

Spain’s Treasury said it has met 73.3 percent of its mid-and long-term funding needs for 2013. Still, the nation’s debt is surging after it secured European aid last year to bail out domestic banks. Eurostat data published this week for the first quarter show the nation’s total public debt load rose above the European Union average -- excluding Croatia -- for the first time in the single currency’s history.

Last year, the Fondo de Reserva focused reinvestments on bills expiring within months in preparation for year-end cash requirements. In July, the fund changed its rules, increasing to 35 percent from 16 percent of its total portfolio the maximum amount that can be invested in an individual security. It also raised to 12 percent from 11 percent the maximum share of the Treasury’s total outstanding debt at any given time.

“Tapping the reserve fund once again isn’t a long-term solution,” said Francesco Marani, a fixed-income trader at Auriga Global Investors SV SA in Madrid. “Interim measures are damaging for Spain’s credibility. What the government needs to do is reform the whole contribution and compensation scheme as other countries have done to lead pension spending onto a sustainable path.”