Spain Regional Rescue Risks Tipping Point on Yields: Euro Credit
Spain’s plan to help cash-strapped regions sell debt risks piling additional liabilities on the central government as borrowing costs approach the level that pushed other nations into bailouts.
The government is under pressure to devise a way to help the nation’s 17 regions regain access to capital markets. Yields on 2013 debt issued by Catalonia, the biggest and most-indebted region, traded at 8.3 percent today, compared with 3.6 percent for equivalent Spanish securities and 4.3 percent for state-guaranteed bonds.
Spain is weighing how to rescue the regions as the rate on its 10-year debt moves closer to the 7 percent level that led Greece, Ireland and Portugal to seek aid from the European Union and the International Monetary Fund. The regions, which owe a combined 140 billion euros ($175 billion), are adding to the burden as liabilities swell following the bailout of Bankia group, the country’s third-biggest lender.
“Some kind of central-government funding that gets disbursed to the regions is probably the most cost-effective way to do it,” said Harvinder Sian, a London-based fixed-income strategist at Royal Bank of Scotland Group Plc. “The problem is loading up on extra issuance at this point where the market is fragile; it could be a tipping point to get you toward 7 percent.”
The rate on 10-year Spanish debt rose to 6.47 percent today, pushing the spread over German bonds of the same maturity to a euro-era record of 509 basis points. The yield has risen almost 50 basis points since May 9 when the government nationalized BFA-Bankia. The bank said May 25 after markets closed that it would need 19 billion euros from the government, or about 1.8 percent of gross domestic product, to bolster capital and cover potential loan losses.
Budget Minister Cristobal Montoro and Economy Minister Luis de Guindos have said the government will help regions raise funds. They haven’t said how and they’re still thrashing out details two months after de Guindos announced the idea. Regions face about 15 billion euros of redemptions in the second half of the year, according to data on the Budget Ministry’s website.
On May 16, the government finalized a rescue to help regions and town halls settle their unpaid bills with lending backed by the local administrations’ revenues, the Economy Ministry said. The government organized a 30 billion-euro syndicated loan from banks, guaranteed by the Treasury, which in turn is backed by regions’ and town halls’ receipts from the central government.
“The risk to the sovereign would be if this is announced without mechanisms to control the regions,” said Ricardo Santos, a European economist at BNP Paribas SA in London. The reason is investors “could price in that regions would have bigger incentives to spend,” he said.
Overspending in the regions, most of which are shut out of markets, pushed Spain’s overall budget deficit over its target last year and was responsible for a second revision of the 2011 deficit, announced May 18, to 8.9 percent of GDP. They also missed their deficit goal in 2010.
The move mirrors a debate among European officials over whether the 17 euro members could move toward joint issuance of bonds to reduce weaker states’ financing costs.
Italian Prime Minister Mario Monti said May 24 that Europe “can have euro bonds soon” as a united Europe is “in Germany’s interest.” German states are also pushing Chancellor Angela Merkel to share their borrowing rates.
The Spanish plan may be positive for the sovereign by reducing the risk of a regional default, which would have “serious reputational repercussions” for the central government, Moody’s Investors Service said in a report published April 2. The final impact will depend on whether the regions can be pushed to meet their deficit targets, Moody’s said.
Spain’s overall debt-to-GDP ratio, forecast to reach 80 percent this year, already includes regions’ debt even as the law forbids the central government from paying it off.
Efforts for the regions come as Prime Minister Mariano Rajoy says the nation risks being locked out of markets. Spain, which favors the creation of joint euro bonds, is rated BBB+ by Standard & Poor’s, having lost its AAA rating in January 2009.
Foreign investors reduced their holdings of Spanish central government debt to 37 percent of the total in April from 50 percent at the end of last year. Domestic lenders, helped by emergency funding from the European Central Bank, have picked up the slack, increasing their holdings to 29 percent from 17 percent. The trend will continue, Fitch Ratings said May 23.
That may help explain the delay in designing the strategy. De Guindos first announced the plan on March 27, saying the government may allow regions to issue debt jointly in sales guaranteed by the national Treasury.
Montoro, tasked with making the regions meet their deficit goals, has offered fewer details on the plan, saying only that a mechanism should be in place by July and it won’t jeopardize Spain’s rating or shield regions from the consequences of overspending. His deputy for regional governments, Antonio Beteta, said in an interview with ABC on May 20 that the state would offer guarantees on a case-by-case, issue-by-issue basis.
The mechanism, which is “complicated,” will be ready “soon,” Josep Duran i Lleida, the leader in Parliament of Catalan party CiU, said on May 25 after a meeting Prime with Rajoy. He declined to give details in a briefing to reporters.
“If you pile the regional-issuance needs into central-government funding, you could end up spooking the market,” RBS’s Sian said. “If you go off and do it with some sort of underlying guarantee in a separate entity, you may not be able to get reasonable funding rates: in many ways they are stuck.”
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