Spain’s economic and political future hangs in the balance, as fears over Greece’s exit from the eurozone leaves the credibility of its financial stabilization plans in tatters without urgent redress from eurozone policymakers, analysts have said.
As European politicians scramble to discourage Greece from leaving the monetary union, leading analysts have sounded the alarm over its potential spill-over impact in Spain – with far-reaching consequences for global markets – given the timidity to-date of its banking reform plans, weak fiscal structure and negative sovereign-bank feedback loops.
The dangerous brinkmanship between vested European policymakers over the Greek crisis threatens to spark a dangerous debt spiral in Spain – setting off, once more, rising Italian sovereign bond spreads, a game-changer for the eurozone project, analysts conclude.
Last week, European bank spreads, as well as Spanish and Italian sovereign spreads, jumped with the Euro Stoxx index down around 15% from its March peak, while safe-haven assets have rallied, as the crisis in Greece intensified.
Fears are growing that the Spanish government lacks the financial capacity to recapitalize the banking system. The economy is in recession, with unemployment at 25%, property prices still in free fall, while the banking system is on life-support thanks to a liquidity drip from the European Central Bank (ECB). Spain’s 10 year government yield on Monday traded at 6.27%, just below last week’s high of 6.3%, a five-month peak, sparking fears its spread over a basket of triple-A benchmarks will rise above 450 basis points (bp), a level in which LCH Clearnet, a bond settlement house, demands higher margins.
Banks’ bad-loan ratio hit a record 8.16 in March, while borrowing from the ECB hit a record €263.5 billion in April, 14.5% of Spanish GDP. The government has bailed out Bankia, the country’s fourth-largest bank, and has asked financial institutions to make a further €30 billion of provisions to cover real-estate losses – only three months after an initial €54 billion of provisions was ring-fenced.
Before Greek exit fears took centre stage, market consensus over the Spanish government’s funding needs has been relatively sanguine, since the net cash required from domestic investors in its 2012 issuance programme is estimated at a manageable €10 billion.
Debt spiral
However, the Greek crisis has triggered fears Spain will face rising regional funding needs and a jump in the cost of cleaning up the banking system – faced with the prospect of large-scale deposit flight – combined with widespread foreign selling in the secondary government bond market.
“Spain may not be able to withstand market contagion effects from growing fears of a Greek exit,” say analysts at Société Générale.
Helen Haworth, head of European interest rate strategy at Credit Suisse, notes: “The risk is that the market deterioration becomes self-reinforcing, and Spain’s ability to continue to fund quickly becomes in question, with contagion spreading via the banking system.
“Recent financial reforms are clearly in the right direction, but not nearly extensive enough, and there needs to be far more transparency, particularly at Bankia. If market stresses remain high, it isn’t clear that Spain will have the time or funds necessary to continue with the reforms without external support.”
Market uncertainty over the true losses facing Spanish banks is one driver for the sell-off in banks’ stock and debt prices, analysts conclude. The Spanish government is set to announce the appointment of BlackRock and Oliver Wyman to independently value banking system’s real-estate loans, according to market reports.
As we have reported, the challenge for auditors to assess the divergence between the book value of bank loans, the current value on a mark-to-market basis and a more stressed scenario is challenged by the propensity of banks to carry loans at par value - even after missed debt service payments and sharply reduced collateral values.
Given the dire consequences of a Spanish funding crisis, policymakers will make a last-minute dash to craft a rescue package, say analysts at BCA Research. “We expect that until Spanish or Italian 10-year yields break through 6.5%, policymakers will hesitate to be pro-active," they state. "But yields sustaining above that level would force policymakers to take the next step to protect Spain."
However, as we have reported, market consensus is that the current European stabilization mechanism is inadequate to cover Madrid’s funding needs and a Spanish crisis will instantly spill over to Italy.
The only solution to stem the rot lies in a pan-European policy response, with the European Stability Mechanism (ESM) assuming responsibility for Spain’s banks, rather than the sovereign, analysts conclude.
However, this plan centres on political backing, since the current structure of the European Financial Stability Facility and ESM does not permit direct banking interventions of this nature.
Source: SocGen