Thursday, June 17, 2010

Investors Refrain From Spain

Now that the Greek bail-out is being hailed as the tremendous success it is (sarcasm intentional), Spain is reportedly seeking a similar, but far bigger, rescue package of its own. 

Sentiment towards Spain was hit by press reports, later denied by the European Commission, that the European Union (EU), International Monetary Fund (IMF) and U.S. Department of Treasury were drawing up a liquidity plan for Spain, including a credit line of up to €250 billion, about twice the amount made available to Greece. 

Yields on Spain's sovereign debt are rising, but are still far below levels which would indicate immediate and irreversible distress.  Spanish 10-year bond yields rose 12 basis points to 4.85% yesterday, the highest since July 2008, taking the spread over German Bunds to 2.21% – the highest since the introduction of the Euro in January 1999.

Spain faces a significant refinancing hurdle next month when €16 billion of bonds will need to be re-financed.  While memories of the Greek crisis are at the forefront of investor minds, Madrid is nowhere near the crisis situation experienced by Athens.  Spain's 10-year bond yield is still below 5%, which is less than Greece is paying on its IMF facility.  Greece didn't seek emergency funding until its two-year bond yield reached 10%.  By comparison, Spanish two-year bonds currently yield a very comfortable 3.3%.

Madrid's banking system, however, is a completely different story.  Spanish banks borrowed €85.6 billion from the European Central Bank (ECB) last month.  This was double the amount lent to them before the collapse of Lehman Brothers in September 2008 and one sixth of net Euro-Zone loans offered by the central bank.

This is the highest amount since the launch of the Euro-Zone in 1999 and a disproportionately large share of the emergency funds provided by the Euro’s monetary authority, according to an analysis by Royal Bank of Scotland (RBS).  Spanish banks account for 11% of the Euro-Zone banking system.

The rise in borrowing from €74.6 billion in April, which makes up nearly 15% of the net liquidity pumped by the ECB into the Euro-Zone financial system, provides further evidence of the acute distress in the Spanish financial sector.

RBS estimates the total amount of Spanish liabilities held by overseas investors is €1.5 trillion, or 142% of the country’s Gross Domestic Product (GDP).  By comparison, Madrid's budget deficit is fairly tame, at approximately 60% of GDP - a far cry from Greece, which is well in excess of 100%.  Of the total debt held by external investors, more than half, or €770 billion, has been issued by Spanish banks.

While investors have not yet required high yields on Spain's sovereign debt, the concern is that the situation in Madrid will continue to deteriorate.  With austerity measures in place which will undoubtedly weigh on the Spanish economy, 4th largest in the Euro-Zone, investors have every reason to doubt that the situation will turn around anytime shortly. 

Every European country that gets in financial trouble causes every other country to suffer.  So goes Greece, so goes Spain, so goes Portugal, so goes Ireland and on and on.  Even France and Germany can only absorb so much.  With such low yields on its sovereign debt, it's no wonder that investors are beginning to refrain from Spain.

Marko's Take

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