Monday, May 28, 2012

The market to Spain: recapitalize the banks or face funding problems

Spain's banking system and regional debt problems are now becoming the key driver behind the risk aversion sweeping  the Eurozone. The German current 3-month bill yield is now firmly in the negative territory. People are paying the German government to hold on to their euros.

German current 3-month bill yield

Spanish authorities continue to deny there is a problem. It's all because of the euro...
Reuters: - Prime Minister Mariano Rajoy pinned the blame for the rising borrowing costs on concern about the future of the euro.
... while the denial of the inevitable continues.
He again ruled out seeking outside aid to revive a banking sector laid low by a property boom that has long since bust.
And now the nation's ability to meet its near-term funding requirements are being questioned.
Reuters: - Spain's trump card is that it has issued well over half the debt it needs to this year, in the first five months.

But that advantage is being eroded.

The government said last week its highly indebted regions faced 36 billion euros of debt refinancing bills this year, way above the previously stated 8 billion. Catalonia said it was running out of options and needed central government help.

A plan to recapitalize Bankia with Spanish government bonds, which the bank could then use as collateral to get cash from the ECB, could add to the government's refinancing problems.

Spain's Treasury insisted it would repay debt maturing without problems.

"We are in a very strong position (to meet debt maturing shortly)," said Ignacio Fernandez Palomero, deputy director of public debt at the Treasury, pointing to redemptions in July and October, when Spain has big amounts due.

Spain's central government and regions need to refinance 117.5 billion euros of debt by the end of the year, while funding a deficit worth 52 billion euros.
Not a problem...  Except the market doesn't buy it.

The euros going into German bills are coming out of Spain, as the country's 5- and 10-year spread to Germany as well as the 5-years CDS hit new records today.

Spain 10y spread to Germany

What's even more concerning is the change in the sovereign spread curve shape. The chart below shows Spanish bond spreads to German bonds by maturity - now and a month ago.

Spanish bond spread (to Germany) curve

The shorter tenors (3-5yr) have widened out more than the longer tenors as the spread curve becomes steeper in the short end and inverted in the longer end. The market is pricing in a higher probability of default closer in time - as usually happens with distressed names. A similar situation is developing in the CDS curve.

Spain CDS spread curve (green is now, yellow is 1m ago)

The 5-year CDS is now implying 44% probability of default in the next 5 years, assuming a 50 cent on the euro recovery (the probability drops for the same spread if the expected recovery is lower).

The market is now saying to Spain: recapitalize your banks or your funding situation becomes untenable.
"The events at Bankia will reinforce the view that the upcoming external review should identify a significant recapitalization need for the Spanish banking system," analysts at Nomura said in a note, putting a recapitalization of the whole sector at between 50 and 60 billion euros, with the main listed banks requiring an additional 16 billion euros.

Nomura said only BBVA, Santander and Sabadell would not need to strengthen their capital, while the government would need to clean up smaller lenders it has already propped up, such as Banco de Valencia, Novacaixagalicia and Catalunya Caixa.

"Given the current economic and political uncertainties facing the euro zone, this could see additional pressure on Spain to consider using external funds for the bank recapitalization," Nomura said.
Spanish bank bailout now seems inevitable..
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