Tuesday, July 10, 2012

As Spain's 2012 funding requirements increase, the nation may need to finds other buyers for its debt

On a relative basis Spain's government funding requirement for the remainder of the year is fairly modest - about €34bn (discussed in this post). Analysts at BNP Paribas were quite comfortable that Spain should be able to cover its 2012 funding needs. But there may be a problem.

1. The €34bn assumes target budget deficit for 2012 of -5.3%. The actual number could be considerably worse, requiring additional funds.

2. This funding requirement does not cover regional needs for funding. And the regions are no longer able to roll some of their own debt (due to their rising deficits and debt levels). Therefore the central government will have to step in to bail out the regions.

This tells us that Spain's funding requirements may be considerably larger than previously estimated. The table below from CS shows three possible scenarios.

Source: Credit Suisse

Spanish periodic government auctions have been quite small in recent months - about €2bn each. But as the last row of the table above shows, Spain will need to step these up dramatically  (double or triple the amount) in order to raise the funds it needs for the rest of the year.

Source: Credit Suisse

And who is going to buy this incremental debt? So far it has been the Spanish banking sector, who often used their own bonds guaranteed by the Spanish government to borrow under the LTRO program (the process of using own paper to borrow from the ECB is described in this post). But two changes took place recently that will be quite problematic for the Spanish government.

1. The 3-year LTRO program is no longer offered by the ECB (for now), making it harder for banks to obtain term financing needed to fund volatile Spanish paper. As the data below shows, net purchases by Spanish banks have been limited recently (the big spike early in the year was driven by the LTRO). In fact the small recent auction purchases have been from Spanish pensions instead of banks.

Source: Credit Suisse

2. The ECB has just changed their collateral rules and may no longer be accepting bank issued government guaranteed bonds (h/t Kostas Kalevras; also see this post by Joseph Cotterill)
The ECB (see attached document): - Counterparties that issue eligible bank bonds guaranteed by an EEA public sector entity with the right to impose taxes may not submit such bonds or similar bonds issued by closely linked entities as collateral for Eurosystem credit operations in excess of the nominal value of these bonds already submitted as collateral on the day this Decision enters into force.
That means that at least for now Spain's banks will be unable to absorb the increased auction sizes from the Spanish government. Spain will need to find other buyers - soon.
CS: - Spain is now rapidly falling behind its issuance schedule and needs to start increasing the size of its auctions. If the Spanish banks are unable to provide support, the date at which a new buyer is required is fast approaching.
But we all know there are no significant private buyers of this debt outside of Spain. It is therefore quite possible that before the end of the year, the ESM rescue vehicle will not only be required to bailout Spanish banks, but will also be asked to buy material amounts Spanish government paper (possibly in addition to Italian paper - Italy has €120bn to raise). And that's just to get through this year.

ECB ruling on collateral

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