Sunday, 10 June 2012

$125 billion bailout for the Spanish banking sector

After Ireland, Portugal and Greece, the financial contagion has finally spread to Spain, as the Southern-European country asked on Sunday for a bailout worth as much as $125 billion dollars. The money will most likely come from the European Financial Stability Facility and the yet-to-be ratified European Stability Mechanism and are supposed to go towards the recapitalization of Spanish liquidity stripped banks. If the EU does not start taking bolder steps towards more integration Italy may go next.

More pain for Spain

Spain`s economy, which is the fourth largest in the euro-zone is in bad shape: the official unemployment rate reached 24,1%, the GDP contracted 0.3% in the first quarter of 2012, it recently revised up its 2011 budget deficit from 8.5% to 8.9% and its banking sector is sinking under insolvent mortgages created during the boom years.

Spain`s third biggest lender, Bankia (chart from Financial Times), was recently bailed out under a 19 billion rescue package. By some accounts the troubled bank currently owns more than €32 billion in toxic assets. BFA, its parent company announced on Monday night that its correct results for 2011 show a €3.3 billion loss instead of the €41 million it previously posted. A huge loss for a bank with a market capitalization of 2.05 billion and thin capital reserves. The initial plan was to borrow the money on the open market, but at record high yields, this was not a sensible option.

Fourth bail-out (and counting)
While investors parking their capital in German 10-year bonds accept yields of 1.32%, and after accounting for the 1.9% inflation rate, a negative real yield of 0.58%, Spanish 10-year yields are moving towards the point of no return. When yields on 10 year notes reached 7%, Ireland, Portugal and Greece had to arrange state bailouts. Spanish yields are currently at 6.21% and rising. On the 7th of June the Spanish Treasury successfully sold €2.1 billion of bond, at an average yield of 6.04%, following higher than expected demand. 
Spanish and German 10 year yields from Bloomberg:

Even though this was a successful test to see at which price can Spain tap the market, it did not prevent Fitch Ratings, a credit rating company to cut its credit rating from A to BBB. It`s a tad to late to notice that Spain is not an A country anymore, ain`t it Fitch ?

Even though Spanish officials have been denying for months then need of a bail-out, it fell to the finance minister, Luis de Guindos to accept the harsh reality.  He announced on Saturday that "the government of Spain declares its intention to request European financing". No mention of how much money is required, but European finance ministers stated that Europe is prepared to lend up to 100 billion. Spain insists that this agreement is different in that it is targeted to supply Spanish banks with much needed capital and does not include money from the IMF (which are most often attached to the implementation of austerity measures). The money from the European Union would come with conditions attached, but they would mostly be directed toward the financial sector and less to the government itself.

This brings with it some advantages: it gives the crediting side of EU some sort of control over the banking sector of bailed out countries and such contributes to the overall financial and banking integration, it is convenient for the governments that are reluctant to give any more power away and it makes way for a EU fiscal unions The success of the Spanish bail-out may ultimately ease some of the steam off other troubled countries like Italy or Belgium.

Photo credit Reuters

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