By Geoffrey T. Smith
LONDON (Dow Jones)--Spain's bailout won't break the vicious circle of
sovereign and bank debt problems, not least because it will make it
more difficult for the country's embattled banks to borrow from their
last truly reliable source of funding, the European Central Bank.
Analysts say it looks inevitable that Spain will lose its last A-grade
sovereign rating, now that the government has put itself on the hook
for up to EUR100 billion in aid--more than 8% of gross domestic
product--that its banks may receive from European bailout vehicles.
That will lead to an immediate jump in borrowing costs for Spanish
banks at the ECB, owing to the ECB's system of graduated "haircuts"
for the collateral it accepts when it lends.
The ECB applies far larger discounts to collateral if it doesn't have
an A-rating of some kind. After two recent downgrades, Spain only has
one A-rating left, an A3 rating with Moody's Investor Service.
"From our perspective, the apparent need to seek support from its
European partners to help their recapitalization process is viewed as
having negative credit implications," Yves Lemay, managing director
with the sovereign risk group at Moody's, told Dow Jones before the
weekend developments.
For five-year sovereign debt, the haircut rises from 2.5% to 7.5% once
the last A-rating is lost. For most of banks' covered bonds, which
frequently enjoy rating treatment similar to sovereign debt and are
also popular as collateral, the haircut rises from 5.0% to 25.5%.
That means that Spanish banks will have to post more collateral to
borrow the same amount of money from the ECB--and their borrowings had
already risen to EUR316 billion in April, before the situation became
so acute as to trigger the weekend's action. That ties up more
resources, leaving the banks less money to make new loans or replace
existing ones.
"It's definitely positive that one of the major uncertainties has been
taken out of the markets," said Tobias Blattner, an economist with
Daiwa Capital Markets in London. "At least we know now that there is a
credible backstop for Spanish banks."
But Mr. Blattner acknowledged that the measures failed to do what
observers had hoped for before the weekend, namely, that the euro zone
could find a way of backstopping Spain's banks without overburdening
its sovereign balance sheet. Even at the end of last year, Spain's
public debt was only 69% of GDP according to EU calculations--well
below Germany's 82%.
But Fitch Ratings now sees Spain's ratio rising as far as 95% by 2015,
even if the actual extra capital needs of the banks are no more than
EUR60 billion.
Daiwa's Mr. Blattner also pointed out that the way the bailout is
structured doesn't solve the problem of getting foreign investors back
into Spanish bonds. Not only is the cost of funding them at the ECB
going to rise, but existing bondholders also face the risk of being
"subordinated" by loans from Europe's bailout vehicles--meaning that
they would be less likely to receive all their money back in the event
of a national bankruptcy.
If foreign investors aren't going to buy Spanish bonds, that puts the
onus back on Spanish banks to keep buying them. The government still
needs to issue EUR36 billion this year to meet its funding
requirements--but April's data from the ECB showed that the banks'
appetite for that is already fading.
Spain's banks bought nearly EUR70 billion in government bonds in the
four months after the ECB announced two emergency injections of
three-year loans. But ECB data for April showed that they turned net
sellers of government debt, offloading EUR799 million.
Mr. Blattner said the ECB, which has long campaigned for troubled
banks across the euro zone to be recapitalized, would be more likely
to offer support through additional monetary policy easing once this
process is underway, first through extra liquidity operations, then
through the purchase of government bonds "if things get really
explosive."
Write to Geoffrey T. Smith at geoffrey.smith@dowjones.com
(END) Dow Jones Newswires
June 11, 2012 12:15 ET (16:15 GMT)
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