Spain asks for help

Spain gets up to EUR 100bn bailout.

Key points:

• Timing largely as expected. The Spanish aid call was expected sometime this months and Friday’s rumour correctly said that it would be already this weekend.
• Size in the high end. The Wall Street Journal said last week that expectations on the size of the bailout ranged from EUR 40bn to 90bn and hence 100bn is in the high end.
• More could be needed. The bailout covers current recapitalisation needs. The portfolio of mortgage loans is above 600bn and house prices are still falling and unemployment still rising. The longer the recession in the Euro area lasts, the larger the risks that more help could be needed for Spain.
• Helpful, not decisive. The bailout helps break the negative feedback loop between banks and sovereigns, but Spain still needs growth and better sentiment in general to prevent the need for more help at a later stage.

Market impact:

The Spanish bailout will probably give some relief to the markets in the near term, but it is likely to be limited because it will not end the debt crisis, the Greek elections are still looming, and Spain may need more help eventually and risks downgrades following the bailout. Moreover, the easy conditions attached to the Spanish rescue may prompt attempts from Greek, Ireland and Portugal to improve their respective conditions. As has often been the case following EU bailout decisions, we could easily see a short-lived rally in risk assets and Spanish bonds, while German bonds would face pressure, but do not expect any huge risk appetite during the coming week.

See more in our three survival questions for the Euro area from last week here: http://research.nordeamarkets.com/en/?p=7843

Details and more views:

As was widely rumoured on Friday, Spain made an initial cry for help on Saturday, and this was approved preliminarily by the Eurogroup of Euro-zone finance ministers. The Eurogroup said the loan will be scaled to provide an effective backstop covering for all possible capital requirements estimated by the diagnostic exercise which the Spanish authorities have commissioned to the external evaluators and the international auditors. The loan amount must cover estimated capital requirements with an additional safety margin, estimated as summing up to EUR 100 billion in total. The actual amount thus becomes known, when two independent consultants, Oliver Wyman and Roland Berger, finalize their review of the Spanish banking sector in the coming weeks.

So the Eurogroup was willing to almost write an open check to Spain, albeit capped at EUR 100bn. In addition, the statement added, the Eurogroup considers that the policy conditionality of the financial assistance should be focused on specific reforms targeting the financial sector, including restructuring plans in line with EU state-aid rules and horizontal structural reforms of the domestic financial sector. In other words, Spain will not face new requirements regarding its fiscal policy or structural reforms. The known details of the programme were clear signs that the Eurogroup was very eager to settle the Spanish case before the Greek elections, not particularly surprising.

The money will be channeled either through the temporary European Financial Stability Facility (EFSF) or the permanent European Stability Mechanism (ESM). Using the EFSF would be preferred from the market perspective, though the use of ESM looks somewhat more probable, as several member countries appear to prefer the use of the ESM, not least to limit their total exposure. The advantage of using the EFSF (it has more than EUR 200bn of uncommitted capacity) would mean that the EUR 500bn capacity of the ESM would remain for possible future bailout requests, while the preferred creditor status of the ESM could be a further deterrent for investors in Spanish government bonds. Still, as the Greek debt restructuring illustrated, public loans can be treated in a different way in any case. The downside for using the EFSF would be that Finland would demand collateral again for its part of the support, though bank equity in the institutions receiving the funds could serve this purpose.

It is of course good to remember that the ESM is not operational yet, though it should be by the start of July. In any case, after the actual aid request is made, the package needs parliamentary approval in several countries. It thus looks unlikely that any money would move before July at any rate. All the money will come from the Euro-zone bailout mechanism, as the IMF will only support the implementation and the monitoring of the aid programme. Spain will pay the same interest rates on the upcoming loans as the other countries under EU bailout programmes.

The terms of the Spanish bailout will likely increase demands from Ireland that its aid, largely due to the huge costs of bank bailouts, should be renegotiated. Such demands would have some validity in them, while there should be grounds for Ireland to renegotiate the terms of the promissory notes used to recapitalize the Anglo Irish Bank. The Spanish bank bailout may thus end up benefiting Ireland as well.

Will the EUR 100bn be enough then? This will most likely meet the requirements to be revealed by the independent audits, while it is at the high end of most private-sector estimates. In that sense, it should ease worries towards the Spanish banking sector. Carrying out an independent audit, followed by recapitalizations, was certainly an important step to help bring confidence back in Ireland, so that precedent would be encouraging for Spain as well. That said, the losses for Spanish banks have been stemming mostly from the real estate development sector, not loans to consumers. There is more than EUR 800bn of loans to consumers outstanding, though most of these are mortgages with houses as collateral. Record-low interest rates will help in servicing these loans, rising unemployment will not.

Despite the bailout, notable challenges for Spain remain. Spain’s public sector deficit remains one of the largest in the Euro zone, the unemployment rate of the country is the highest among Euro-zone countries, the budgets of the autonomous regions cause problems, and the economic outlook is grim at least in the short term. Spain still has a lot to do to bring longer-term investors back to its bond markets. Further, the structure of the bailout means that the capital injections increase the debt of the Spanish government, even though it eases the immediate funding pressure. Still, it is good to note that at the end of last year, Spain still had a relatively low public debt, less than 70% of GDP and some 13%-points lower than e.g. Germany. Of course, the debt is still rising fast, which is a problem, but a EUR 100bn bailout, or around 10% of GDP, in itself should still be very manageable.

For the more general outlook for the Euro zone, the Spanish bank bailout is another step towards a closer co-operation and a banking union. However, the EU summit on 28-29 will be followed closely to further assess the determination of the Euro-zone countries to take steps towards a tighter union.

In conclusion, the Spanish aid package should bring some limited relief to markets and to Spain. As has often been the case following EU bailout decisions, we could easily see a short-lived rally in risk assets and Spanish bonds, while German bonds would face pressure. Nevertheless, it seems that expectations for a Spanish bailout had already increased notably during the past week, and this weekend’s decisions were unlikely to have exceeded these expectations notably. In addition, dealing with the Spanish banks is not a game changer on its own, as the Greek elections still remain a major source of uncertainty. In short, do not expect any huge risk appetite during the coming week.

Jan von Gerich and Anders Svendsen

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