Markets failed to rip after Spain secured a €100 billion bailout for its banking sector.
That was in large part because they were still waiting the results of private sector audits of Spanish banks.
Well those results are in. Spanish banks could need €62 billion in capital a black sky event.
CLSA analyst Christopher Wood writes that there a few reasons everyone is still concerned about Spain.
Spanish insistence that this is a ‘limited’ bailout
No one believes Spanish prime minister Mariano Rajoy’s explanations that the latest bailout is one of just the country’s banking sector and not the country itself. This is in large part because the LTROs served to make Spanish banks even more intertwined with sovereign credit.
Spanish banks increased their holdings of Spanish government bonds by €83 billion as a result of the LTRO. From Wood:
“It is clearly an intellectual absurdity to make a distinction between a country’s economy and its banking sector. Yet that is what the Spanish leader, Prime Minister Mariano Rajoy, has in effect been doing.
If a country’s banking sector is sick, so is its economy.
There are about €1.8tn of loans in the Spanish banking system amounting to 170% of GDP. Assuming, say, a default rate of 24% as in Ireland, which is not completely absurd, this would mean losses of €430bn or 40% of GDP. It should also be noted that Spanish banks now hold about one-third of Spanish sovereign debt.”
Moreover, many doubt that €100 billion will be enough to save Spanish banks.
Subordination of private bondholders
Credit markets in particular are concerned that holders of Spanish government bonds will be subordinated, if money comes from the EFSF or the yet to be created European Stability Mechanism (ESM) i.e. official bodies will get preferential treatment over private creditors.
This isn’t “sending out a message to buy Spanish government bonds, which is why non-Spanish buyers have continued to shun the market,” writes Wood. And any preferential treatment doled out to Spain, with regards to their bailout, against the severe conditions forced on Greece, Ireland, and Portugal will cause problems in the periphery.
Corporate deposit flight
Finally, Wood says that investors should keep an eye on corporate deposits, because while they do form a smaller portion of total deposits than say household deposits, they have acted as a lead indicator for deposit trends.
Spanish bank deposits by non-financial corporations fell 16 percent since June 2011 to the end of April, while household deposits were only down 4 percent in that period.
“The experience in the Eurozone crisis thus far is that corporates are a lead indicator for deposit trends since they are quicker to understand the grim realities of the situation than households which, in the case of Spain, were so divorced from reality that retail depositors were willing to buy the ill-fated IPO of Bankia as recently as in July 2011; when that bank’s management decided cynically to pitch the IPO to domestic retail investors once it became self-evident after roadshows that institutional investors globally were not going to buy the deal.”
Wood says the lack of market exuberance highlights the fact that markets want “ECB debt monetization now”, and not just a Spanish admission of problems in its banking sector.