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Goldman On The Spanish Bond Subordination: "It's Only 13% Of Existing Spanish Debt"

Tyler Durden's picture




 

If anyone felt on the fence about the prospect of Spanish bond subordination by priming ESM loans, the following feeble attempt at justification by Goldman's Francesco Garzarelli, better known for shorting bonds into one of the biggest rip your face off rallies in TSY history, should really set their mind at ease. Or not.

Relative to the status quo, a net gain to existing government bondholders: Compared to a starting point where the Spanish government would have ultimately borne the credit risk from banks (via the FROB) without enjoying large access to market borrowing, the official sector loan represents a net gain for holders of Spanish government bonds, unless it changes incentives or leads to subordination. We consider both: 

  • Incentives: Relative to a situation where government bond funding was available almost entirely from the ECB, under no conditionality other than collateral rules (which have been progressively relaxed), Spain’s EMU peers now have more control over the restructuring process along the guidelines defined in 2011 (available here). In a statement, the Eurogroup indicates that progress on the pace of fiscal and structural reforms will continue to be monitored by the European Commission as for other countries under the excessive deficit procedure. As Andrew Benito argues in a separate note published June 10, Spain’s fiscal challenges remain high, but not insurmountable, in our view. To the extent that the stable funding allays fears of deposit flight, and releases pressures on sovereign funding and hence on the interest bill, the official sector aid should increase the odds of a more orderly Spanish deleveraging.  
  • Subordination: The issue of subordination of government bonds remains a central one for investors. De iure, EFSF loans are pari passu with existing bonds. Concerns have been expressed as to whether de facto the official sector is now a senior creditor. This is always a possibility (as we have seen with discussions over the credit status of the ECB). However, it is also important to note that the EUR 100bn (which are unlikely, on our estimates, to be fully used) represents 13% of the existing Spanish public debt, about 10% of 2011 GDP.

Oh, it is ONLY 13% of outstanding Spanish debt. That's perfectly ok then. Oh wait, most priming DIPs for bankrupt companies tend to be somewhere in the 10-40% of total pre-petition debt too. Sadly however, the mere assumption that €100 billion in senior debt will be sufficient to plug the hole in Spanish banks, which rose from €40 billion to €100 billion in under one week, is laughable. And of course, every incremental dollar of senior debt means less value to existing subordinate Spanish bonds.

Finally, confirming that one should get the hell out of Dodge, is the fact that Goldman now is telling its clients to, wait for it, buy Spanish bonds.

Short-dated Spanish Government Bonds Offer Value

 

Whilst no ‘paradigm shift’ for the way the EMU sovereign and banking crisis is being tackled, relative to where things stood last Friday (June 8) the decision by Spain to seek financial assistance is a marginal positive. Conditionality is limited to the banking sector and we think the larger size of the loan should help foster confidence that there will be sufficient resources to recapitalize banks and to face quite adverse scenarios.

 

The amount seems to reflect the IMF assessment published on June 8 that “it is better to overestimate than underestimate” a backstop for capital shortfalls. The IMF estimates that while the largest banks would be sufficiently recapitalized, several others would need EUR40bn to comply with the Basel III transition schedule (Core Tier 1 capital of 7%) and a larger amount to include restructuring costs and reclassification of loans that will be identified by the independent evaluations. The IMF will host a conference call on Monday to discuss its top-down assessment.

 

Even though the statistics for public debt will increase by about 10% of GDP, the funding program of the Spanish government will not be affected and the loan will come at much more advantageous terms for the public sector than current market rates. The combination of these two factors should reduce pressure on the Spanish sovereign. All else equal, yields should decline, particularly at the front-end of the curve. On Friday, the 3-year benchmark bonds closed at around 480bp over Germany. We could see a rally towards a 400bp spread during the volatile period while more news on the transaction becomes available. A more sustained compression requires a reduction of systemic fears surrounding the EMU project, in our view. Any indications of long-run solutions coming out of meetings taking place this month could be supportive in this direction as argued by the President of the ECB in his last press conference (See Global Markets Daily, Euro Vision).

Yes, we have seen this one so many, many times before: if Goldman is telling its clients  to buy, it means Goldman is....

fill in the blank.

 

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Mon, 06/11/2012 - 06:36 | 2513742 Dr Benway
Dr Benway's picture

It's only a small slice of your neck

Mon, 06/11/2012 - 06:51 | 2513762 Harlequin001
Harlequin001's picture

It's time to play the music,

It's time to light the lights,

It's time to get things started....

Mon, 06/11/2012 - 08:49 | 2513988 knukles
knukles's picture

13% here, 13% there and pretty soon you're part of the 99%

Mon, 06/11/2012 - 06:37 | 2513743 The Reich
The Reich's picture

All clear signs to BUY!

Mon, 06/11/2012 - 06:45 | 2513752 skistroni
skistroni's picture

Long GS.

Short Muppets.

Mon, 06/11/2012 - 06:37 | 2513744 MeanReversion
MeanReversion's picture

Not sure the market agrees with Goldman, the initial big drop in Spanish yields has turned into a rise.  Also, same goes for Italy.  The bond market is already fading the rally.

Mon, 06/11/2012 - 06:37 | 2513745 noses
Mon, 06/11/2012 - 06:38 | 2513747 GeneMarchbanks
GeneMarchbanks's picture

'Yes, we have seen this one so many, many times before: if Goldman is telling its clients  to buy, it means Goldman is....'

Probably already bought the dip. Doubt they have any to sell you, more likely it means the 'Nanke Put is place for the Spaniards.

Mon, 06/11/2012 - 07:07 | 2513778 krispkritter
krispkritter's picture

The "Banks" need to be broken down, a gold stake driven into their heart, and buried forever.

 Keiser: Cuckoo Trading

http://www.youtube.com/watch?feature=endscreen&NR=1&v=LmPVqvl2nis

Mon, 06/11/2012 - 07:21 | 2513799 Tyler Durden
Tyler Durden's picture

Already wider on the day. Better luck next time.

Mon, 06/11/2012 - 07:28 | 2513810 GeneMarchbanks
GeneMarchbanks's picture

That is, of course, exactly my time horizon. The day.

Mon, 06/11/2012 - 06:46 | 2513753 Coldcall
Coldcall's picture

incrediblly moronic reasoning from the geniuses at GS

Mon, 06/11/2012 - 06:49 | 2513758 ziggy59
ziggy59's picture

With goldie suggesting what can possibly go wrong?

Mon, 06/11/2012 - 07:06 | 2513781 Peter K
Peter K's picture

Criminal Negligence is the term that comes to mind. Hey, let's buy Spain before we know what they agreed to. Sounds like sound investor advise. :)

Mon, 06/11/2012 - 07:07 | 2513784 MeanReversion
MeanReversion's picture

T minus 100 basis points till Rajoy is begging the ECB to start buying its bonds.

Mon, 06/11/2012 - 07:11 | 2513790 Dorky
Dorky's picture

Phew, I thought goldman is telling us to buy the stock market.

Mon, 06/11/2012 - 07:17 | 2513795 Ted Baker
Ted Baker's picture

THESE GUYS AT GOLDMAN ARE SERIOUS KILLERS AND FRAUDTERS....YIELD ON SPANISH DEBT WILL RISE AND THIS SHORT-TERM LOAN WHICH IS COMPLETELY INSUFFICIENT FOR THOSE WHO UNDERSTAND ALGEBRA MATHS FROM SCHOOL, WILL ONLY HAVE A SHORT-LIVED EFFECT IN MARKETS...THIS IS DUE TO CHANGE TOMORROW....

Mon, 06/11/2012 - 08:32 | 2513945 sockratte
sockratte's picture

another no-brainer :-)

Mon, 06/11/2012 - 10:02 | 2514221 Grand Supercycle
Grand Supercycle's picture

Rally Warning from last week:

'Daily chart now gives bullish warning and significant
SPX rally & USDX retracement should commence in a week or so'

http://www.zerohedge.com/news/2012-12-24/market-analysis

Do NOT follow this link or you will be banned from the site!