Spain's Debt Buyer Of Last Resort Becomes Seller In Scramble To Fund Deposit Outflows
Several days ago we reported that Spanish financial institutions suffered the largest deposit outflow on record in the month of July when a whopping EUR74 billion, or 5% of the country's entire asset base, picked up and left, the bulk of it most likely taking the well-known path of least resistance to the safety of Swiss and German bank vaults. We showed how this looks visually, and as the chart below confirms it can be summarized in one word only: waterfall.
And while in isolation this news was bad enough, a far more troubling implication arises when one considers that in Europe's financial Ice-9 world, in which the interbank market has been dead for over a year, and where the ECB is the shadow lender of only resort, providing funding via various repo channels to local banks to fund Spain's deficit by purchasing sovereign bonds in the primary market. To wit: since the entire financial system's liabilities (deposits) just declined by a record EUR74 in one month, since the consolidated balance sheet has to balance, either Spain's (thoroughly insolvent) banks had to generate EUR74 billion in shareholder equity in one month, i.e. profits - a prospect which is rather amusing considering Spain's banking system recently officially demanded a European bailout, or banks had to sell a like amount of assets in order to fund this outflow. Naturally, they chose the latter. The problem is that the security they sold is the one which only the banks have been buying recently in order to preserve the illusion that Spain is solvent. It was Spanish sovereign bonds.
Spain is beginning to lose the support of its banks as last-resort buyers of government debt, with lenders selling out of their holdings at the fastest pace in more than two years in July, ratcheting up pressure on the European Central Bank to step in and put an end to the country's burgeoning debt crisis.
The sales are a blow to Madrid, which was increasingly reliant on domestic banks to buy its debt after an exodus of foreign investors. Domestic lenders, under political pressure to support the sovereign, used cheap loans from the ECB to buy an extra EUR87bn of debt between December 2011 and March this year.
But that support has begun to ebb, with Spanish banks selling over EUR17bn of debt since then, according to ECB data. In July alone, domestic lenders reduced their holdings by EUR9.3bn, in part to meet an outflow of deposits, signalling that money is now too tight to support the sovereign.
Spanish banks are facing problems of their own. Data released last week showed that customers withdrew EUR74bn of deposits in July alone - equivalent to 4.7% of total deposits and the biggest monthly outflow since records began. Since June last year, clients have withdrawn EUR233bn, or 13% of the total then.
A need to raise cash to meet those withdrawals may have prompted the recent bond sales, as other assets owned by banks - mainly loans and mortgages - are far less liquid. Spanish bank bond holdings are dominated by Spanish government debt, but also include those of other countries.
Furthermore, as the chart below shows, the supreme irony is that Draghi's biggest enemy in the fight to preserve the illusion of Spanish solvency, is Spain itself, and specifically its depositors, whose bank jog suddenly becoming a sprint, is the worst thing that Spain, and the ECB, can possiby face. Indeed, since Draghi's "whatever it takes" speech, Spanish bonds have roundtripped and are now virtually unchanged. The primary culprit? Spanish banks forced to sell the bonds they bought in the primary market.
As a reminder, while Mario Draghi is furiously trying to come up with a bond buying plan that is endorsed by Germany, Buba and Weidmann, all of whom have, to date, said, "9-9-9", regardless of what the final construct is, whether it includes the ECM, EFSF, and/or ECB buying bonds directly, the key distinction is that no monetary authority can buy bonds in the primary market, as that is a direct breach of Article 123/125, and absent a thorough revision of the Maastricht Treaty, investors will dump as soon as the ECB starts breaking the rules unilaterally. Certainly bonds can be monetized in the secondary market, but someone has to buy them from the government. And if Spanish banks are unable to stem the deposit outflow, there is simply no practical possibility for banks to be buying SPGBs in the primary market even as they are forced to dump them in the secondary market.
In other words, the ECB may or may not surprise next week, but unless the Spanish public is convinced its banks are safe, and the remaining EUR1.5 trillion in Spanish deposits do not explicitly remain within the Spanish bank system, anything Draghi does will be for nothing.
Finally, add to this the surge in Spanish bad debt, which as we reported recently soared to an all time high: NPLs which will have to be provisioned for with cash-hungry charge offs, and one can see why suddenly from a perfect summer, Spain may head straight into the perfect storm.
Spanish loan delinquencies bad and getting worse in a hurry...
And with the August vacation now in the rearview mirror, here is why should the deposit outflows persist, Spain may have a problem or two funding itself now that the peak of its gross issuance is upon us:
- 6 September: Spain auction. Bonds
- 18 September: Spain auction. Bills
- 20 September: Spain auction. Bonds
- 25 September: Spain auction. Bills
- 4 October: Spain auction. Bonds
- 16 October: Spain auction. Bills
- 18 October: Spain auction. Bonds
- 23 October: Spain auction. Bills
Graphically, supply is set to rise significantly in September and October for Spain:
And even if all works out in 2012, it is all downhill from January 1, 2013. As UBS explained:
Even assuming that the Spanish Treasury sticks to its original funding plan of EUR 86bn, the Tesoro will need to continue to sell around EUR 6bn of bonds per month. Monthly net issuance should average nearly EUR 3bn. Moreover, gross issuance could potentially rise to around EUR 8bn per month and total net issuance could reach EUR 13bn if Spain adjusts for the increased net-borrowing requirement.
Considering that Spain usually carries out two auctions per month, this would imply an average issuance of around EUR 4bn per auction. The last time Spain was able to sell such an amount at a single auction session was in early March. Monthly supply has ranged between EUR 5-6bn since April (we exclude the first three months of 2012 when Spanish supply was largely supported by the two 3Y LTROs). Since that time, Spanish banks’ capacity to absorb new government paper has deteriorated.
In our view this should continue to keep Spanish bonds under pressure each time supply approaches, making Spain very vulnerable to a possible loss of market access should other adverse domestic economic factors or events cause demand to fall even further.
Spain’s situation is even more worrisome when looking at next year’s funding requirements.
In 2013, Spain will need to refinance around EUR 60bn of maturing Bonos and Obligaciones while issuing an additional EUR 45bn to cover its public deficit. In this analysis, we assume that the government’s targets for next year are reached. This amount needs to include the funding for the deficit of local administration since regional issuance is unlikely to resume next year. Similarly, the central government very likely will need to cover the EUR 15 billion of Spanish regional debt maturing in 2013, which as it stands now cannot be otherwise refinanced. Additional central government funding may also need to be provided for maturing Spanish international and agency debt such as FADE bonds for a further EUR 3-4bn.
All in all, the total amount of gross bond issuance from Spain in 2013 could be in excess of EUR 120bn. That is around 40% higher than this year, 10-20% higher than in 2009 and almost four times larger than the average amount of Spanish bond issuance recorded in the previous four years.
Perhaps at this point the only thing that can save Spain now that the 1 month respite from reality is over, is fast forwarding straight to the Christmas break, and the inevitable LTRO X, which the ECB will have to do in order to provide additional funding to Spain, which unlike before, however, will no longer work as Spain and the rest of Europe, are out of eligible collateral, meaning the ECB will have to get the Buba to agree to even more last minute rule changes to keep Spain "solvent."
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