Some More Bad Spanish News For The IMF To Refute

Following up on the earlier report from El Economista that Spain is about to resort to another €50 billion in US taxpayer generosity and use €250 billion from the EU/IMF rescue fund, is this piece in the FT which confirms our disclosure from yesterday that Spanish banks have borrowed a record €85.6 billion from the ECB in May. And this is even before all the Cajas were scrambling to merge into Europe's biggest insolvent megabank. From the FT: "Spanish banks borrowed €85.6bn ($105.7bn) from the ECB last month. This was double the amount lent to them before the collapse of Lehman Brothers in September 2008 and 16.5 per cent of net eurozone loans offered by the central bank. This is the highest amount since the launch of the eurozone in 1999 and a disproportionately  large share of the emergency funds provided by the euro’s monetary guardian, according to analysis by Royal Bank of  Scotland and Evolution. Spanish banks account for 11 per cent of the eurozone banking system. The rise in borrowing from €74.6bn in April, or 14.4 per cent of the net liquidity pumped by the ECB into the eurozone financial system, provides further evidence of the acute tensions in the Spanish banking system." And here is the piece de resistance: "'If the suspicion that funding markets are being closed down to Spanish banks and corporations is correct, then you can reasonably expect the share of ECB liquidity accounted for by the country to have risen further this month,' said Nick Matthews, European economist at RBS." You can also expect the army of bureaucrats to deny, deny, deny until the US taxpayer has to fund another trillion dollar bailout. And speaking of spin, here is Goldman's take on all things Spanish.

Yes, there has been a clear jump in borrowing – moreover, it is likely that we will see a higher figure in June. But it is still the case that Spanish banks’ dependence on ECB funds remains below that of many other countries: even with the new level of borrowing, these funds account for 2.5% of Spanish banks’ balance sheets, compared with 2.7% in Germany and the Netherlands (April data), 3.5% in Portugal (April), 5.0% in Ireland (April), 13.6% in Greece (March). The Spanish data for May was published on Monday morning.

As for the El Economista piece, Goldman's Javier Pérez de Azpillaga had this to say:

An article in El Economista, a Spanish daily, says that the EU and the IMF are designing a €250bn liquidity plan for Spain. It says that IMF, EU and US Treasury experts are working on the plan, an information backed by sources close to the IMF and by leading Spanish businessmen. The reports also says that, apparently, the IMF Board of directors held a secret and extraordinary meeting to deal with this issue.  

A spokesman for the EU executive, said the report in the newspaper El Economista was "very bizarre" and added: "I can firmly deny it." , says Reuters. Reuters adds that a Spanish government spokesman said yesterday that talks between the Spanish PMI and IMF’s Strauss-Kahn set for Friday were unconnected with media reports that Madrid may seek a Greek-style bailout.

Comment: The report is too vague to give it much credit although it’s certainly possible that Spain, the EU and the IMF talk about the Spanish situation (and it’s not secret that the new EU/IMF fund is a backstop set up with Spain and other countries in mind). More importantly, the country is not in the situation of having to tap the IMF/EU rescue fund (although these type of news are certainly raising the refinancing risks and costs of Spain). 

And while we are on the theme of Spain and Goldman, here is what the firm's Francesco Garzareli had to say about the whole Spanish fiasco which is promptly getting out of control:

This morning, the focus is on the labor market reforms the Spanish government has promised to present to Parliament. The preliminary draft circulated yesterday is extensive, but not particularly ambitious on a first pass. The parliamentary discussion will be interesting to follow, and Javier Perez will be providing an analysis. The EU Commission yesterday stated that Spain need to be more specific about how it intends to cut the deficit in 2011 to 6%.

Meanwhile, the uncertainties surrounding the unlisted and politically captive regional banks remain alive. As readers may recall, we have been of the view that Spain’s sovereign creditworthiness would decline in relative terms since the end of last year (as reflected in one of our recommended trades). The spread between 5-yr Italian and Spanish, for example, has widened from around 15bp in early April to 60bp currently. Until greater clarity is made on the size of the recapitalization of the unlisted part of the Spanish banking sector market, the underperformance is unlikely to reverse.

On a related note, the FT this morning reports that Spanish bank’s funding with the ECB is continuing to rise. A back-of-envelope calculation suggests that the rise maps into the increase of government securities held on banks’ balance sheets. Government bonds held by Spanish MFIs amount to 4.9% of total assets (for reference, in Italy the percentage is 6.2%). But this corresponds to a bigger share (30%) of total government liabilities relative to Italy’s 13.5%.

The World Cup kicked off last Friday, and 13 of the 32 nations involved (or 41%) are Western European. We investigate whether Euro-Bund futures traded volumes have historically dipped during June and July of those years when the competition took place. Using data spanning 1993 to 2009 and including four tournaments we find that those months during which the World Cup took place showed little difference in trading volumes from those in the corresponding months of non-World Cup years. So even during ‘the greatest show on earth’, it would appear that it’s largely business as usual in the fixed income markets.

Spain Under the Spotlight

From October to April, Eurozone sovereign market pressures were mostly confined to Greece. 5-yr Greek bond spreads to Germany widened from 100bp to 500bp over this period. This marked ‘phase one’ of the ongoing EMU ‘crisis’. On 11 April, the European authorities unveiled a plan to provide Greece with non-commercial funding. Greece’s capitulation to market pressures brought home the idea that a country within EMU could face a liquidity crisis and potentially default unless provided with external help. Since sovereign credit events tend to be correlated, institutional investors such as banks, insurance companies and pension funds, decided to reduce exposure to government liabilities.

A situation where investors decide to all do the same thing at the same time resulted in a greater ‘endogeneity’ in the formation of prices – i.e., the price action started feeding on itself. The economics literature has explored these situations with reference to previous market crises (a good reference is Danielsson and Shin, 2003, where the authors use the analogy of the ‘wobbly’ Millennium bridge of London to illustrate self-reinforcing price dynamics). The response of regulators to ban short sales did not go far in helping the problem, and could have actually amplified it, by increasing uncertainty. Indeed, the marginal price setters are not ‘hedge funds’, but rather a ‘real money’ accounts.

Over the period between mid-April and mid-May, ‘phase two’, all sovereign spreads widened and market turnover declined dramatically. Whereas countries with relatively high financial depth, like Italy and Spain, were able to absorb without discontinuities the repatriation of bonds resulting from the reshuffling of bond portfolios in ‘core’ countries, smaller issuers, like Portugal, Ireland and obviously Greece - where at least three quarters of public debt is in the hands of non residents – were not. This helps explains the decision by the ECB decided to intervene by purchasing bonds of these issuers in the secondary market.

Starting last week, sovereign spreads have started to settle down, a dynamic mostly evident in Italy and Ireland, lending support to the idea that an anti-climax ‘phase three’ could be upon us. (Greece continues to be the odd-man out, and the 5% ‘haircut’ applied to the ECB yesterday justifiably commanded a price impact). The fact that spreads compressed in the absence of clearly identifiable ‘news’ can be taken as evidence that active risk takers are turning of the view that peripheral bonds are sufficiently far from their ‘fundamentals’ to justify some buying. This could be enough for the self-feeding price action to turn on itself without needing much support.

However, Spain remains a focal point. As we have argued before, the country is far from insolvency, but debt roll-over risk remains an issue.  And the EFSF is not a credible deterrent against speculative attacks for a country this size. If the Spanish authorities reinforce their commitment to address the budgetary consolidation, engage structural reforms, and recapitalize the banking system, there is no reason to think that spreads won’t stabilize and reverse, possibly with some little ‘help’ from the ECB. But the ball for now is squarely in the camp of the fiscal authorities.