Sunday, January 23, 2011

European Sovereign Debt Crisis: Spain to Recapitalise Banks?

Sometimes the most obvious things are the hardest to see. If anyone was in any doubt as to the nature of the problem concerning Spanish Sovereign Debt, than this weeks evidence should make things clear. For Spain, it is all about the banks.

I want to take a look at the latest developments in the European Sovereign Debt crisis. Starting with the sudden appetite for risk with their Government Debt. See here, Spain ten year yield premium over Germany...

One-Year Chart for SPAIN 10 YEAR - GERMAN 10 YEAR (.SPAGER10:IND)

Moreover, suddenly the market is happy to insure Spain Sovereign Debt. See five year CDS pricing...

One-Year Chart for SPAIN CDS USD SR 5Y (CSPA1U5:IND)
source: Bloomberg

What caused this turn around in sentiment? 

Spain to Recapitalise the Cajas?

According to reports, Spain is planning to recapitalise the Cajas. The plan seems to involve trying to raise private funding first, and if that fails, the state (via the Fondo de Reestructuracion Ordenada Bancaria) will probably end up buying equity via raising debt.

Of course, raising debt to support the Cajas would not get rid of the risk. It would merely shift it onto the Sovereign Debt. However, the markets reaction suggests that the risk was in the worry that Spain was not dealing with the Cajas problems in favour of pretending the issues didn't exist.  Ever since five of the Cajas failed the European banking stress tests last year-seen as 'soft' by many- the spotlight has been on them. Moreover, according to the BIS, Spanish banks are exposed to $108bn worth of Portuguese Sovereign Debt. A very weak growth outlook and a -still faltering-housing market did nothing to allay fears. However, Spain were not without friends.

Support for Spanish Sovereign Debt

China came on a trade mission and said they would buy European sovereign debt. Japan said it would buy peripheral sovereign debt. The ECB talked about raising the European Financial Stability Facility (EFSF) in order to help with future problems. Nothing worked.

That is, until the Government tried to grasp at the nature of the problem by, at least, talking, about recapitalising them. This is critical because, whilst Portugal can be bailed out with the EFSF, Spain can't. Here is some analysis from RBS on the situation


Spain to Avoid a European Sovereign Debt Crisis?
Based on previous calculations by Markets and Culture found in this link here, Spain appears to have some significant austerity measures still to make which will hamper growth. In order to stay on a sustainable debt path they will need a continuation of moderation in sovereign debt yields and strong growth in Europe.

The good news is that the authorities learnt their lesson from the mini liquidity crises we saw last year when Greece hit the headlines. See the TED spread...

One-Year Chart for Ted Spread (.TEDSP:IND)
source: Bloomberg

So, I would expect growth to be less impeded from Portugal/Spain's problems. Frankly, I don't think Portugal can avoid a bail out, but if Spain acts swiftly it appears that the market believes that the Caja recapitalisation plans give them a chance.

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