Breaking News on the Eurozone Crisis, Up To The Minute Information
Key Summary
There is a growing sense of panic in Europe as Spanish 10-year bond yields continue to rise to eurozone era record highs; over the past 7 days yields have moved from 6.82% to 7.58% this morning. Late yesterday evening, both Spain and Italy moved to impose short selling bans on equities in the hope of arresting slides in the national stock markets that are being fueled largely by concerns over the sovereigns. While Spanish Economy Minister Luis de Guindos categorically ruled out the possibility of Spain seeking a full bailout program on the 23rd July 2012, he is traveling to Berlin today to meet with German Finance Minister Wolfgang Schäuble where it is almost certain that the possibility that the current capital market pressure on Spain could result in the need for a full bailout will be discussed.
In order to avoid a full bailout program (at a cost of approximately €350 billion) that could lead to a need to again increase the lending capacity of the EFSF/ESM, we anticipate that a number of alternative options will be pursued as ‘holding measures’ until details of how ESM direct bank recapitalization are irrevocably announced. It is possible that Spain could seek to use a portion of the €100 billion bailout funds already allocated for purposes other than bank recapitalization:
a) Precautionary Credit Lines
b) ESM/EFSF secondary market bond purchasing (ESM SMP)
c) ESM/EFSF Partial Guarantee
d) ECB SMP
e) ESM/EFSF Primary Market Bond Purchasing (PMP)
The first 2 options above are the most likely to be deployed and Spain’s El Economista is already reporting that the Spanish government is considering seeking a precautionary credit line to meet its funding costs through to the end of 2012.
Given that Spain’s debt to GDP (80.9% for 2012) and deficit (6.4% for 2012) are considerably lower than those of Ireland (113.1% and 8.6% respectively), it is possible that clarity over the ESM direct recapitalization proposals could cause Spanish bond prices to recover even more dramatically than Ireland’s have since the announcement of direct ESM bank recapitalizations on the 28th June 2012. Irish 10 yr bond yields are currently at 6.41% having closed at 7.48% on the 27th June 2012. Prior to the emergence of widespread concerns about Spanish bank insolvency on the 4th July 2012 Spanish 10 yr yields stood at 5.4% while in the immediate aftermath of the announcement of ESM direct bank recapitalization on Spanish 10 yr yields fell to lows of 6.18% on the 4th July 2012.
Key Analysis
In spite of its bank bailout package, it is clear that the funding situation of the Spanish sovereign remains precarious and further shocks in the broader eurozone or domestically through higher than expected recapitalization costs, lower than expected GDP growth and overspending in the regions could still push Spain towards a full EU/IMF bailout program. Spain faces a relatively light maturity schedule until October 2012 which could allow the government to hold out in the face of elevated bond yield through the slow summer period:
Debt Redemptions 2012:
07/30/12 – 12,873
08/24/12 – 9,815
09/21/12 – 6,595
10/19/12 – 7,392
10/29/12 – 5,299
10/31/12 – 14,967
11/23/12 – 3,718
12/14/12 – 7,528
Total – 74,275
In order to avoid a full bailout program (at a cost of approximately €350 billion) that could lead to a need to again increase the lending capacity of the EFSF/ESM, we anticipate that a number of alternative options will be pursued as ‘holding measures.’ It is possible that Spain could seek to use a portion of the €100 billion bailout funds already allocated for purposes other than bank recapitalization, most likely either through:
a) A precautionary credit line, possibly including an element of partial debt issuance guarantees. Spain’s El Economista is reporting that the Spanish government is considering seeking such a facility to meet its funding costs through to the end of 2012.
b) ESM/EFSF secondary market bond purchasing (ESM SMP) which could temporarily be used to quash yields ahead of major debt redemptions.
These options could be used until substantive details on the cost and format of the Spanish bank recapitalization, including the format for direct ESM recapitalization, are irrevocably announced. Given that Spain’s debt to GDP (80.9% for 2012) and deficit (6.4% for 2012) are considerably lower than those of Ireland (113.1% and 8.6% respectively),[3] it is possible that clarity over the ESM direct recapitalization proposals could cause Spanish bond prices to recover even more dramatically than Ireland’s have since the announcement of direct ESM bank recapitalizations on the 28th June 2012. Irish 10 year bond yields are currently at 6.41% having closed at 7.48% on the 27th June 2012. By way of reference, Spanish 10 yr bond yields have been far lower than the current rate of 7.5% when fears over the implications of financial sector difficulties for the sovereign have not been as pronounced:
July/August 2011: On the 4th July 2011, Spanish 10 year yields stood at 5.4%. Following widespread speculation about Spanish bank insolvency, on the 22nd July 2011 the Spanish State was forced to provide Caja de Ahorros de Mediterraneo (Cam) with €2.8 billion of capital (EBA stress test results published the previous week had identified a capital shortfall of just €2.5 billion for Europe as a whole). Spanish 10 year yields rose to highs of 6.5% on the 2nd August 2011, only coming under control when the ECB announced on the 7th August 2011 that it would reactivate the SMP bond buying program.
June/July 2012: Spanish 10 year bond yields reached highs of 7.1% on the 28th June 2012 before the announcement was made that the ESM would be allowed directly recapitalize banks. In the immediate aftermath of that announcement, yields fell to lows of 6.18% on the 4th July 2012.
Spain currently faces a total of €27.658 of debt maturing in October 2012 and it is highly unlikely that it would be considered ‘sustainable’ to refinance this level of debt with 10 year yields at the current rate of 7.5%. If yields cannot be brought under control before October 2012, very real consideration could possibly be given to granting Spain a full bailout package. Should Italy also be under severe capital market pressure at this time, increasing the lending capacity of the ESM may be discussed at the EU Summit on the 18th/19th October 2012. However, it is important to note that any measures that are introduced in support of Spain are likely to have a positive knock on effect for Italian yields which will reduce the likelihood of EU leaders addressing a politically contentious issue such as ESM expansion in October 2012.
A. Spain
There is a growing sense of panic in Europe as Spanish 10 year bond yields continue to rise to eurozone era record highs; over the past 7 days yields have moved from 6.82% to 7.58% this morning. Over the same period, Italian 10 year yields have moved from 6.05% to 6.42%.
On the 24th July 2012, Spain sold €1.63 billion in 3 month T-Bills at a yield of 2.434% compared to 2.362% at the previous auction. Spain also sold €1.42 billion 6 month T-Bills at a yield of 3.950%, compared to 3.369% at the last auction on the 26th June 2012.
To date, neither the bank recapitalization program first announced on the 9th May 2012 nor Prime Minister Mariano Rajoy’s latest round of austerity measures announced on the 11th July 2012 have succeeded in restoring bond market confidence in Spain. Even the announcement on the 28th June 2012 that the ESM would be allowed lend directly to banks has only provided a short-term reprieve:
Late yesterday evening, both Spain and Italy moved to impose short selling bans on equities in the hope of arresting slides in the national stock markets that are being fueled largely by concerns over the sovereigns. Both countries had instigated bans on the short selling of financials in August 2011 due to the extreme market volatility at the time which was also fueled by fears over the financial situation of the respective sovereigns. These bans were lifted in February 2012.
The latest ban in Spain applies to the short-selling of all stocks trading on local exchanges for the first time ever and will be in place until the 23rd October 2012. Italy has banned the short-selling of bank and insurance stocks for one week. In August 2011, France and Belgium joined Spain and Italy in banning short-selling of financials but there is no indication that they plan to follow suit on this occasion. The reaction to the short-selling ban has for the most part been negative, one New York based trader is quoted by the WSJ as saying the Spanish ban “reeks of desperation.”
While Spanish Economy Minister Luis de Guindos categorically ruled out the possibility of Spain seeking a full bailout program on the 23rd July 2012,[2] he is traveling to Berlin today to meet with German Finance Minister Wolfgang Schäuble where it is almost certain that the possibility that the current capital market pressure on Spain could result in the need for a full bailout will be discussed.
JP Morgan has estimated that it would cost €350 billion (including the cost of bank recap) to remove Spain from the markets through to end 2014. Given that the remaining capacity of the combined EU/IMF bailout resources will only be €467 billion in September 2012 and will peak at €734 billion between January & July 2013.
Even if we assume the best case scenario, whereby Spain’s bank recapitalization is at the lower end of the scale identified by the two independent audits (€51 to €62 billion), only €416 billion would remain for a full bailout program for Spain which would prevent the ESM from acting as a credible backstop for Italy. It must also be borne in mind that these funds are also meant to continue to act as a realistic backstop for other eurozone Member States, including in the event of a 3rd Greek bailout package or 2nd bailout for Ireland/Portugal.
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