BOND MARKETS will pass their initial judgment this morning on whether Spain has broken the link between its fiscal crisis and its banking crisis.
The €100 billion bailout agreed this weekend is being characterised as a bank rescue but investors will focus on the likely terms of the loan. A key issue is where the funds will come from and whether investors holding bonds issued by Spain and its banks will rank behind the new lender.
The funds will be channelled through the state-run Fund for Orderly Bank Restructuring and Spain will “retain the full responsibility of the financial assistance and will sign” the agreement with the other partners, according to the statement issued yesterday.
The document did not make clear whether the European Stability Mechanism – the region’s permanent support fund, due to start in July – or the temporary European Financial Stability Facility will make the loan.
“This is state financing and the risks of an equity injection into the banks will stay with Spain,” said Alberto Gallo, head of European macro credit research at Royal Bank of Scotland Group in London. “Spain needs a systematic restructuring of its banking system, which could entail haircuts to subordinated bank debt. Official lenders, on the other hand, are likely to demand seniority.”
Spanish prime minister Mariano Rajoy has been forced to abandon his attempt to recapitalise the nation’s banks without outside help as the country’s descent into recession obliged lenders to own up to spiralling losses.
While Mr Rajoy said the agreement was “the opening of a credit line” rather than a bailout such as those received by Greece, Ireland and Portugal, and the conditions of the loan affected the financial industry, the sovereign is ultimately responsible for it. If the cash comes from the ESM, its treaty provides it with preferred creditor status, junior only to the International Monetary Fund.
“The risk is now all Spanish bonds are inferior to the ESM,” Steen Jakobsen, chief economist at Saxo Bank in Hellerup, Denmark, wrote in a note.
Holders of the subordinated debt of banks that Spain has to rescue will probably have to accept losses, according to Gary Jenkins, director of Swordfish Research in Amersham, England.
“Whilst Spanish politicians tried to claim that this was not a bailout, it is of course a de-facto bailout of Spain itself. Considering that sovereign support for Greece required private-sector involvement it would be a bit of a turn-up for the books if the equivalent for banks did not involve PSI.”
– (Additional reporting: Bloomberg)
