Published June 11, 2012
MADRID – Euphoria over a lifeline of up to €100 billion ($125 billion) to rescue Spain's hurting banks morphed into a financial markets rout in a matter of hours Monday, as investors digested the still-undefined plan and became concerned the country may be unable to repay the new loans.
The rate on Spanish 10-year bonds — a measure of market trust in a country's ability to repay debt — rose to an alarmingly high yield of 6.47 percent at the close of trading after falling to 6 percent in the morning. And the benchmark IBEX-35 stock index closed down 0.5 percent after surging 6 percent in the morning.
Overshadowing Spain's acceptance over the weekend of a bailout for banks burdened by toxic property assets and loans are Greek elections next weekend and concerns that the anti-bailout left-wing party Syriza could become the largest party in parliament, putting the country's membership in the zone at risk.
Investors also zeroed in on Italy, sending its bond yields sharply higher amid worries it could be next in line for a bailout because of a deepening recession and increasing pressure on the administration of Premier Mario Monti. And Spain's economy is in terrible shape with no sign of improvement anytime soon.
"Plenty of risk still remains in place, with question marks over the ability of Spain to repay the debt, especially, if the country fails to get back on the growth path, the outcome of the upcoming Greek elections and the perception of situation in Italy," Anita Paluch of Gekko Global Markets wrote in a note to clients.
Spain's bond yield is worrisome because it is perilously close the 7 percent rate that is considered unsustainable, and the level that pushed Greece, Ireland and Portugal to ask for bailouts of their government finances. While Spain's bailout does not include the government, investors are worried that Spain might eventually be forced into such a situation.
The rescue for Spain's banks was portrayed by Spanish and European officials as a bid to contain Europe's widening recession and financial crisis that have hurt companies and investors around the world. Providing a financial lifeline to Spanish banks was designed to relieve anxiety on the economy.
Finance ministers of the 17 nations that use the euro said Saturday they would make the loan of up to €100 billion available to the Spanish government to prop up banks laden with non-performing loans and other toxic assets after the collapse of a real estate bubble.
Recession-hit Spain, which has the eurozone's fourth-largest economy, has yet to say how much of this money it will tap while it waits for the results of two independent audits of the country's banking industry, not due until June 21 — after the Greek elections. The bailout loans will be paid into the Spanish government's Fund for Orderly Bank Restructuring (FROB), which would then use the money to strengthen the country's teetering banks.
In a report released late last week, the International Monetary Fund estimated Spain needs around €40 billion to prop up banks hurting from an unprecedented real estate boom that went bust.
Worried investors still don't know precisely how much Spain will seek, and how large a safety margin of extra money it might take to cushion itself against further shocks, such as a deterioration in the economy already in its second recession in three years with unemployment of nearly 25 percent, the highest in the eurozone.
"Markets will certainly ask the question about whether a second bailout might be required and the margin for error between the sort of euro40 billion the IMF is saying and the €100 billion ceiling in terms of what we heard," said Mark Miller of Capital Economics in London.
He added that with the bailout, Spain's debt-to-gross domestic product ratio — which was a relatively low 68.5 percent at the end of last year — could shoot up to the 90s next year. And bond yields will remain high.
If the ratio gets up to Greek levels of 120 percent or so, and 10-year yields close in on the near-7-percent levels Spain hit several weeks ago "then people will ask that question about a second bailout" for Spain, Miller said.
Another issue is whether the European money comes with strings attached for the government, and not just an obligation for banks to restructure. When the bailout was announced on Saturday, Spanish Economy Minister Luis de Guindos said the rescue would not force any new austerity measures on a government that has already issued a wave of painful measures since taking power in December.
Speaking to reporters Sunday, Prime Minister Mariano Rajoy avoided using the term 'bailout' to describe the aid, calling it instead a credit line without the strict austerity conditions that have accompanied bailouts for Greece, Portugal and Ireland.
However, the European Union made clear Monday the money is more than just a loan. Besides being paid back with interest, there will be conditions for the Spanish government.
"When people lend money, they never do it for free. They want to know what is done with the money," said Joaquin Almunia, the European Competition Commissioner.
"I am not talking about just the obligation to pay back the money, but also some other kind of terms," he told Cadena Ser radio, adding that these remain to be determined.
Spain's economy ministry released a statement later saying the package includes "the necessary conditionality for the financial sector" but requires no new fiscal consolidation or structural reforms beyond those the government has already embarked on.
The loan will be supervised by the European Commission, the European Central Bank and the IMF, Almunia said.
A European Commission spokesman, Amadeu Altafaj, told Spanish state television that this troika will have people on the ground overseeing the restructuring of the Spanish financial sector. Representatives of the same three groups regularly visit Greece, Ireland and Portugal to make sure the governments in those nations are complying with bailout terms,
Altafaj noted that the European Commission last month recommended Spain undertake further reforms such as speeding up the phasing of a higher retirement age — it is to go from 65 to 67 — and raise VAT sales tax. The newspaper El Pais quoted EU officials Monday as saying these changes and others are part of the conditions that come with the bank rescue package.
Adding to the gloomy mood on Monday, the Fitch Ratings agency downgraded the credit rating of Spain's two largest international banks Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA from A to BBB+.
The agency said the reasons for the downgrade were primarily because Spanish credit rating was downgraded to two notches above junk last week, because of a fresh forecast that Spain's faltering economy will remain in recession into 2013 "compared to the previous expectation that the economy would benefit from a mild recovery in 2013."
Banco Santander and BBVA are seen as immune from needing help from Spain's bank bailout because profits from their international operations have buffered their Spain losses. But Fitch also said they could be affected by any downturn that affects operations outside Spain. Both are big players in Latin America.
"Growth prospects for emerging markets in which Santander and BBVA subsidiaries operate have been revised down and they are not entirely immune to global economic trends but earnings from these markets will continue to contribute significantly to group earnings at both institutions," Fitch said in a statement.
Harold Heckle and Alan Clendenning in Madrid contributed to this report.