Spanish Bank’s Get Government Brokered Bailout

Madrid / Brussels. While Spanish Prime Minister Mariano Rajoy continues to deny Spain’s need to bailout its banking sector an informal agreement has been reached on the possibility of Spain taping 100 Billion Euros for the purpose of restructuring its banks. The agreement was apparently reached in less than two hours over the weekend at which time Spain was offered $125 Billion with virtually no strings attached. While the details of the agreement remain unannounced, previous rounds of austerity measures and structural reforms were enough to convince Northern Europe of Spanish fiscal credibility and bailout merit.

Whether the European Stability Mechanism will be employed to fund the European loan to Spain or whether the temporary European Financial Stability Facility will be used remains to be negotiated as the ESM is not slated to be in operation before the end of June 2012. Spanish borrowing needs till the end of the year amount to roughly 70 Billion Euros and estimates for a banking bailout in Spain have ranged from 40 to 90 Billion Euros, meaning the European loan could very possibly be large enough to cover all governmental liquidity needs till 2013. If that is the case the nominal yield on Spanish debt will matter little in for the short term and give Spain another 6 months to implement structural reform conducive to growth.

The loan will be provided to the Fund for Orderly Bank Restructuring (FOBR), a Spanish regulatory group created in 2009 to oversee bank mergers and acquisitions, with the objective to ensure that all banking groups in Spain remain solvent. With a war-chest previously estimated at 99 Billion Euros minus the Bankia bailout, the European loan will bring the FOBR’s capital firepower up to ~180 Billion Euros.

The downside of the loan is that it would bring Spanish debt to GDP levels up to ~90%, a historically undesirable number. Another worry for investors is whether the ESM or EFSF will be the loan issuers. ESM issued loans and rescue passages will have senior status and subordinate all previously issued bonds and treasury bills, while the EFSF originated loans have the same status as privately marketed debt securities. This uncertainty wiped out all the gain in Spanish bond prices initially generated by the announcement. It is widely speculated that the loan will not subordinate private debt as Germany and co. would like to see Spain return to capital markets to finance its deficits at reasonable yields.

Another concern is the continued slid in property values that could lead to higher bad loan ratios at the banks. Banking loans past due by 3 months have already reached highs not seen since the mid 90′s, at a staggering 143.5 Billion Euros. With property values continuing to slide and unemployment still at ~24% the risk of a continued slid in Spanish bank assets may eclipse the size of the current bailout proposal.

Negotiations are expected to resume once Mariano Rajoy has finished watching the Euro football championship, which might be soon seeing as the Spaniards could not even beat Italy in round robin play.