Fitch welcomes Spanish bailout but eurozone crisis still prevails
Fitch’s base case is that Spain will only require €60 billion, boosting the fire-fighting appeal of the €100 billion loan facility. But the subordination of private creditors in favour of the official sector, the lack of wholesale financing for Spanish banks and Greece's elections trigger market panic.
Fitch offered a little good news on Monday, having delivered a savage three-notch ratings downgrade to Spain last week, citing the potential cost of fixing the country’s damaged banking system.
The ratings agency points out that the €100 billion bailout for the country’s banks, confirmed by the euro group over the weekend, would cover losses arising from the most extreme stresses that Fitch modelled before the downgrade.
Spain would have to endure an Irish-style property collapse to require that full €100 billion to restore banks’ core-capital-to-risk-weighted-assets ratio to 10%. Fitch’s base case is that Spain will only require €60 billion, although the final requirement won’t be determined until external auditors complete their examination of banks’ loan books at the end of this month and report in July.
If Spain uses €60 billion of the bailout fund, it will put the country’s gross general government debt on a trajectory to peak at 95% of GDP in 2015.
When Fitch cut Spain’s ratings to BBB last week, it also left the country on outlook negative. Now the ratings agency says: “The recourse to external funding for the bank recapitalization underscores the constrained financing flexibility of the sovereign to respond to adverse shocks.
“Nevertheless, securing low-cost and long-duration funding from European partners to assist in restructuring the Spanish banking sector is consistent with Spain’s current sovereign rating. If effective in restoring confidence in the banking sector and easing the fiscal burden of restructuring, such support would be credit positive.”
Concerns persist, however, not least over the final amount of subsidized financing required and whether or not it will come from the European Financial Stability Facility (EFSF) or from the European Stability Mechanism (ESM), which enjoys superior creditor status and so will subordinate holders of existing Spanish government bonds. That carries unwelcome echoes from private sector involvement in Greece.
The good news for Spain is that neither the EFSF nor the ESM is set up to require additional fiscal-austerity measures as a pre-condition of advancing funds.
However, the consequences are yet unclear for other sovereigns seeking to re-negotiate the terms of earlier bailouts and especially for the Greek elections where it might prove that the example of Spain receiving a bailout will bolster the case of those seeking to renegotiate Greece’s terms. The stresses on the single currency might not ease any time soon.
In a note on Monday, Barclays economists Antonio Garcia Pascual and Laurent Fransolet draw encouragement from the imposition of strict and binding guidelines to restructure Spanish banks in line with European Union state-aid rules, saying that this will help restore transparency and credibility, and might help alleviate funding pressures.
However, the problem confronting Spain, and the rest of the periphery, is bigger and remains the survival of the single currency.
“So long as the euro area does not remove the tail-risk of potential FX redenomination for periphery countries, medium- and long-term investment commitments by foreign capital – or even domestic – are unlikely, and that creates a growth disadvantage,” note the economists. “Without growth prospects, there is little hope for the periphery to emerge out of the crisis.”
Jim Reid, strategist at Deutsche Bank, asks: “Is it wise to continually prop up banks that anything close to capitalism would force to fail/default?
“If you want to avoid a short-term spiral, the answer is yes but surely we are increasingly locking ourselves into an inefficient allocation of scarce capital for years by these continual injections into weaker banks. This can’t be great for enhancing structural growth.”
Furthermore, it remains to be seen whether the injection of more loss-absorbing capital into the Spanish banks will be sufficient to ease their return to wholesale financing markets.
The International Monetary Fund, in its report on the Spanish banks also published over the weekend, notes: “Two-thirds of all sample banks ... fall below the net stable funding ratio benchmark of 100 percent, which together with maturity mismatches up to one year of almost all banks in the sample, raises concerns about the stability of current funding sources”
Matteo Ramenghi, analyst at UBS, points out: “Spanish banks may also require funding support measures to facilitate the process of rebalancing their loan-to-deposit ratios and to deal with current challenging funding market conditions.”