With markets nose-diving this morning the FTSE Eurofirst 300 is down 2% at time of writing all eyes are, once again, on known unknowns in Europe: rising Greek eurozone exit risks and the looming threat of a collapse in the Spanish banking system. Here is Nomura''s dispassionate take on the ever-fattening tail risk in Spain:
Two conditions for market confidence to be restored in the health of the Spanish banking system are 1) that a realistic assessment of any possible capital deficit in the banking system is acknowledged and 2) that a credible plan be in place for plugging the gap. While we have concerns that the first condition will be met via the current reform proposals, the second condition may prove even more problematic unless Spain draws on broader Eurozone support
Put simply, Nomuras view is that the Spanish government is continuing to underestimate the scale of the problem.
For instance, Moodys expects losses of up to 306bn across loans to small companies and corporates, and mortgages. These estimates were based on more conservative default rates than those experienced in Ireland. CEPR meanwhile has estimated losses at 380bn. Clearly there are many assumptions which affect the estimates, but these numbers are significantly larger than have been recognised by the Spanish government.
Similarly, we are sceptical that we are close to a bottom in the Spanish property market. In a recent report Fitch mentioned that, on average, sales of homes reposed by banks saw prices just 48% of the original estimated value. Even with average LTV rates on mortgages at a conservative 60%, mortgages may need higher provisioning levels. Likewise the current announced scheme allows for no additional provisions on corporate loans.
While current European rescue mechanisms simply lack the capacity to bail out the sovereign itself, Nomura considers the possibility of keeping the banks directly - but this is a political taboo
However, currently all bank bailouts need to be routed via the sovereign and therefore will add to the national debt burden, although in theory the source of repayment would not be the tax system. Providing direct injections of capital into the banks by the bailout funds would be one way to resolve this, but this has been ruled out on a number of occasions by European policymakers.
With Spanish banks poised on a knife-edge spreads on Spanish bonds hit 486 basis points over Bunds this morning negative sovereign-bank feedback loops will remain structurally embedded in the eurozone financial system.