Spain: It Hails More Downgrades

Yesterday Moody's downgraded the ratings of 28 Spanish banks by one to four notches. As always, this comes just at the right time, i.e. when pressure in European financial markets is already at the boiling point.  Of course the banks concerned presumably deserve to be downgraded – it should have been done long ago. This newest wave of downgrade is apparently flowing from the recent downgrade of Spain's sovereign rating. 

As Reuters reports:


„Moody's Investors Service has today downgraded by one to four notches the long-term debt and deposit ratings for 28 Spanish banks and two issuer ratings. Today's actions follow the weakening of the Spanish government's creditworthiness, as captured by Moody's downgrade of Spain's government bond ratings to Baa3 from A3 on 13 June 2012, and the initiation of a review for further downgrade.

Moody's adds that today's downgrades of the long-term debt and deposit ratings also reflect the lowering of most of these banks' standalone credit assessments.

The debt and deposit ratings declined by one notch for three banks, by two notches for 11 banks, by three notches for ten banks and by four notches for six banks. The short-term ratings for 19 banks have also been downgraded between one and two notches, triggered by the long-term ratings changes.

Today's actions reflect, to various degrees across these banks, two main drivers:


(i)   Moody's assessment of the reduced creditworthiness of the Spanish sovereign, which not only affects the government's ability to support the banks, but also weighs on banks' standalone credit profiles, and

(ii) Moody's expectation that the banks' exposures to commercial real estate (CRE) will likely cause higher losses, which might increase the likelihood that these banks will require external support. This notwithstanding, Moody's views positively the broad based support measures being introduced by the Spanish government to support the Spanish banking system as a whole. Moody's will assess the impact of the upcoming recapitalization on banks' creditworthiness and bondholders once the final amount, timing and form of funds flowing to each individual bank are known.“


Nevertheless, Spain's government bond yields were only slightly higher in today's trading, while stocks actually recovered a little bit of the ground they have lost on Monday.  This suggests that the markets were either not surprised by this latest rating action or that a delayed market reaction will be in the offing.










Spain's 10 year government bond yield was only slightly higher in today's trading, while the IBEX actually gained 67 points – click chart for better resolution.



Germany Pressed on Seniority of Bailout Funds

Bloomberg reports that an effort is underway to pressure Germany into relenting regarding the seniority of the bank rescue funds about to be released to Spain. As we have pointed out a few times in the past, the fact that public entities lending out funds for bailouts are accorded seniority over existing bondholders has pressured the bond markets of all recipients of EFSF bailouts greatly. As was seen in the case of Greece, the fact that preexisting bondholders become subordinated creditors after these bailouts are consummated actually increases their risk considerably. As a result many sell first and ask questions later.

In Spain's case, this fact has actually increased the link between banks and the sovereign even further. A vicious spiral has ensued ever since it became known that Spain will receive outside help to bail out its banks and Spain's long term bond yields have even briefly breached the panic highs of last November.

“Germany faces pressure to surrender preferred status on rescue loans to Spain’s banks in a standoff that echoes Chancellor Angela Merkel’s rejection of debt sharing to fight Europe’s deepening financial crisis.

Along with Finland and the Netherlands, Germany wants official loans of as much as 100 billion euros ($125 billion) to Spain to be repaid first in the event of a default, putting bondholders at a disadvantage, said two European officials.

Finance ministers from the three AAA rated countries stood their ground last week, said the officials who asked not to be named because the talks were private. The decision next goes to Merkel and fellow government leaders who have been forced to renounce previous attempts to put taxpayers ahead of investors in structuring bailouts.

“This is one of the focal points for market anxiety about the Spanish bailout,” said Nicholas Spiro, head of Spiro Sovereign Strategy in London. The move to assert seniority “undermines the credibility of the bailout. This is partly what is fueling ‘bailout creep’ in Spain — the fact that the price Spain is paying for this new bailout, due to its flawed structure at present, is a price that is too high.”

The threat of a subordinated status was one reason why Spanish bonds tumbled after the bailout offer was made on June 9. Ten-year Spanish yields have risen 49 basis points to 6.71 percent since then. They rose as high as 7.29 percent last week.”


(emphasis added)

This is yet another case in which the AAA rated creditors named above are quite unlikely to relent. They are asked to put the interests of existing bondholders before those of their tax payers, something that will prove politically very difficult. On the other hand it is undeniably true that the fact that the imminent subordination of existing creditors plays a major role in the sharp sell-off in Spain's government bond market. In short, the AAA rated countries may actually increase rather than decrease the risk to their tax payers by standing firm, as it becomes more likely that Spain will require a full-scale bailout if interest rates on its debt continue to rise. Spain still has to obtain slightly less than 50% of its financing needs for 2012, and 2012 is the year in which the biggest bulk of government debt rollovers are scheduled to take place.



When Spain's government bonds mature,  in billions of euros. 2012 sees the bulk of the country's debt rollovers, but 2013 and 2014 are also big years – click chart for better resolution.



Ironically, Spain's stock market has been among the world's best performing assets in so far this month,  as the comparison chart below shows:



Asset performance to in June 2012, via Scott Barber of Reuters. Spain's IBEX was in the lead in June – many other 'risk assets' also outperformed the 'safe havens.



The Oldest Bank in the World Bailed Out – Again

Monte dei Paschi di Siena Bank was founded in 1472, which makes it the oldest banking institution in the world. It even survived the banking crash that brought down the famous Medici Bank in 1499 and every upheaval of the fractionally reserved banking system since. Evidently the bank's managers were traditionally very conservative and prudent. Sadly, the bank is now insolvent and requires another bailout to stay afloat. The reason? Its vast exposure to 'risk-free' Italian sovereign bonds. This is not the first bailout of Monte Dei Paschi as it were – it already received one in 2009.

Reuters reports:


“Monte dei Paschi is the first Italian bank to have to resort to state aid since 2010 as the euro zone crisis deepens, with the bank hit hard by its 25 billion-euro exposure to Italian government bonds, which is proportionally higher than that of its domestic peers.

Under its restructuring plan Italy's third biggest lender said it aims to slash its loan book, close 400 branches and cut 4,600 jobs, and also estimated it would sell 1.5 billion euros of new special bonds to the Italian treasury, against a maximum of 2 billion euros approved by the government on Tuesday.

That will bring total state support to the bank to 3.4 billion euros, including similar bonds that Monte Paschi already sold to the state in 2009. The bank pledged to almost entirely pay them back by the end of its 2012-2015 plan.

"We've gone back to being a state bank," said a frustrated MPS employee.


(emphasis added)

One wonders if the cockroach theory applies in this case – i.e., there is never just one. Italy can ill afford having to bail out its banks all over again.



The share price of Monte dei Paschi barely reacted to news of the bailout -evidently the market has already discounted it in advance. The stock is down over 95% from its  2007 highs – click chart for better resolution.



Selected Credit Market Charts

Below is a selection of our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Tuesday's close.

Euro area CDS spreads and bond yields continued to rise on Tuesday as advance disenchantment over the upcoming euro-group summit dominated trading activity.

We have also included a long term chart of the Chinese yuan against the US dollar, as there may be a trend change in the offing. This would presumably be quite meaningful for a number of financial assets, especially commodities.



5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.



5 year CDS on Germany (white) , the US (orange) and the Markit SovX index of CDS on 19 Western European sovereigns (yellow) – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on the senior debt of eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) –  white line,  compared to 5 year CDS on major US banks (Morgan Stanley – red line, Goldman Sachs – orange line, Citigroup – green line) as well as Credit Suisse – yellow line – all ticking higher again – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – click chart for better resolution.



Austria's 10 year note yield (green), UK gilts yield (yellow), Ireland's 9 year note yield (white) and the price of the Greek 2 year note (orange line – prior to the PSI deal in March this shows the yield on the old two year note) – click chart for better resolution.



A long term chart of the Chinese Renminbi versus the US dollar – it seems the trend is about to change and the dollar about to strengthen against the yuan. This has implications for commodity prices as well as the global economy. Note that global 'reflation' is commonly associated with a rising yuan – click chart for better resolution.



Finally, a 'chart of the day' from Bloomberg,  showing the US 'chemical activity barometer' compared to US industrial production. It appears from this that the former traditionally leads the latter in incipient downturns. The recent sharp decline in the spread appears to bode ill for the US economy – click chart for better resolution.





Charts by: Bloomberg, BigCharts, Reuters, Der Spiegel



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