Spanish bonds hit by Bankia bailout fears

Posted on May 28, 2012

Spain’s cost of borrowing jumped as worries over the country’s banking system and the cost to the state of taking over Bankia eroded bond market sentiment.

Spreads on Spanish 10-year bonds over German Bunds hit new euro-era highs, climbing to 511 basis points.

    Yields on Spain’s 10-year government bonds briefly moved above 6.5 per cent, moving closer to the 7 per cent level that led to bailouts for Greece, Portugal and Ireland.

    While a possible Greek exit from the euro remains a concern, investors are also nervous about the health of Spain’s banks, which lent heavily during the property bubble and are sitting on an estimated €180bn of bad loans. Many analysts feel that moves by Mariano Rajoy’s government to deal with worries at Bankia and the wider economy have not gone far enough.

    Last week Madrid unveiled its latest plan to tackle problems in its banking system, announcing it would make an emergency €19bn injection into Bankia. The move will take the total amount of state aid in Spain’s second-largest bank by domestic deposits to €23.5bn and will give the government up to 90 per cent of Bankia.

    The capital injection could see Madrid directly injecting its own government debt into Bankia, whose shares fell sharply on Monday, and its parent. Under the plan, Madrid would issue government guaranteed debt to Bankia in return for equity. The bank would then be able to deposit those bonds with the European Central Bank as collateral for cash.

    “Everything about Spain makes us very cautious,” said David Owen, chief European financial economist at Jefferies. “It’s built up substantial imbalances … On a macro sense it is in a very bad space.”

    Moreover, Spain’s banking system is so systemically important that the repercussions for the eurozone would be far greater than problems in the Greek financial system, he said. The country has about €450bn of deposits from foreign companies and individuals. “What happens if that money starts to leak out?”

    He believes that the ECB is moving closer to having to act to ease problems in the eurozone, either by cutting interest rates or “quantitative easing”.

    In December and February the ECB pumped more than €1tn into Europe’s banking system, via its three-year, longer-term refinancing operations. Hundreds of banks took advantage of the cheap funding.

    However, Mario Draghi, president of the ECB, continues to stress that banks and governments must also play their part in driving growth.

    The ECB has been reluctant to revive its securities market programme, under which it has bought sovereign eurozone debt. Data released on Monday showed the central bank held back from using the bond-buying programme for the 11th week in a row.

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