Spanish Bank Rescue Is Prelude to Broader Bailout

June 28, 2012

Ken Orchard, T. Rowe Price sovereign credit analyst.

The Spanish government and EU institutions recently announced that the European Financial Stability Facility or the European Stability Mechanism will lend up to €100 billion to the Spanish government to recapitalize its banking sector. The announced program is likely to be the first step toward a bigger rescue of the sovereign, according to Ken Orchard, T. Rowe Price sovereign credit analyst.

• Contrary to the Spanish government's claims, the problems in Spain are not confined to the banking sector. The Spanish economy is deteriorating, the fiscal deficit is on track to miss its target, and the regions have large refinancing requirements that they are unable to meet on commercial terms. Therefore, we believe a banking sector package alone is unlikely to allow Spain to regain market access at sustainable spreads.
• The chart above shows the Spanish government's financing requirements from July to December 2012. In aggregate, we estimate that the government needs to raise €102 billion: approximately €80 billion to refinance maturing debt and over €22 billion to finance the budget deficit.
• Raising this amount of money in the capital markets is not impossible, but it will clearly be difficult. It would require a large shift to short-term financing and would be vulnerable to all manner of confidence shocks.
• The €102 billion also does not include regional governments, which have around €30 billion in debt maturing in the second half of 2012. The regional governments have been struggling to roll over their debt. Many are being forced to pay high interest rates for short-term loans. The central government is supposed to be rolling out a guarantee scheme for the regions, but no announcement has been forthcoming so far.
• The timing for the next stage of the rescue is difficult to forecast. A bigger and broader sovereign rescue will require a significant compromise from both the Spanish government and the eurozone governments/institutions. Spain will have to accept some degree of macroeconomic and fiscal conditionality and monitoring. In exchange, the eurozone will likely agree to structure the rescue in a more flexible and less intrusive manner than is the case for Portugal and Ireland. We expect that Spain will be forced to accept a larger and broader European rescue program before the end of the year.