Spanish Yields at 7% Show Investors Slamming Door: Euro Credit

Investors who oversee more than $3.2 trillion expect Spain to become the fourth euro member to need external funding as borrowing costs surge to levels too punitive for the nation to finance its needs on the capital markets.

Spanish debt has slumped, pushing the 10-year yield today to a euro-era record of 7.14 percent, as investors at Fidelity Investments, Frankfurt Trust and Principal Investment Management say the nation may lose market access. The bonds are the worst performers among 26 developed markets since June 9, when Economy Minister Luis de Guindos said he would request as much as 100 billion euros ($127 billion) of emergency loans from the euro area to shore up a Spanish banking system hobbled by bad assets.
“Yields are at levels at which Spain can’t really afford to finance itself for more than a few months,” said Craig Veysey, head of fixed income at Principal Investment Management in London, part of Sanlam Group, which manages $72 billion. “The banking bailout doesn’t really help Spain’s credibility in the market and the probability is rising that it will be asking for a bailout for the sovereign.” Veysey said he doesn’t own Spanish government bonds and has no plans to purchase them.

Prime Minister Mariano Rajoy called on Europe’s policy makers last week to do more to support Spanish bonds after the bank rescue failed to halt yields from climbing to levels at which Greece, Portugal and Ireland needed to seek help. His government is battling to reduce the nation’s debt load as the recession in the euro area’s fourth-largest economy deepens, leaving the jobless rate at more than 24 percent.
Greek Election

Adding to investor concern is Greece, where analysts at Bank of America Merrill Lynch say the country may run out of money next month. The nation’s largest pro-bailout parties, New Democracy and Pasok, will have a combined 162 seats, assuming they govern together in the 300-member parliament after yesterday’s elections, according to Interior Ministry projections with 99 percent of the vote counted. The result eased speculation that Greece was headed for an imminent exit from the 17-nation euro area.

Spain’s 10-year bond rate has surged more than 2 percentage points from this year’s March 1 low. The yield climbed 26 basis points today. The yield difference to similar-maturity benchmark German bunds widened to 572 basis points, the most since the start of the euro.
Funding Needs

The nation’s bonds also risk incurring higher trading costs at LCH Clearnet Ltd. as their performance relative to Europe’s AAA rated benchmark deteriorates. LCH, Europe’s biggest clearing house, increased the cost of trading Irish and Portuguese bonds by 15 percent when yield spreads for those securities climbed above 450 basis points.

A three-year, fully-funded program for Spain would probably cost about 300 billion euros in addition to the 100 billion euros already provided in the banking bailout, said Nick Eisinger, a sovereign analyst at Fidelity Investments in London, a U.S. mutual fund company with $1.6 trillion of assets.

“The market is very skeptical because the bank deal doesn’t really make any difference to the tricky and challenging position of the Spanish economy,” Eisinger said. “There’s a pretty strong likelihood that the Spanish sovereign will need some kind of a funding program in the next six to nine months.”
Rising Debt

The bank aid will increase Spain’s debt to about 90 percent of gross domestic product, Moody’s Investors Service said on June 14, since the sovereign is responsible for repaying the loans. That threatens to further limit its ability to sell bonds, Moody’s said, as it dropped Spain’s rating three levels to Baa3, one step above junk. Standard and Poor’s has a negative outlook on Spain’s BBB+ rating, which is three steps above junk.

Natixis Asset Management is betting that Spanish bonds will decline, as public debt rises after the bank bailout and bondholders grow wary of being subordinated. Lenders to Greece lost more than 70 percent of their investments when the nation restructured its debts, while the European Central Bank and other agencies were exempt from the discounts.

The statement on aid for Spanish banks didn’t specify where the loans would rank or how the funds would be raised.

Bad loans as a proportion of total lending at Spain’s financial institutions jumped to 8.72 percent in April, the highest since 1994, from 8.37 percent in March, the Bank of Spain said on its website today, fueling concern that the recession is forcing more companies, consumers and homeowners into default.

The “biggest unknown” after the banking deal is whether Spanish bonds would rank after European loans, said Axel Botte, a strategist in Paris at the company that oversees the equivalent of $704 billion. If bailout cash comes from the European Stability Mechanism, it becomes a preferred creditor, outranked by only the International Monetary Fund.
Default Risk

“If you’re buying an asset that might be subordinate to official loans, that makes it more risky and there has to be a premium built in,” said Mohit Kumar, head of European interest- rate strategy at Deutsche Bank AG in London. “The move in Spanish yields reflects this.”

The cost of insuring against a default on Spanish government bonds climbed to a record 607 basis points last week, according to data compiled by Bloomberg, while bond investors lost 3.3 percent, including reinvested interest, on Spanish debt, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Foreign investors’ share of Spanish bonds dropped to 38 percent in April from 52 percent in December, Spanish Treasury data show, while domestic lenders’ rose to 30 percent from 16 percent.

“The market looks at Spain as a nation which has problems other than the banks,” said Ralf Ahrens, who helps manage about $20 billion as head of fixed income at Frankfurt Trust, which is underweight Spanish bonds. “There is a danger that if market confidence doesn’t come back then Spain will have to ask for further help.”