Be bullish on a Spanish bank bailout

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Overnight Spain managed to sell €3.18 billion worth of bills which was ahead of the target of €3 billion. The sale appears to have been the catalyst for a surge of optimism with a rally on the European markets. Short term debt is well within the LTRO window and so we are still working in an highly artificial market at this end of the curve. But even with the LTRO behind it rates were up with 12-month bills at 2.623% up from 1.418% and 18-month bill up to 3.11% from 1.711$ last month. Spain plans to auction another €2.5 billion of bonds on April 19.

On the downside, following comments earlier this month and seemingly ignored by the market, was an announcement by the Spanish central bank that Spanish banks will seek:

additional provisioning needs totalling €29.08 billion and higher core capital requirements amounting to €15.58 billion, following the extraordinary write-downs of €9.19 billion made in advance at the close of 2011.

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Yes that is in addition to the provisions and capital adjustments that they have already made. This seems tremendously ambitious given the state of the Spanish economy, and I am quite doubtful it is even the end of it. As I have been explaining over the last month or so as the economy deteriorates so to will the bank’s balance-sheets. If we don’t see some amazing upside adjustment in Spain’s economy, which seems increasingly unlikely, then this is only going to get worse. That being the case I am finding it increasing difficult to believe that the Spanish banking system isn’t going to need a bailout of some kind. Whether that comes from a new ECB program, the EFSF, IMF or the other external body is yet to be seen, but ultimately this will lead back to the Spanish government’s balance sheet at a time when it is supposed to be de-leveraging.

Overall, at this stage, it is estimated that Spain’s banks will need €53.8 billion, the government had estimated the number to be €52 billion in February. Spanish banks have until May 31st to specify whether they will be seeking to merge with other banks or choose to weather the storm themselves and there are already plans in place for 5 mergers. All banks have until the end of 2012 to raise their capital levels, or at least work out a way to report that fact.

Back in early Februaury I mentioned 2 black cygnets I was watching in Europe that I thought would come back to effect the stability of the area.The first was Spain, which has obviously now occurred, the second were the European elections, specifically the French presidential race.

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Back in February I noted that François Hollande, if elected, was looking to unwind many of the agreements that had been setup under the Franco-German alliance of Merkel and Sarkozy, but much has changed since then. Mostly notably Sarkozy’s stance.

France’s Nicolas Sarkozy stepped up his demand on Tuesday to give the European Central Bank a bigger role in driving growth, despite a German rebuff, in a quest to convince voters five days from an election that he is the best defender of the economy.

Sarkozy raised hackles in Berlin by declaring at a weekend campaign rally that he wanted a debate on having the ECB direct its exchange rate policy to propel growth, breaching a November agreement not to publicly discuss the bank’s role.

The conservative president, who is losing momentum in opinion polls, told France Inter radio that giving the ECB a pro-growth role would not require modifying European treaties or throw the bank’s independence into question.

“It is not possible that the ECB does not participate in supporting growth, like all the central banks in the world,” Sarkozy said, citing China’s use of the yuan exchange rate to boost its export-led economic output.

“It is wrong to say that just because the ECB is independent, we do not have the right to talk.”

Merkel was never seen walking the streets of Paris. Sarkozy’s political strategist have obviously decided that she was political baggage and the tone has obviously changed. With the dumping of pro-German policy and talking tough on immigration and protectionism Sarkozy has slowly whittled away Hollande’s advantage with the most recent polls showing a dead heat with 5 days to go.

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But you have to ask at what cost to Europe. Sarkozy is focussing on “closed border” policy while Hollande wants to tax the rich in order to spend more on public services. Neither campaign has any time for talk about austerity or aligning more strictly with the European fiscal compact.

With Spain looking increasingly troubled, Mario Monti about to announce Italy is going backwards and Portugal and Greece continuing to struggle the risk is that a breakdown in the Franco-German relationships will leave Europe as a sinking ship with an in-fighting admiralty.

Markets are unlikely to be happy if this occurs.

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Bank of Spain Statement on Bank Recaps