Spanish banks may have to run to the European Central Bank for financing if the state's debt risk premium reaches a critical level of 450 basis points, analysts warn.
The risk premium on Spanish bonds -- the extra return demanded by investors compared to safe-bet German debt -- surged to a euro-era record of 407 basis points on Wednesday.
The premium increases the cost of borrowing for Spain's government but it also poses a grave threat to banks, which have 117.59 billion euros ($165.44 billion) in bad loans after the 2008 property bubble collapse.Spanish financial institutions gross debts amounted to a staggering 113 percent of the country's gross domestic product in 2010, according to the International Monetary Fund.
Many of the banks raise their short-term financing on London's LCH Clearnet -- a major debt clearing house -- by providing Spanish government bonds as collateral.But if the risk premium on those bonds rises to 450 basis points compared to a basket of AAA-rated government bonds, the clearing house can demand an extra 15 percent downpayment to let the trade go ahead."We would generally consider a spread of 450 basis points over the 10-year AAA benchmark to be indicative of additional sovereign risk," the LCH Clearnet policy says.LCH Clearnet, which has to pay the other side of the deal in case of a default, had already demanded additional 15 percent margins from banks using Irish and Portuguese bonds when their risk premiums hit 450 basis points.Soon after, both Ireland and Portugal had to be bailed out.For the banks, the extra margin can be costly."What does that mean? It means that they have to post more collateral. Since they are already very, very, very stretched it becomes too much," said Barcelona-based independent economist Edward Hugh.Since 2007 Spanish banks had been unable to obtain substantial, economically viable financing on the wholesale debt markets, he said. As a result, they had accumulated a large quantity of short-term borrowing.If LCH Clearnet demands higher margins the banks are likely to go running to the European Central Bank for short-term financing, Hugh said, warning that if the ECB could not cope it may even have to call in the European Financial Stability Facility, used in the Greek, Irish and Portuguese bailouts."Spain is getting closer to the trigger level of an additional LCH haircut," said a report by Bank of America Merrill Lynch European economist Laurence Boone and rates strategist Sphia Salim."Spanish banks will have to turn to the ECB to cover the funding gap and the prospects of similar deterioration in funding availability for Italian banks would severely impede the functioning of the Eurozone interbank market," they warned.Nuria Alvarez Anibarro, financial analyst at online brokerage Renta 4, said the scenario of a European rescue because of an extra margin call by the LCH was somewhat extreme.
Spanish banks had a large book of assets that could be used as collateral to raise liquidity from the ECB if they decided it was not worth paying the extra margin in London.
Even if the risk premium hits 450 basis points, much depends on how long it stays there, she said."It also depends a lot on the banks' debt repayment schedule. Almost all Spanish banks have their repayments covered for 2011. They don't need to go to the markets as such," Alvarez said.If banks were shut out of the markets well into 2012 with repayment deadlines looming, the situation would be more serious, she said. But "it is a bit soon to make that guess when we have only just reached 400 points."Nuria Garcia, analyst at Spain's Ahorro Corporation, said banks were paying a lot for financing in part because of the high cost of state debt, which was a benchmark, but they still had ample assets to use to borrow from the ECB.Spanish banks' borrowing from the ECB had declined from last summer, when they accounted for 23 percent of all ECB lending, to just 11 percent now, she said.