Spain’s medium-term borrowing costs spiraled to a euro-era record at an auction Thursday, before an independent audit was due to reveal the size of the capital hole in Spanish banks to be filled by a eurozone bailout.
Eurozone finance ministers will discuss how to channel up to 100 billion euros ($126 billion) in rescue loans to Spanish lenders weighed down by bad loans from a burst property bubble. Many in the markets see the package as a mere prelude to a full program for the Spanish state.
“We have already started working on the design of the aid with the Commission, the European Central Bank and the International Monetary Fund,” Spanish Economy Minister Luis de Guindos told reporters as he arrived for the ministerial talks in Luxembourg. “We will present the request in the next few days.”
Spain’s financial plight has taken center stage a week before an EU summit tackles long-term plans for closer fiscal and banking union in an effort to strengthen the euro’s foundations following bailouts for Greece, Ireland and Portugal failed to end a 2-1/2-year-old debt crisis. To pave the way, the leaders of Germany, Italy, France and Spain will meet in Rome Friday.
Madrid sold 2.2 billion euros in medium-term bonds and attracted strong demand. But yields on five-year paper rose to a 15-year high of 6.07 percent, a level regarded by analysts as unaffordable for any prolonged period.
The runaway Spanish yields contrasted with a French auction in which the yield on five-year benchmark paper hit an all-time low of 1.43 percent.
“The first worry is can they [Spain] fund from the markets? They raised 2.2 billion versus a 2 billion target, so they can raise the money,” said Achilleas Georgolopoulos, a strategist at Lloyds in London.
“Then the [question is], are the yields threatening for the medium term? And yes, clearly they are much higher than the previous auction ... but still they can continue for a few months to fund at these levels.”
Two independent auditors are due to deliver a report to the Spanish government on the recapitalization needs of the banking sector following last month’s sudden nationalization of Bankia, the fourth-biggest lender.
De Guindos will present the findings to his eurozone colleagues in Luxembourg. Banking sources believe the report will say the lenders need to raise a further 60-70 billion euros.
The finance ministers will discuss which of the eurozone’s rescue funds – the temporary European Financial Stability Fund or the permanent European Stability Mechanism – will lend Spain the money. This matters to investors because ESM loans would be senior to other Spanish borrowing, meaning private bondholders would face first losses in any debt write-down.
The ministers are also expected to ponder the next steps with Greece, following the formation of a coalition of mainstream parties committed to the country’s 130 billion euro EU/IMF bailout, but determined to renegotiate some of the terms.
Athens will ask lenders for two more years to hit fiscal targets and an extension to unemployment benefits as it seeks to soften the punishing terms of the bailout saving the country from bankruptcy, a party official said.
Greek officials have said this would entail an extra 16-20 billion euros in foreign funding. It sets up a showdown with Greece’s eurozone partners, in particular paymaster Germany, which have offered modifications but no radical rewrite of the conditions attached to the lifeline agreed in March.
“We can always discuss conditions of the loan. But let us not forget one thing: This is not one-way development aid,” Luxembourg Finance Minister Luc Frieden said.
The German government and opposition reached a deal that will allow parliament to approve the eurozone’s permanent bailout scheme next week, but Germany’s top court may delay the rescue fund’s start date scheduled for July 1, saying it needed time to study the treaty.
The ESM cannot go into effect without approval by Europe’s biggest economy. Ratification also requires the signature of the president and a nod from the constitutional court in Karlsruhe.
The parliamentary floor leader of Merkel’s conservatives appeared to dash French and southern European hopes of nudging Berlin toward common euro area debt issuance, saying there would be no mutualization of debt in Europe.
The eurozone finance ministers may consider a suggestion by Italian Prime Minister Mario Monti to use the eurozone’s rescue funds to buy the bonds of Spain and Italy in the secondary market to bring down their borrowing costs.