5 Min Read
LONDON, Aug 31 (IFR) - Spain is beginning to lose the support of its banks as last-resort buyers of government debt, with lenders selling out of their holdings at the fastest pace in more than two years in July, ratcheting up pressure on the European Central Bank to step in and put an end to the country's burgeoning debt crisis.
The sales are a blow to Madrid, which was increasingly reliant on domestic banks to buy its debt after an exodus of foreign investors. Domestic lenders, under political pressure to support the sovereign, used cheap loans from the ECB to buy an extra EUR87bn of debt between December 2011 and March this year.
But that support has begun to ebb, with Spanish banks selling over EUR17bn of debt since then, according to ECB data. In July alone, domestic lenders reduced their holdings by EUR9.3bn, in part to meet an outflow of deposits, signalling that money is now too tight to support the sovereign.
"The spike in yields that we saw in July is consistent with deposit outflows and a local sell-off of sovereign paper," said Sohail Malik, senior portfolio manager for European Credit Management's special situations team. The firm has USD9.5bn in assets under management. "Ultimately, you need one entity to assume a huge amount of supply and that can only be the ECB."
Yields on Spanish 10-year government bonds hit a euro-era record high of 7.7% in July. While they have since come down after ECB President Mario Draghi signalled the central bank might be willing to buy Spanish debt, there are as yet no concrete plans for a rescue. The ECB meets again this Thursday.
"We saw some improvement after the Draghi speech, so the rally must have been backed up by opportunistic hedge funds and trading books of banks," said Malik. The yield on 10-year debt is currently about 6.6%. "But the endgame is that we need an entity to absorb a huge amount of supply."
Madrid is planning a further seven debt auctions before the end of the year, the next coming on Thursday. The sovereign has already completed about two-thirds of its planned EUR86bn of debt issuance this year, but the final slog could be difficult if the ECB fails to buy and domestic banks continue to shrink their holdings.
Spanish banks are facing problems of their own. Data released last week showed that customers withdrew EUR74bn of deposits in July alone - equivalent to 4.7% of total deposits and the biggest monthly outflow since records began. Since June last year, clients have withdrawn EUR233bn (see chart), or 13% of the total then.
A need to raise cash to meet those withdrawals may have prompted the recent bond sales, as other assets owned by banks - mainly loans and mortgages - are far less liquid. Spanish bank bond holdings are dominated by Spanish government debt, but also include those of other countries.
Foreign banks and other investors are also showing few signs of increasing their purchases of Spanish sovereign debt. BNP Paribas, the second-biggest bank in the eurozone and one of the biggest holders of government debt from the region, recently announced plans to impose limits of EUR10bn per country to reduce its exposure.
"We need to have a portfolio of sovereign bonds; that isn't something we will change," executive board member Alain Papiasse told IFR. "But, given new regulatory constraints, holding some government debt can hurt our capital ratios. For that reason we globally reduced our exposures by 35% since June 2011."
Treasurers and senior bankers at other European lenders say either they have introduced similar limits already or they intend to do so. That will restrict their ability to buy foreign government debt, even if fundamentals improve or prices prove alluring.
"It's completely rational to be limiting your exposures to each of these countries given the uncertainties still out there," said one head of financial institutions for EMEA at a US investment bank. "It is what I would do if I were in their shoes."
Spain does seem to be a unique case, however. Banks in other eurozone countries have largely left their government bond holdings intact in recent months, according to ECB data - although French banks did reduce their holdings by EUR6.9bn in July. Italian banks actually increased their holdings by EUR345m.
All eyes will now be on Draghi this Thursday for any details of a possible bond-buying programme for Spain and others. After the August meeting, he said: "The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective." (Reporting By John Geddie and Gareth Gore; Editing by Owen Wild)