Spain Grazing Junk Status Fuels Contagion Risk: Euro Credit
Angeline Benoit
Spain’s slide down the credit-rating ladder has brought the nation within a hair of junk status and risks triggering contagion in Italy and beyond should investors completely shun its bonds.
The yield on Spain’s benchmark 10-year notes was at 6.89 percent at 2:33 p.m. in Madrid, after rising to a euro-era record 6.92 percent yesterday. That came after Moody’s Investors Service cut its rating three levels to Baa3, one step above junk. Investors demanded 5.3 percentage points more to hold its 10-year debt than that of Germany, with which it shared an AAA rating as recently as September 2010.
Moody’s said Spain’s decision to seek as much as 100 billion euros ($126 billion) of European funds to shore up its banks increased the risk the country would need a full bailout. Spain’s aid request and the credit-rating reduction have increased foreign investor flight, leaving the Treasury increasingly reliant on the soon-to-be rescued domestic banking industry to buy its debt.
“Junk status would be serious and would confirm it is locked out of the capital markets,” said Marc Chandler, head of global currency strategy at Brown Brothers Harriman & Co. in New York. “It would mean the bank aid turns into a full-fledged aid package, redouble pressure on Italy and France while Portugal would take another hit.”
Italy’s 10-year bond yield has risen almost 30 basis points since Spain said it would request the bank assistance on June 9. That pushed the premium investors demand to hold Italian debt over comparable German bunds to 455 basis points.
Under Scrutiny
Moody’s has kept Spain on review for a possible further downgrade. Fitch Ratings, which rates Spain two levels above junk at BBB, said June 12 that all euro countries were at risk of downgrade. Standard and Poor’s has a negative outlook on Spain’s BBB+ rating, which is three steps above junk.
Spain’s financing needs are increasing along with its costs. The debt load surged after a budget surplus turned into a ballooning deficit following the end of a 10-year real-estate boom. The economy is stuck in its second recession since 2009, complicating efforts to trim the euro-region’s third-largest deficit by 40 percent in a year.
Spain’s total public debt rose to 72.1 percent of GDP in the first quarter from 68.5 percent at the end of last year, the Bank of Spain said today. In April, the central government’s deficit was at 2.4 percent of GDP, compared with a full year target of 3.5 percent, according to the Budget Ministry. It surged from a year ago due to cash transfers to the 17 semi- autonomous to help them reorder their finances, it said.
Debt Load
The bank bailout will increase Spain’s debt to about 90 percent of gross domestic product and threatens to further limit its ability to sell borrow, Moody’s said when announcing the rating decision. That will make the government more dependent on the same domestic banks that needed the rescue to cover their bad real-estate loans.
Treasury data show foreign investors’ share of Spanish bonds dropped to 38 percent in April from 52 percent in December, while domestic lenders’ rose to 30 percent from 16 percent.
“This is an unsustainable situation,” Moody’s wrote in its June 13 report. “The government is likely to become increasingly constrained with regard to the terms under which it is able to refinance maturing debt.”
Rating Pressure
A junk rating also may put additional pressure on the banks by reducing the value of the government bonds that Spanish lenders use as collateral to access funding from the European Central Bank.
Bank of Spain data published yesterday showed the lenders increasing dependence on ECB funding, which rose 9 percent in May to a record 288 billion euros. Under ECB rules, governments must maintain a rating equivalent to at least BBB- from one of the four accepted rating agencies.
The recent widening in Spanish corporate bond spreads partly reflects growing concerns about a junk rating, said Georg Grodzki, who helps oversee $515 billion at Legal & General (LGEN) Investment Management in London. Telefonica SA (TEF)’s $1.5 billion of 5.462 percent bonds due in 2021 yield 7.20 percent, or 550 basis points more than comparable maturity Treasury bonds, about 200 basis points than at the start of March, according to data compiled by Bloomberg.
“A junk rating of Spain would be much more significant than those of Portugal and Ireland as billions of corporate bonds that would no longer qualify for investment grade funds would be subject to forced selling,” Grodzki said.
To contact the reporter on this story: Angeline Benoit in Madrid at abenoit4@bloomberg.net
To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net