Spanish Banks Recapitalized: A Closer Look at the Funding Picture

Spain’s €100 billion ($125 billion USD) euro zone rescue bank aid was not warmly received across U.S. markets yesterday as investors sold into the brief morning rally and then focused on the question of how euro zone plans to pay for the bank aid and whether Spain is truly capable of paying down its growing sovereign debts with a declining GDP and rising unemployment level reaching near 25% of the Spanish population.

Making Good Provisions

The €100 billion rescue aid reaches the highest continuum of bank rescue estimates from Fitch and the IMF that was used to determine a troubled scenario for the recapitalization of Spanish banks.

Last Friday The IMF said that Spain’s banks would need to raise at least €37 billion, or about $46 billion USD, as a firewall against a sharper economic contraction in Spain, a level that is far lower than €100 billion .

On Monday speculation has grown stronger about which euro zone bailout fund will be used to pay for Spain’s €100 billion banking rescue since there was no specific mention during Saturday’s conference.

Here is a closer look at the 2 bailout funds that operate in the euro zone and will be involved in the latest Spanish banking bailout.

 The European Financial Stability Facility, known as ESFS, is a  temporary bailout fund that was created as an emergency fund in 2010 while European leaders raced around to bail out Greece and contain debt contagion spreading across other weak euro-zone member nations. Euro zone countries pledged 440 billion euros in loan guarantees, which the EFSF used to disburse 192 billion euros in bailouts for Ireland, Portugal and Greece.

The European Stability Mechanism, known as ESM, is a more permanent 500 billion euro rescue fund and is sometimes described as Europe’s version of the International Monetary Fund and is funded by all euro zone member nations although Germany and France are the largest contributors.

The ESM was originally intended to become operational in 2013 but it will now become operational in July 2012. ESM rules dictate that its loans are senior to all other debt that is held from private bondholders. That rule is different from the EFSF which can spread its repayments more equally among private bondholders and member countries.

Some investors have raised concerns that loans from the ESM have the potential to trigger the payout of Spanish credit default swaps (insurance against default) since the appearance of a preferred creditor such as the ESM would aggravate the conditions for existing Spanish debt holders.

However,  Reuters reports that  a senior euro zone source said that such an interpretation was going too far and that CDSs would not be triggered, but that to avoid such investor concerns, the loan for Spain could be originally made by the EFSF, which does not have preferred creditor status. The bailout could then taken over by the ESM, which is expected to become active from July 9, but under current rules, the transferred loan would not become senior to other Spanish debt because it originated in the EFSF.

The ECB’s Role with the LTRO

The graph on the left shows the funding levels Spanish banks received from the ECB’s long-term refinancing operations (LTROs) that provided three years’ worth of funding at bargain rates (click to expand).





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