The Wall Street Journal is reporting this morning that investors are “fleeing” Spainish bonds (Tesoros).
After a burst of strength Monday morning, Spanish bond yields changed course and began a sharp rise. By afternoon in London, the 10-year yield was at 6.54%, three-tenths of a percentage point higher than Friday’s close. Bond yields rise when their prices fall.
Credit-default swaps on the Spanish government, insurance-like contracts that pay off if Spain defaults, zoomed higher Monday. Spain dragged Italy deeper into trouble, too; the Italian 10-year yielded 6.04%, up more than a quarter of a point.
Perhaps they didn’t believe S&P’s report earlier this morning that the proposed new bailout facility wouldn’t affect Spain’s already bad rating, or perhaps they didn’t like the fact that senior bondholders would be subordinated to the bailout facility (ESM):
LONDON (Standard & Poor’s) June 11, 2012–Standard & Poor’s Ratings Services said today that the Spanish government’s decision to seek up to €100 billion from eurozone member states to recapitalize its banks has no immediate effect on our ratings on Spain (BBB+/Negative/A-2).
The amount of funds Spain is seeking covers our estimate of the provisioning shortfall in both our base case and a scenario of accelerated recognition of 2012-2013 credit losses (see “The Timing Of Recognition Of Mounting Loan Losses Could Push Spanish Banks Over The Edge,” June 7, 2012) and our expectations when we downgraded Spain on April 26, 2012 (see Ratings On Spain Lowered To ‘BBB+/A-2′ On Debt Concerns; Outlook Negative”).
We expect the final amount, which will likely not be confirmed until an independent audit of the Spanish banking sector is completed in the coming weeks, will be made available to the relevant banks by the Fondo de Reestructuracion Ordenada Bancaria, the government entity charged with the orderly restructuring of Spanish financial institutions.
By our calculations, if the €100 billion made available through either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) were fully drawn, Spain’s net general government debt would increase to over 80% of GDP during 2012-2014. At the same time, however, the borrowing would crystallize the contingent liabilities on Spain’s balance sheet in respect of the relevant financial institutions. Under our sovereign credit rating methodology (see Related Criteria below) we believe this would reduce Spain’s total contingent liabilities as they would be transformed into government debt.
Finally, the ESM borrowings, in contrast to those from the EFSF, would subordinate Spain’s senior bondholders. If the amount borrowed from the ESM were to materially exceed the currently expected €100 billion, the ESM’s self-declared preferred creditor status could, in our view, constrain Spain’s access to the capital markets and therefore reduce the likelihood of bondholders being paid in full.
Could we see disintermediation of Spain’s banks?