Spain set to seek bailout as country’s credit rating heads towards junk status

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By Bob Duncan
 
Spain looks set to ask Euro group finance ministers for a financial bailout after Spanish bonds were downgraded to almost junk status and several banks headed towards meltdown.
 
According to a report by Reuters, which cited EU and German sources, the eurozone’s fourth largest economy could make a request for financial aid as early as this weekend.

The wire service said on Friday that finance officials from all 17 Euro area nations will hold a conference call Saturday to discuss the rescue package.

According to Guy Schuller, a spokesman for Jean-Claude Juncker, head of the Euro group of finance ministers, Spain has not yet requested financial assistance and no conference call has been scheduled.

However he added: “Should Spain submit a request for financial assistance, all instruments are in place and ready to be used, following the agreed guidelines”.

German Chancellor Angela Merkel appeared frustrated with Spanish dithering, saying “We have everything we need for a stable Euro zone and it is up to the individual countries to come to us.  That has not happened”.

On Thursday, rating agency Fitch hit Spain with a significant downgrade to its sovereign debt rating, slashing it three notches from “A” to “BBB” with a negative outlook, just a hair above junk status.

Fitch pointed to Spain’s need for a banking industry bailout of up to €100 billion, saying it now expects a prolonged recession in the country that will run throughout 2013.

According to Nick Stamenkovic, fixed income strategist at RIA Capital Markets in Edinburgh, the downgrade “clearly refocused markets on financial problems in Spain and the hole in the balance sheets of the banks,” adding that Spain has become the latest sour point with its banking crisis and high unemployment.

The Spanish government has been struggling with soaring unemployment and to contain a deepening banking crisis since it announced last month that one of the nation’s largest banks, Bankia, needs a €19 billion bailout.

While Spain has a relatively low level of debt, it does not have the capacity to recapitalise its banks.  Madrid has already signalled that it will not meet its deficit reduction targets this year as the Spanish economy, like that of the UK, has fallen back into recession.

In addition, Spain’s borrowing costs have risen recently as investors demand increasingly higher interest rates to lend money to the government.

The yield on 10-year Spanish bonds rose to a high of 6.6% last week, prompting a warning from the nation’s Treasury minister that the government is in danger of being priced out of the market.  However, yields eased this week following a successful bond auction on Thursday and are currently around 6.2%.

Spain is trying to avoid the humiliation and strict economic conditions that would come with a full international bailout, like the ones given to Greece, Ireland and Portugal.  Efforts are being made to find a way of helping its banks directly, rather than funds going through the central government.

Payment would probably be made by the European Financial Stability Facility to Spain’s bank restructuring fund, known as the Frob. 

Speculation about the actual amount required varies wildly.  Three former savings banks, including the recently nationalised Bankia, have already asked for a total of €28bn.

Spain has said that it will not make a decision on its financial needs until after two assessments of the banking sector are complete and has commissioned an external audit of its banks, which is not expected to be concluded until later this month.

Spanish Deputy Prime Minister Soraya Saenz de Santamaria told a news conference: “Once the estimates of the numbers are known with regard to what the financial sector might need, the government will state its position.”

However, Dutch finance minister Jan Kees de Jager has said that emergency talks this weekend to discuss a bailout for Spain cannot be ruled out, describing the situation in Spain as “urgent”.

The first steps in a dramatic bailout for Spain will be taken this weekend, with a final figure on the size of the rescue package to be ready within a week, according to sources in Brussels and Madrid.

The moves reflect a growing consensus that a Spanish collapse must be averted to prevent a devastating chain reaction that could bring down Italy and ultimately destroy the single currency.  There are fears that this would spark a global downturn, extending to the US and China, and both countries urged Europe to move swiftly to fix its long-running debt crisis.

President Barack Obama called on European leaders on Friday to strengthen their banks and urged Greece to remain in the eurozone. “There is a path out of this challenge,” Obama told reporters at the White House.

“These decisions are in the hands of Europe’s leaders; they understand the urgent need to act.  There are specific steps they can take right now to prevent the situation from getting worse.  One of those steps is taking clear action as soon as possible to inject capital into weak banks.”

While there are still uncertainties about whether Greece will be forced to drop the euro following its upcoming parliamentary elections on June 17, the possibility of Spain needing help is a more pressing concern due to the size of the economy, the fourth largest in the Euro zone.

The International Monetary Fund (IMF) is expected to issue a report on Monday about the health of Spanish banks.  The IMF has reportedly pegged the banks’ capital requirements at up to €40 billion under a worst case scenario.