SEB's Chief Strategist Johan Javeus argues that Spain is likely to need a bailout but is unlikely to default.

1. Likely to need a bailout
The pain in Spain but unlikely to default
johan.javeus@seb.se

2. Tensions rising in Spain
Likely to need a bailout but unlikely to default
Over the last two months Spanish CDS prices have surpassed the all time highs from November 2011
The growth outlook for Spain has deteriorated and latest consensus estimate predicts a recession (-1.4%
of GDP) for 2012. Further downward revisions are likely
The government has been forced to revise its budget deficit forecast for 2012 higher (5.3% of GDP) and
growth forecast lower (-1.7%). Risks are for an even larger deficit
The CDS market is currently pricing a 70% risk of a 20% haircut on Spanish government debt within the
next five years
Conclusions
It is likely that Spain will need some form of bail out arrangement this year possibly alongside with
continued partial funding in the private market. For this to be possible the market needs to see steady
progress on deficit reduction and structural reforms
Given that the Spanish debt level is still not alarmingly high (69% of GDP in 2011) the country still has
some time to fix its problems on its own. The relatively low debt level is the best insurance that a
Greek-style default can be avoided
The biggest risks are 1) problems for Spanish banks and falling property prices, 2) difficulties to control
excessive spending in its autonomous regions, 3) a poor growth outlook with rising unemployment
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3. CDS market is already pricing a high probability of sovereign
default within the next 5 years
Spain
500 8.0
The CDS current pricing* indicates a default
probability within the next five years of: 400 7.0
70% when assuming a 20% haircut (same as 300 6.0
original proposal for Greece)
200 5.0
38% when assuming a 50% haircut (same as
2nd proposal for Greece) 100 4.0
29% when assuming a 70% haircut (same as 0 3.0
08 09 10 11 12
the likely final deal for Greece)
CDS 10Y Government 10Y
Above calculations are based on a 5 year CDS. By
comparison the equivalent probabilities for France
are:20% haircut: 36%, 50% haircut: 16%, 70% haircut:
12%
Contrary to the CDS market the Spanish
government yield curve shows no tendencies of
becoming inverted which is the classical sign of
default expectations
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4. The LTRO’s did great things for Spain and Italy but the positive
effects are fading
10 year government yields
Net purchases of Gov bonds by the 10.0 10.0
banking system (EUR bn)
9.0 9.0
Dec 2011 – Jan 2012 (BIS)
Yield level where Greece, Ireland & Portugal
8.0 were cut off from private funding
8.0
7.0 7.0
6.0 6.0
5.0 5.0
4.0 LTRO
4.0
1&2
3.0 3.0
2.0 2.0
1.0 1.0
Spanish and Italian banks were jan mar maj jul sep nov jan mar
large net buyers of government 11 12
bonds after LTRO:s Spain Italy Germany
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5. The case for a soft bailout in Spain
It Spain is unsuccessful in regaining enough market confidence for its deficit reduction
plans to bring down borrowing costs it will need assistance
The help could come from either the ECB through its currently dormant Securities Market
Program (SMP) or through the introduction of new LTROs
Neither of these measures are likely to provide a long term solution and thus a formal
bailout arrangement would be the next logical step to calm markets
There are several reasons to why a bailout for Spain is likely to be less extensive
than the ones in Greece, Ireland and Portugal
1) The current bailout funds EFSF/ESM/IMF are not large enough to fully fund Spain for
several years and also (if necessary) take care of Italy. Thus offering Spain a full bailout
may destabilize the situation rather than calm things down
2) If Spain is fully funded by official creditors (EU/IMF) that view themselves as prioritized
over private creditors the risk of a future default on privately held bonds increases as the
EU/IMF take on a growing share of the total Spanish government debt
3) A full bailout would mean that Spain would drop out as a guarantor for outstanding
EFSF bonds thus increasing the burden of the other EU countries
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6. Spain public finances outlook
General government gross debts
% of GDP (OECD estimates)
211%
The budget deficit for 2011 came in at 8.4%
of GDP (vs a target of 6%)
The Government plans to cut the budget 165%
deficit to 5.3% of GDP 2012 (vs. original
target of 4.4% of GDP) 127%
113%112%
Despite further austerity measures recently 98% 98%
90%
announced to save another €27bn (2.5% of 84%
74%
GDP) the risk is still for a larger deficit 2012 61%
56% 56%
The goal is still to cut the budget deficit to 46%
3% of GDP in 2013 a task which would
require additional austerity measures or a
rapid improvement in economic growth
a rk
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Spa in
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While deficits are not likely to fall as quickly
ay
J apa
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as predicted the debt level is nevertheless
unlikely to spiral out of control
Note: the deficits of Spain's autonomous regions and its
municipalities are included in the general government debt
Consensus (March) expects a budget deficit numbers
of 5.7% in 2012 and 3.9 % in 2013
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7. Spain still has a lower public debt than Germany
(Each data point represents one year. 2011-13 are ECFIN forecasts)
Eurozone public finances outlook (ECFIN)
0 Germany
0
2009
-3%
good 2012 fc
Government budget balance (% of GDP)
-5 -5
Italy
Belgium
2009
France 2009
2009
-10 Spain -10
2009 Portugal
2009
Ireland
-15 2009 -15
Greece
2009
-20 -20
-25 -25
-30 -30
bad
-35 -35
40 50 60% 70
60 80 90 100 110 120 130 140 150 160 170 180 190
Government debt (% of GDP)
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8. €140bn of government debt matures in 2012
Spain faces large bond redemptions in April,
July and October
Total redemptions and coupon payments
amount to €140bn in 2012 (12% of GDP)
On the positive side
1) the average maturity of the central
government debt is still relatively long –
currently 6.40 years (down from 6.54 years
one year ago)
2) Spain has front loaded its financing for
2012 so far having secured almost half of its
full year medium to long term financing A M J J A S O N D
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9. Risk 1 – Spanish banks
The Spanish banking system is relatively large
compared to other countries. Assets of about
340% of GDP vs an average of 200%
On the positive side Spain’s biggest banks are
among the best capitalized and well diversified
in Europe
The banking sectors problems are concentrated
to the remaining 17 regional savings banks (the
Cajas)
While the overall situation for the Spanish
banking system remains problematic it is still
unlikely that the government will face an Irish
style scenario with massive bank bail outs
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10. Higher unemployment + falling house prices rising NPL
The total stock of non performing Spain
loans has risen sharply to €140bn in
110 8
January 2012 equivalent to 8% of total
loans 100 7
Continued house price declines and 90 6
unemployment increases will fuel a
further rise in non performing loans 80 5
(NPL) 70 4
60 3
50 2
40 1
30 0
02 04 06 08 10 12
NPL as % of total lending
Real Estate Market Index
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11. Restructuring the banking sector
Government has gone from good to better
The government has taken several steps to solve the problems in the banking sector
2009: Creation of the Fund for Orderly Bank Restructuring (FROB). Its initial capital of €9bn can be leveraged up to
10 times creating a total fire power of €99bn
2010: Initiated reforms for the savings banks (Cajas) reducing their numbers through shotgun marriages from 45 to
currently 17
2011: Increased core capital ratio requirements to 10%
2012: Forcing banks to make additional provisions of €50bn for NPL of the banks total €323bn exposure to the real
estate sector.
As growth continues to deteriorate and house prices falls the credit losses of banks will rise. The aim
of the restructuring is to limit the burden for tax payers as much as possible. Banks will have to deal
with credit losses through
- Provisions and future profits to help plug the holes
- FROB (so far €15bn has been committed)
- Private sector involvement (PSI): private investors taking losses on bank debt
1) The general impression is that so far the government (current & previous) has done a
good job in handling the banking crisis
2) Spain’s ability to consolidate and restructure its banking sector will ultimately decide if
the Spanish government will remain solvent or not
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12. Spanish banks financing
A large deposit base make Spanish banks less dependent on issuing bank debt. Financing
through ECB via the Target 2 euro system has risen sharply
Spanish banks liabilities Target 2
funding
4500 4500
4000 4000
3500 3500
3000 3000
2500 2500
2000 2000
1500 1500
1000 1000
500 500
0 0
00 01 02 03 04 05 06 07 08 09 10 11
Eurosystem borrowing Equity & reserves Deposits
Other Debt securities
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13. Risk 2 – Excessive regional spending
Spain has 17 autonomous regions (state General government debt
governments) which together account 800 800
for about 11% of the total public sector
debt 700 700
In addition local authorities have debt of 600 600
about 3% of GDP
EUR (billions)
The central government has had a 500 500
billions
difficult time restricting spending at the 400 400
state level
The government has recently introduced 300 300
new legislation aimed at excerpt better
200 200
control over regional spending. We still
need to wait to see how effective this will 100 100
be
For markets confidence in Spain it is 0 0
00 02 04 06 08 10
vital that the central government is
able to regain control of regional Central government
spending/deficits State government
Local government
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14. Risk 3 – Deteriorating growth outlook
Consensus sees -1.4% GDP growth in 2012 and 0.1% in 2013. Further downward
revisions likely in coming months
Consensus GDP forecasts for 2012
each point represents the month the forecast for 2012 was made
2.0
1.0 0.6
Germany
0.0 0.2
France
-1.0 Spain
-1.4 Italy
-2.0 -1.6
Portugal
-3.0 Greece
-3.7
-4.0
-5.0
-5.6
-6.0
Jul Aug Sep Oct Nov Dec Jan Feb Mar
2011 2012
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15. The Spanish economy in brief
Surging unemployment and plummeting consumer confidence
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16. Spanish export sector may be a way out of crisis
Spanish exports relatively geographically
Spain Exports 2010 diversified with limited dependence on GIPS
9.1% 0.9%
Spanish export sector is slightly larger than
France/Italy
47.4% Export, goods and services, % of GDP
50 50
45 Greece Portugal 45
France Germany
42.5% 40 Italy Sweden 40
Spain
35 35
30 30
25 25
Total ex EMU Portugal 20 20
EMU ex Greece/Portugal Greece 15 15
Source: IMF
10 10
5 5
0 0
Source: OECD
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17. Spain has a very large net debt to foreigners
International net investment position. % of GDP. SEB estimates
80
60
75
40
55
20 43 37 75
10
4 12
0 -10
-13 -13 -17
-24
-20
-59
-40 Sweden: 50% in early 1990s
-60
-100
-80
-100
-100 -107 -100
-120
Ita ly
G IIP S
US
N o rw a y
E U -1 7
C h in a
UK
Po rtu g a l
S p a in
Japan
F in la n d
G e rm a n y
F ra n c e
D e n m a rk
Ire la n d
Sw ed en
G re e c e
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