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Spain’s banks may struggle to refinance about 85 billion euros ($111 billion) in debt next year

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Spain’s banks may struggle to refinance about 85 billion euros ($111 billion) in debt next year as costs surge on concern continental Europe’s fourth- biggest economy may need an Irish-style bailout. “There’s a universal dumping of Spain going on,” said Andrea Williams, who helps manage about 623 million pounds ($968 million), including shares in Banco Santander SA, at Royal London Asset Management. “The fear is that Portugal, Spain and Italy are now in line after what happened in Ireland.”

Anxiety over Spain’s ability to bring down the euro- region’s third-highest budget deficit after Europe handed Ireland an 85 billion-euro aid package has driven up financing costs for the country’s lenders already battered by rising bad loans and falling revenue. The average yield investors demand to hold euro-denominated Spanish bank bonds, relative to government debt, rose 117 basis points to 361 basis points in November -- the biggest monthly jump on record, according to data compiled by Bank of America Corp. As the cost of insuring the country’s debt against default rose to its highest level, Spanish lenders now pay the biggest premium ever on their debt relative to other banks in Europe. Spreads on Spanish bank bonds in euros rose to a record 147 basis points more than the average for all lender debt denominated in the currency, up from a gap of 63 basis points on Oct. 31, according to Bank of America data.

‘Big Elephant’

The risk for Europe is that Spain’s economy is twice as big as that of Greece, Ireland and Portugal combined, meaning the euro region’s 750 billion-euro bailout fund may not be big enough if the country resorts to aid. Spain’s 10-year government bonds slid yesterday by the most since the euro’s debut. The extra yield investors demand to hold the securities instead of benchmark German bunds widened to euro-era records. “The big elephant in the room is not Portugal but, of course, it’s Spain,” Nouriel Roubini, the New York University professor who predicted the global financial crisis, said at a conference in Prague yesterday. “There is not enough official money to bail out Spain if trouble occurs.” Spanish financial companies sold 300 million euros of bonds in Europe this month, excluding debt with government guarantees, compared with 2.37 billion euros in the same period a year earlier, according to data compiled by Bloomberg. Spain says the government’s finances and the country’s banks are sound. The lenders are “fundamentally healthy,” Jose Luis Malo de Molina, chief economist of the Bank of Spain, said in a news conference in Madrid yesterday. “The Spanish financial system does not have a problem of deep frailty such as the Irish economy has.”

Debt Maturing

The country’s lenders have about 30 percent of their medium- and long-term debt maturing by December 2012, according to the Bank of Spain’s October financial stability report. The report says the fact that 50 percent of maturities fall after 2013 “softens” the refinancing needs of the lenders, even as it advises them to rely more on debt with longer maturities. “Asking the Spanish banks how they are going to meet these refinancing needs is absolutely a fair question for them,” Claire Kane, a banking analyst at MF Global in London, said in a phone interview. Four months after the Bank of Spain said publication of stress tests of Spanish lenders “confirm the soundness” of the country’s banking system, investors are again driving up their financing costs. Investor concerns are most likely to focus on the needs of Spain’s savings banks, said Daragh Quinn, an analyst at Nomura International in Madrid.

Savings Banks

Savings banks, immersed in a restructuring process that will see their number shrink by almost two-thirds as the central bank coaxes them into cost-saving mergers, have about 30 billion euros of debt coming due next year, according to Bloomberg data. The cost of insuring the five-year senior debt of Caja de Ahorros del Mediterraneo, an Alicante-based savings bank, is about 700 basis points compared with 253 basis points for Santander, Spain’s biggest lender, which earns about 25 percent of profit from its home country as it boosts income from countries such as Brazil and the U.K. “The government and European policy makers must be looking at what they would need to do if the cajas were unable to refinance next year,” said Peter Chatwell, a fixed-income strategist at Credit Agricole CIB. “It’s at that point the situation would start to look like that which Ireland has suffered.” Even in the toughest scenario, it’s unlikely funding would be cut off for the strongest Spanish lenders such as Santander, Banco Bilbao Vizcaya Argentaria SA or La Caixa, Quinn said.

Funding Strategies

Spanish lenders can pick among different strategies for bridging a prolonged period of being shut out from the debt markets, said John Raymond, an analyst at CreditSights Inc. in London. Those include tapping funding from the European Central Bank, stepping up the already stiff competition for retail deposits or scaling back lending, he said. Spanish banks had loans from the ECB of 67.9 billion euros in October, a 30 percent drop from the previous month. Spanish ECB loans as a proportion of banking assets stand at about 2 percent, compared with about 7.8 percent for Ireland. Santander, which has 27 billion euros in debt maturing next year, said it added 94 billion euros in customer deposits this year and also has as much as 100 billion euros in collateral it can use to tap funds from central banks. A spokeswoman from Santander, who asked not to be named in line with company policy, declined to comment. “If Santander were to go to the ECB for 50 billion euros then we really would be in crisis territory,” said Kane. She said that was highly unlikely because Santander can also sell debt through its non-Spanish subsidiaries.

Deposit Yields

The funding squeeze is already hurting banks in Spain as they drive up yields on savings to attract retail deposits, Raymond said. Net interest income at Santander’s Spanish branch network, which has been offering 4 percent deposit yields when three-month euribor stands at 1.03 percent, fell 11 percent in the third quarter from a year earlier. Caja Cantabria, a savings bank in Santander, Spain has 4 billion euros of collateral it can use to tap ECB funding and expects its deposit base to increase by 1 percent this year, Javier Eraso, its general director, said in a phone interview. While its ability to tap ECB funding means it has no pressing financing needs now, the lender, which is in the process of merging with three other savings banks, has 680 million euros in debt, or three quarters of its total, coming due in the next two years. “It’s a real cause for concern because this situation affects the whole of Spain,” Eraso said, referring to the funding squeeze facing the country. “If this goes on for a number of months, it doesn’t just affect banks, but the whole country.”

Bond Data

The costs to insure Portuguese debt against default rose to a record today and Spanish bonds slid the most since the euro’s debut for a second day, highlighting investor concerns that officials lack the tools to contain a debt crisis threatening the currency’s survival. The Italian 10-year bond yield rose 18 basis points to 4.83 percent as of 8:26 a.m. in London. The 3.75 percent security due in March 2021 fell 1.36, or 13.60 euros per 1,000-euro ($1,311) face amount, to 91.79. The spread with 10-year German bonds increased to 205 basis points, a euro era record. The yield on similar-maturity Spanish bonds increased 20 basis points to 5.66 percent. That pushed up the yield spread to German debt to 289 basis points. German 10-year bonds rose, with the yield three basis points lower at 2.72 percent. The Irish 10-year yield was little changed at 9.47 percent.

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