Spain: Deal in the Making?

Spain is on the bubble. The 10-year yield is pushing through 7% and 2-year yield is flirting with 5%. As we noted earlier, the entire curve and CDS pricing is above Ireland's. The Spanish crisis is really a combination of three different debt issues: sovereign, banks and regions.

The Eurogroup of finance ministers meet today and although there will be much talk, no formal decision in expected on Spain. However, this will not prevent some sketching out of the eventual plan that could be ready later this month. The take away is that the model that Europe developed to address the Greek crisis, and then applied to Ireland and Portugal, is being jettisoned in Spain's case, which could be the new model.

The EU is reportedly preparing to propose that Spain's fiscal goals be relaxed. The new one may be a 6.3% deficit this year, followed by 4.5% next year and 2.8% in 2014. In exchange for this forbearance, Spain would be expected to 1) provide a multi-year budget, including structural reforms by the end of July; 2) establish an independent budget office to oversee and monitor fiscal policy; 3) agree to quarterly review of its progress.

The Eurogroup meeting may also sketch out the terms of the assistance. A long-term loan period is being discussed and some reports suggest that a term of 15 years is being considered. An interest rate on that aid of 3-4% looks likely, but this arguably is tantamount to a transfer/subsidy when Italy is paying 6.15% for 15-year money. 

The third leg of Spain's debt problem is the regions. The regional debt problem has been overshadowed by bank and sovereign issues, but today a Spanish paper reports that Valencia is warning that without additional help from the government it is headed for default. The head of the region claimed it needs the funds by the end of the month. The Rajoy government has already given Valencia 135 mln euros to honor its debt commitments for this month. Reports suggest it has another 115 mln euro maturity at the end of August and for all practical purposes is locked out of the capital markets.

The Rajoy government had hoped to unveil a new financing mechanism for the regions at the end of last month. Instead, it appeared to simply extend the credit line that had already been established to help pay off the region's debt. It had been set to mature June 30. The government also moved away from the initial plan to create a financing instrument for the regions that would carry the government's guarantee. These were the so-called "Hispanobonos".