It is not Just Spanish Banks...

Currency in Crisis

There has been great concern about the state of Spain's banks. The Rajoy government has been slow in recognizing the needs of the sector. As recently as Feb, Rajoy was maintaining that no extra funds are needed. Now it continues to resist pressure for it to seek funds from the EFSF. Instead the Rajoy government is seeking to avoid the stigma and conditionality such borrowing entails.

It wants the ECB to buy more of its bonds. It wants the banks to be able to borrow directly from the ESM, which does not exist yet and even when it does, it is mandated to lend to sovereigns not banks. The pressure to change the ESM may make it more difficult for Merkel to secure a majority of her party to support it, forcing her to rely on the opposition. Even assuming that the treaty can be modified, it hardly can take place soon enough for Spain.

Spain of course is not the only one having a banking problem. This week Portugal has injected 6.65 bln euros into three of its largest banks. The 78 bln euro aid package provides most of the funds for this, though a state-owned bank is also getting a capital infusion but that is not covered by the aid. The recapitalization part of the aid has about 7 bln euros left.

With the next tranche of aid (~4.1 bln euros) approved to be paid in the coming weeks, Portugal will have received about 75% of the 78 bln euro aid package. The Troika recently revised their forecast for Portuguese GDP this year from -3.3% to -3%, but there is little sign that the Portugal will be able to go back to the markets next year. The 2-year yield is just below 11%. The 10-year yield is well below the 18.3% neared in late January, but at nearly 12% effectively signals that Portugal, which the Troika says in doing the rights things, continues to be locked out of the capital markets.

Yet before more aid for Portugal will be agreed, it is likely that Cyprus seeks its first assistance. Cyprus, like Spain, wants to argue that the support it needs is only for the banks not because its fiscal situation. Yet, Ireland could have made the same claim. It is not that what Cyprus says is not true, but more so what? Its banks assets are roughly 9 times larger than GDP (~157 bln euros).

Russia has helped support Cyprus since the crisis in Athens first erupted. It made a bilateral loan of about 2.5 bln euros late last year. With the collapse in energy prices, Russia appears to be feeling less generous. The Greek PSI hit a fragile Cyprus banking system and several banks look as if they are not going to meet the June 30th capital requirements
.

Ten year sovereign yields are hovering around 14% and 2 of 3 main rating agencies regard it as below investment grade. The EC has pressed Cyprus to rein in spending. The economy is projected to contract by almost 1% this year.

Given the rules of the engagement in Europe, if one is receiving assistance, one is not responsible to provide assistance to others. This gives a first mover advantage. If Spain goes before Cyprus, Cyprus perversely would have to assist it.