Spanish banks risk new financing threat: analysts

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Spain's banks may have to run to the European Central Bank for financing if the risk premium on government debt reaches a critical level of 450 basis points, analysts warn.

The risk premium on Spanish bonds -- the extra return demanded by investors compared to safe-bet German debt -- surged to a euro-era record of 407 basis points on Wednesday.

Although the surge increases the cost of borrowing for Spain's government, it also poses a new threat to banks weighed down with bad loans from the 2008 property bubble collapse.

Many of the banks raise short-term financing on London's LCH Clearnet -- a major debt clearing house -- by providing Spanish government bonds as collateral.

If the risk premium on those bonds rises to 450 basis points compared to a basket of AAA-rated government bonds, the clearing house can demand an extra 15 percent downpayment to let the trade go ahead.

"We would generally consider a spread of 450 basis points over the 10-year AAA benchmark to be indicative of additional sovereign risk," the LCH Clearnet policy says.

At this point, it says, the clearing house could ask for an extra 15 percent margin, and more if the risk premium deteriorates further.

LCH Clearnet, which needs the margins because it has to pay the other side of the deal in case of a default, had already demanded additional 15 percent margins from banks using Irish and Portuguese bonds when their risk premiums hit 450 basis points. Soon after, both Ireland and Portugal had to be bailed out.

"What does that mean? It means that they have to post more collateral. Since they are already very, very, very stretched it becomes too much," said Barcelona-based independent economist Edward Hugh.

Since 2007 Spanish banks had been unable to obtain substantial, economically viable financing on the wholesale debt markets, he said. As a result, they had accumulated a large quantity of short-term borrowing.

If LCH Clearnet demands higher margins the banks are likely to go running to the European Central Bank for short-term financing, Hugh said, warning that if the ECB could not cope it may even have to call in the European Financial Stability Facility, used in the Greek, Irish and Portuguese bailouts.

"Spain is getting closer to the trigger level of an additional LCH haircut," said a report by Bank of America Merrill Lynch European economist Laurence Boone and rates strategist Sphia Salim.

"Spanish banks will have to turn to the ECB to cover the funding gap and the prospects of similar deterioration in funding availability for Italian banks would severely impede the functioning of the Eurozone interbank market," they warned.

Nuria Alvarez Anibarro, financial analyst at online brokerage Renta 4, said the scenario of a European rescue because of an extra margin call by the LCH was somewhat extreme.

Spanish banks had a large book of assets that could be used as collateral to raise liquidity from the European Central Bank, she said.

If the banks were asked to provide an extra 15-percent margin on the London markets, they would have to weigh up whether it made more sense to go the ECB for financing.

Major banks BBVA and Santander had huge margins of collateral, Alvarez said.

A key question in such a scenario would be whether the risk premium remained above 450 basis points for a brief period of a month or so, or for a longer period of year or more.

"It also depends a lot on the banks' debt repayment schedule. Almost all Spanish banks have their repayments covered for 2011. They don't need to go to the markets as such," Alvarez said.

If record risk premiums of 450 basis points or more carried on into 2012 and banks were shut out of the markets for many months with repayment deadlines looming, the situation would be more serious, she said.

But "it is a bit soon to make that guess when we have only just reached 400 points."

© 2011 AFP

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