Monday, August 1, 2011

Spanish 10-year yield spread is just 100 bps of margin requirements

The IMF warned on Friday – the day that Prime Minister Zapatero called early elections – that Spain “is not out of the danger zone”. As a result of the recent widening, the Spanish 10-year yield spread is just 100 bps shy of the level that could trigger margin requirements at central clearing houses.

Spain will hold early elections on November 20th, Prime Minister Zapatero announced last Friday. The elections had been due to take place in March next year. Mr Zapatero said he wanted to create “political and economic certainty” for the next few months. However, the market will probably interpret the early election as an additional element of near-term uncertainty and draw a parallel to the earlier change of government in the 3 bailout countries (Greece, Ireland and Portugal). On a more positive note, Zapatero also announced that Spain will make “extra efforts” to meet its budget deficit targets, which seems to make sense given the downside risks to fiscal consolidation posed by the weak growth environment and the likely fiscal slippages at the regional government level. The latest data from the Ministry of Finance (released earlier last week) suggest that the central government is broadly ‘on track’ to meet its budget deficit target of 2.3% of GDP in 2011.

The decision to bring forward the election date came on the same day that Spain’s credit rating (Aa2) was put on review for a possible downgrade by Moody’s. The debt ratings of 5 Spanish banks (Santander, Caixabank, BBVA, La Caixa and CECA) were also placed on review by Moody’s. The IMF poured further oil on the fire, by warning that Spain “is not out of the danger zone”. The Spanish 10-year yield spread over Bunds ended last week at a little over 350 bps. That is just 100 bps shy of the level that could potentially trigger margin requirements at central clearing houses. Indeed, clearing house LCH Clearnet has stated that it “would generally consider a spread of 450 bps over the 10-year AAA benchmark to be indicative of additional sovereign risk and LCH may materially increase the margin required for positions in that issuer”. Spanish banks have significantly increased their repo financing through central clearinghouses such as LCH Clearnet over the past 12 months, and currently borrow around €100bn (or 3.0% of banking sector assets) in foreign repos. The above suggests that the recent widening of Spanish government bond spreads, were it to continue, could create fresh problems for the Spanish banking system.

Published: 26 July, 2011
written by: Bill Hubard , Chief Economist at Markets.com