Four questions and a subordination | FT Alphaville

Four questions and a subordination

1) How do holders of Spanish bonds react to ESM subordination?

The cat’s out of the bag now, isn’t it. On the one hand Spain borrows up to €100bn for the bank recapitalisation which everyone knew was coming, but at a lower rate than everyone had priced into Spanish bond yields. Bond yield relief, maybe.

On the other hand, up to €100bn of senior debt borrowed at a lower rate from the ESM is still senior debt. What price bondholder recoveries now, if Spain eventually defaults? Of course you could argue that the bondholders already had to contend with ECB holdings of Spanish debt, and that they should also really know by now about the dangers of recovery on an overwhelmingly local-law bond stock.

But in the months we’ve been covering this, the funny thing about the ESM’s preferred creditor status was always that the ESM Treaty makes the seniority de jure. Unlike de facto IMF loan seniority, this stuff’s been written down.

When it’s been made that obvious, and Spain will presumably sign up to loans which include seniority in their terms, what do bondholders do?

2) Does Spain continue to guarantee future EFSF debt?

This is an oddity which we noted over the weekend: Spain is backstopping its own rescue.

We’re not surprised if Spain can’t step out of capitalising the ESM. But re-reading the EFSF Framework Agreement, it also seems that Spain can’t step out of further EFSF guarantees either, so long as its EFSF loan is aimed at bank recaps.

If the EFSF plays a fill-in role in the Spanish bank bailout until the ESM comes online, shouldn’t the situation with Spain’s guarantees be officially clarified?

3) Which recapitalisation tools are used for Spanish banks?

Essentially, how much of this Frob model will change? (Slide from this presentation)

4) What about the economy?

Or, assuming the bank recap loans eventually add just under 10 percentage points to Spain’s debt to GDP ratio, what if the denominator deteriorates further. (“Assuming the full €100bn is used, Spanish general government debt would hit 90% of GDP in 2013 compared to our pre-package forecast of 80.5%,” Societe Generale’s analysts said on Monday.)

For example… you could argue that Spanish banks will/should use the recap to fund the contraction of loan books, replacing the lender forebearance we’ve already seen. The potential impact on lending, money supply, and growth, is something you’d hope the EU and IMF will be thinking about in advising Spain.