Budget Deficit Widens
One shouldn't be particularly surprised by this, but Spain announced yesterday that it won't be able to meet even its already twice revised budget deficit target this year. In fact, the gap between the target and the newest estimate yawns pretty wide.
"The Spanish government Saturday said the effort to clean up an ailing banking system will have a big impact on its finances, widening its budget gap and increasing its debt load. Budget Minister Cristobal Montoro said the government forecasts its budget deficit will stand at 7.4% of gross domestic product this year. Excluding the impact of measures to help banks to digest a massive pile of toxic real-estate assets, he said Spain will comply with the deficit target of 6.3% of GDP for 2012 it has committed to with the European Union.“
No-one could see that one coming of course. Also, the deficit target originally committed to with the EU was definitely not 6.3%. Originally – this is to say in late 2011 – Spain increased the deficit target for 2012 from a planned 4.4% to 5.3%. That was the "original commitment". This was then raised to 6.3%. So now it is being raised again, to 7.4%. Unfortunately, the 7.4% figure is just as credible as the revisions that preceded it. At mid year 2012, the deficit already amounted to 8.56% of GDP annualized. Nothing that has happened since then would indicate to us that things have improved – on the contrary, several regions have applied for bailouts and unexpected additional capital injections into banks have been undertaken as well (primarily into insolvent Bankia).
As to the reliability of Spain's budget deficit forecasts, note that even the deficits of the past keep getting revised higher:
"Mr. Montoro said at a news conference in Parliament to present next year's budget plan that Spain's government aid to its ailing banking system also widened last year's budget deficit to 9.44% of GDP, up from the previously reported 8.96% of GDP.
The government's debt load will also jump this year and next, Mr. Montoro added. Spain's debt-to-GDP ratio will rise to 85.3% in GDP in 2012 and to 90.5% in 2013. Earlier this year, the government forecast a debt-to-GDP ratio of around 80% for this year. In its 2013 budget plan, the government said the sharp debt increase takes into account the up-to-€100 billion EU bailout for the country's banks, Spain's contribution to bailouts for other euro-zone countries and the financing of subsidized electricity tariffs.“
It is of course lough-out-loud funny that Spain has to include "its contributions to the bailouts for other eurozone countries" when estimating the size of its public debt next year. This illustrates nicely how utterly absurd all these bootstrapping exercises have become.
The markets showed themselves largely unperturbed by these new revelations, probably because it is reckoned that they bring the Spanish bailout application closer, and with it, unlimited bond buying by the ECB.
5 year CDS on Spain, Portugal, Italy and Greece: not much change after Spain revealed it is going to miss yet another deficit target.
Spain's 10 year government bond yield, weekly. There has been very little movement lately.
The Bank "Stress Test"
The above linked WSJ article also references the recently released Oliver Wyman 'stress test" of the Spanish banking system, which revealed a "lower capital shortfall than had been feared"
"Spanish authorities estimate the country might need around €40 billion of the EU credit line, after an independent audit of the banking system released on Friday showed a capital shortfall of €53.75 billion. But as the country's borrowing costs remain at unsustainable levels, the Spanish government might soon be forced to ask for another bailout to help meet its own financing needs.“
As a friend based in Spain remarked to us, the 'stress test" is full of erroneous assumptions – in fact, the entire methodology of the test is flawed. This is a point we have frequently made as well when the EBA's (European Banking Authority) ridiculous stress test exercises on systemically important euro area banks were performed. The potential losses are moving targets. It is not possible to ascertain in advance to what extent assets will be impaired unless one actually engages in real market transactions involving these assets. Only once market prices for them have been established does one have a basis that can be used to work out what the eventual capital requirements may amount to. And even then one must still take into account that the situation remains highly fluid and dynamic.
Spain's banking system is like Ireland's on steroids: it is dead certain that the stress test result will be revealed as wide of the mark once transactions occur more frequently (currently the Spanish real estate market and the associated financial instruments are in suspended animation). Here is a list of the most glaring significant errors according to our friend, including additional comments by us:
Sovereign risk was completely ignored – according to the Oliver Wyman report, it simply doesn't exist. That clashes with established market facts, as Spanish regional debt is trading at yields around 15% (note that the regions enjoy a great deal of fiscal autonomy in Spain; if one wants to assess the true extent of sovereign risk in Spain, one cannot simply gloss over the regions).
House price declines: the "adverse scenario" of the OW report assumes a 37% peak-to-trough decline. This is not "adverse" enough. The official price decline already amounts to 25%, and we would note to this that the official numbers are thoroughly massaged in an effort to flatter bank balance sheets. Since the market is in a coma, many of the transactions that are in fact recorded are of the sort the banks undertake among themselves in order to mask the deterioration of RMBS portfolios held in various conduits (we have discussed these tricks in some detail before). It is worth repeating the following little item from an analysis of 8,000 properties that were repossessed in Spanish RMBS that had been rated by Fitch. This analysis was undertaken by Fitch in March/April this year:
"For example, properties managed and serviced by Catalunya Banc/CX have the lowest recorded depreciation rates (20%) of all transactions in this analysis; however, this level is maintained artificially low due to a large volume of sales to intra-group companies at above-market prices. Elsewhere, properties managed and serviced by EdT/BBVA have higher depreciation rates (58%), driven by a commercial strategy that results in one of the shortest time-for-sale ratios (11 months) when compared to other transactions.“
Obviously "depreciation rates of 58%" are a far cry from Oliver Wyman's "adverse case", not to mention the official house price index. Banks have been shuffling assets around between their own subsidiaries in order to create artificial transaction prices that have helped to hold the index aloft.
As our friend remarked, the actual size of the eventual price declines seems highly relevant given that „this variable references at least 60% of the entire credit portfolio of the Spanish financial system, i.e., real estate developers and retail mortgages are already € 830 billion out of the € 1,4 billion total.“
Lastly, he noted that the report's assumed profit generation by banks for the years 2012-2014 is in line with what was seen in 2008-2011, notwithstanding the fact that the banks cooked the books in those years, something the report doesn't deny. The assumption of deposit flight of 3% per year (compounded) also seems hardly "adverse" enough given the fact that faith in the banking system is thoroughly shaken (not to mention the fact that recent observations indicate an acceleration in deposit flight).
Another point our friend made is that unfinished buildings are no longer assets, but must be regarded as liabilities: it will cost money to demolish them and it obviously also costs money to leave them standing.
So where will the Spanish banking system wind up in terms of the capital ultimately required? No-one can say for sure of course, but in all likelihood it will turn out to be a multiple of the $53.75 billion estimate by Oliver Wyman once all is said and done.
It is no wonder that Germany and several other euro area member nations are extremely reluctant to rush into a "European banking union".
Next Year's Financing Requirements
On occasion of the disseminating the news about the latest "target miss", budget minister Cristobal Montoro also revealed how much money Spain will need to borrow in the coming fiscal year. In addition, the maturity profile of Spain's government debt becomes ever shorter (making more frequent debt rollovers necessary).
“Spain plans to borrow 207.2 billion euros ($266.5 billion) next year, the Budget Ministry said today, as pressure builds for Prime Minister Mariano Rajoy to tap the European rescue fund instead of financial markets.
The 207.2 billion euro gross debt issuance forecast for 2013 compares with a forecast of 192 billion euros for 2012 made at this time last year. Spain has sold 145.4 billion euros of debt so far this year.
Spain intends to cover 41 percent of its new financing needs by selling treasury bills and 51 percent from bonds, increasing the share of short-dated notes in circulation to 15.7 percent, the ministry said in its so-called yellow book, which provides details of the budget.
The average maturity of Spanish borrowing will fall to about 5.8 years from 6.3 at the end of 2012”
And how do we know that all these budget forecasts are not worth the paper they were written on? It is the same reason for which we know this to be the case for France's budget (as discussed yesterday). The government bases its budgeting on economic growth estimates that are pure fantasy at this stage:
“The Achilles’ heel of this budget is the economic outlook,” said Jose Ramon Pin, a professor of public administration at IESE business school in Madrid. “If it proves accurate, the numbers will stack up.”
Economists forecast that growth will contract 1.3 percent, almost three times the government’s forecast, according to the median of 21 responses in a Bloomberg survey.”
To be sure, we don't necessarily think that the median of the forecasts of 21 mainstream economists is likely to be any more reliable. However, if anything, they probably underestimate rather than overestimate the extent of the economic contraction. Moreover, Montoro presented a rather optimistic forecast of the likely interest bill faced by the government next year (much will of course depend on whether or not the bailout application comes, and when):
“Rajoy may decide the conditions the EU will set on a bailout are an acceptable price to lower an interest bill on public debt that Montoro forecasts will jump 34 percent to 38.6 billion euros without intervention. That forecast assumes Spanish 10-year bond yields average 5 percent next year compared with an average of 5.966 so far in 2012.”
Mind, this is the forecast without ECB intervention taken into account.
Lastly, there haven't been any major moves in the credit market indicators we are watching, so we haven't bothered to post an update (as you can see on the "PIGS" CDS chart above, not a lot has happened since last week's update; the other charts look roughly similar).
However, our proprietary CDS index on European banks has seen a fairly decent bounce-back, as can be seen below:
Our proprietary unweighted index of 5 year CDS on the senior debt of eight major European banks – the white line (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito), compared to 5 year CDS on the senior debt of Goldman Sachs (orange), Morgan Stanley (red), Citigroup (green) and Credit Suisse (yellow) – bouncing back.
Charts by: Bloomberg