A Morass of Co-Dependencies
Europe and the world breathed a collective sigh of relief once the votes tallied showed the pro-Euro, pro-bailout and pro-austerity New Democracy Party claiming first place in the Greek Parliamentary elections. Relief, though, should not be confused with euphoria. The core problems plaguing Europe and the Euro remain.
So, while the Greeks may have bought more time and just might secure some short-term concessions, the pressure on Spain — seen as the next domino in line — is unlikely to abate. This is reflected in the relationship between Spanish central government note yields and the share prices for Spanish banks. Over the past year, rising yields translate into falling bank share prices.
Since banks constitute the largest sector of the Spanish stock market — approximately 32 percent of the Índice Bursatil Espaňol or IBEX — how bank shares fare, largely determines the direction of the broader market. Spain's two largest banks — Banco Santander and Banco Bilboa Vizcaya Argentaria (BBVA) — together account for approximately one-quarter of the combined capitalization.
Over the past year, their share prices have fallen over 40 percent. Both Santander and BBVA are global financial institutions, deriving the majority of their revenues and profits from outside of Spain. For BBVA only 16% of its profits are attributable to Spain. For Santander the corresponding ratio is just 12 percent. While both have exposure to distressed Spanish residential mortgages, both are comparatively well capitalized and appear to be able to access additional capital should it be needed. An assessment echoed by a recent International Monetary Fund study. But, both are seen by investors as Spanish banks plagued by the same problems as the caja de ahorros (or savings banks).
The perception of these problems deteriorated significantly with the request by Bankia on May 25th for €19 Billion in emergency funding. Bankia is a conglomerate formed from by the merger of seven caja in December 2010. The idea was to create a stronger, larger, national entity from seven weaker, regional institutions. Bigger though has not proven to be better.
For Santander and BBVA is this the rub. Both banks are too big to fail; but both banks are too big to be rescued — should the necessity arise — by either the Banco de Espaňa (the Spanish central bank) or the Spanish government itself. Although there is no reason to suspect either is in any imminent danger, the financial markets are worried the pan-European institutional arrangements necessary are non-existent or at best rudimentary. Hence, the divergent reactions in the debt and equity markets following the request of a €100 Billion
(approximately $125 Billion) facility by the Spanish government through the European Central Bank (ECB).
One solution proposed to restore public confidence in Spain's banks is to create a pan-European deposit insurance program. Our view is such schemes will probably not make a difference. The fear (on the part of depositors) is not insolvency; rather the apprehension of waking up one morning to find out overnight their Euros in the bank have been redenominated, and are now drachma, punts and pesetas. Although there is no roadmap for a participating country to exit the monetary union, this is not an insurmountable barrier. No matter how protracted or convoluted, the option of leaving the European Monetary Union remains an option.
Investors have conflated Spain's problems — rightly or wrongly — with those of the Euro's. Furthermore, they have linked the fiscal problems of its governments with the credit issues of a segment of its banks. Until investors can tear apart their individual contributions, Spanish share and yield movements will be linked by a morass of co-dependencies.
The FTSE Spanish Bank Equity Index is a market capitalization weighted index of the free float adjusted market values of commercial and savings bank stocks domiciled in Spain. Index results include the re-investment of dividends paid by the constituent companies.
The Índice Bursatil Espaňol or IBEX is a market capitalization weighted index of the thirty-five largest companies traded on the Bolsa de Madrid.
Ten year Spanish government debt yields reflect yields-to-maturity based on secondary market prices. A decline in price equates to an increase in yield, and vice versa, all other factors being equal.
(Sources: FTSE; Lipper; Banco de Espaňa; Bolsa de Madrid .)
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American Independence Financial Services, LLC ("AIFS") is the investment adviser and administrator for the American Independence Funds and the NestEgg Target Date Funds. The firm is a limited liability company founded in 2004.
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