Reuters: Bankruptcy News: COMMENT: Grexit steals spotlight from Spain

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COMMENT: Grexit steals spotlight from Spain May 17th 2012, 16:55 By Divyang Shah Thu May 17, 2012 12:55pm EDT LONDON, May 17 (IFR) - Developments in Spain continue to worry us at a time when financial markets are preoccupied by a possible Grexit. We continue to favour an adjustment of the Spanish curve led by the front-end, and see 2/10-year Spain not only flattening but having the potential to invert. We have favoured the underperformance of the front-end of the Spanish curve for sometime (see "Focusing on 2yr Spain"; April 5). Our suggestion was to look at a 2-year Spain/Germany widener and a 2/10-year Spanish curve flattening trade. While we hit our target of 400bps on the 2-year Spain/Germany spread, the progress on the 2/10-year curve trade has been slow. The news flow of late has done little to dissuade us from the potential that 2/10-year Spanish curve will flatten and while our initial target was 150bps we now feel that the curve may now even have the potential to invert. While the Spanish sovereign has managed to complete 55% of its funding for this year we should keep in mind 1) we are simply seeing a transfer of Spanish paper from non-residents to Spanish banks, and 2) despite this domestic buying, yields on 10-year BONOs have underperformed other benchmarks both in the core and periphery this year. While the sovereign might look to be better placed from a funding perspective, we must keep in mind that at the end of the day we are dealing with a financial crisis as well as a sovereign crisis. The nationalisation of Bankia has simply added to the air of uncertainty over the financial system, made worse by concerns over an inability to release audited accounts and reports of sharp deposit withdrawals. Bankia could prove to be one of those early steps towards an eventual overhaul of the financial sector using funds from the EFSF/ESM. Failure to do so would lead to concerns that the sovereign was ready to taint its own balance sheet by taking on board the financial sector risk, and in effect walk down the same road as Ireland. The chance of a Grexit has only intensified the focus on deposit flight out of Spain and Italy, and reports that Bankia lost EUR1bn in the week after nationalisation do nothing to help sentiment. The deposit flight theme is not new to banks in Greece, or even to those in Italy and Spain who both last year saw significant outflows that ultimately led the ECB to provide a lifeline in the form of 3-year LTROs. Many questions remain unanswered and if Greece chooses to stay in the euro at the election on June 17 this will only intensify the market's focus on Spain. We continue to see the front-end of the curve adjusting and would stick with a 2/10-year flattener with a view to an eventual inversion. Link this Share this Digg this Email Reprints

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