Money markets spain banks buy govt bonds while cheap fund effect lasts

← Homepage

* S&P cuts 11 Spanish banks, threatens 5 more* Italian banks also snap up government bondsBy Kirsten DonovanLONDON, April 30 Spanish banks continued to load up on government bonds in March, ECB data showed on Monday, tying them ever closer to their indebted sovereign and raising questions over who will support the government when cheap central bank funding is exhausted. The value of Spanish banks' holdings of sovereign bonds rose almost 18 billion euros in March to over 260 billion euros. That is up around 85 billion euros in total since the end of November as institutions invested cheap funds from the European Central Bank's two three-year liquidity operations (LTROs). Much of the rise is widely believed to be domestic banks buying their own country's sovereign bonds, with some of the increase accounted for by changes in market value of the paper."What happens when the firepower of the LTROs is exhausted?" said Nikolaos Panigirtzoglou, European head of JPMorgan's global asset allocation team - adding that that moment would likely come around the middle of the year."Who is going to step in? Are banks going to be willing to borrow at the three-month financing operations to support their sovereign or is someone else going to have to do it?"

Spanish government bonds have sold off sharply in April on growing concerns about the country's ability to meet fiscal targets and its leveraged banking sector. So if Spanish banks continued to be net buyers of the paper in April, then it would indicate that selling by international investors was picking up pace."The domestic banks stepped in to bridge the gap which was left by a fairly sizeable exodus of non-residential bondholders, which is why the LTRO magic has worn off so quickly," said Rabobank rate strategist Richard McGuire. Spain sank into recession in the first quarter, data showed on Monday. With concerns about the banking sector mounting, credit rating agency Standard & Poor's downgraded 11 Spanish banks and warned a further 5 that their ratings could also be cut.

The move came after S&P cut Spain two notches to BBB-plus last week. And on Friday a government source said banks, rather than the government, would assume the cost of any unprovisioned losses on real estate assets after they are moved into a special holding company."We're still focusing on early cycle losses such as the real estate loans which come to light quite quickly in a downturn," McGuire said."But there's later cycle losses that we've yet to dive into such as corporate loans as the country returns to recession."

Italian banks' were also keen buyers of government bonds in March, with holdings up around 22 billion euros and up around 75 billion euros since the end of November."Our sense is there is more capacity and willingness in the Italian banking system to support their sovereign than in Spain," JPMorgan's Panigirtzoglou said."The two largest Spanish banks are clearly not that willing to keep buying sovereign debt and also the capacity of the banking sector in Italy is bigger. Spain's largest bank, Santander, said in its first-quarter results that borrowing from the ECB's three-year financing operations had mostly gone back on deposit with the central bank. Panigirtzoglou calculates that Santander and BBVA have bought just a net 5 billion euros of Spanish bonds in the first quarter."Spanish banks' government bond buying has been overwhelmingly tilted towards smaller banks. That seems likely to continue....(with Santander and BBVA) having characterised their LTRO borrowing as liquidity insurance," he said. Despite banks being flush with ECB cash, loans to euro zone households and firms grew more slowly than expected in March, as banks continued to reduce lending to businesses. However, the vast amount of liquidity in the banking sector drove interbank lending rates to 23-month lows on Monday.