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Bank of Spain released its balance sheet data for August:

Lending to credit institutions increased during August as well, by €9.47bn, using both MROs and LTROs. This lending was used to finance outflows since Target2 liabilities increased by €14bn to €428.62bn (more than 40% of GDP). The increase in external liabilities was also financed by a further drop in the deposit facility of €3.72bn, while government deposits grew somewhat to €6.42bn (+€1.1bn). All in all, although the growth rate in T2 liabilities clearly slowed, outflows continued, increasing financing difficulties for Spanish banks. It is no coincidence that BdE activated ELA financing on a limited basis. We ‘ll see if the recent OMT bull market resulted in net inflows in Spain during September.

BdE also released data on government debt based on the excessive deficit procedure. Government debt is now 75.9% of GDP (compared to 69.2% at the end of 2011). The increase is attributed to long-term loans which increased from €114.67bn to €148.78bn (+€34.11bn) in one quarter. These loans were taken mainly by ‘Other units classified as central government’ as is evident in the corresponding table. Debt will most probably register over 80% by the end of the year, while taking into account the €100bn EFSF loan and other debts (such as public enterprises and unpaid bills) it will be close to the 100% mark.

On a related development, home prices fell 3.3% on a quarterly basis and 14.4% from a year earlier.

Update: ftalphaville has a very nice analysis on Spanish deposit flight. Worth a read.

Today, Bank of Spain released its balance sheet data for July which point to continued growth in its lending to domestic credit institutions and target2 liabilities. More specifically:


MROs increased significantly, from €45bn to €69.34bn while LTROs also posted an increase of €12.8bn, from €320bn to €332.85bn. In total, lending to credit institutions is now €402.2bn.


The larger growth came from Target2 liabilities, which grew €42.81bn, to €414.62bn (more than 38.5% of GDP), pointing to a continued capital flight out of Spain with Target2 liabilities still being larger than total bank lending. Banknotes increased somewhat by €1.5bn to €71.6bn, while general government deposits decreased further to just €5.3bn, a figure that has not been registered during 2011-2012. The deposit facility decreased a bit in July as well to €26.64bn (a drop of €1.15bn) while the reserve accounts increased by only €0.5bn. The Spanish banks safety buffer is now only limited to the funds in the deposit facility. Net Other Assets kept their steady decline during 2012, registering at €79.84bn in July.

What is interesting is the fact that while the increase in Target2 liabilities was €42.8bn, new net lending from BdE was €37.2bn with entries such as government deposits and the deposit facility used to also fund the outflows. As stated before, this pattern of €40-50bn outflows per month is not sustainable and coupled with the difficult government financial situation points to some sort of development  in September.

Since Friday, Spanish bond yields are clearly over the 7% threshold making market access and debt sustainability a challenge. I ‘ll take the opportunity to look into more details on the Spanish balance sheet regarding other residents.

The first table includes main liabilities to RoW based on BdE balance of payments data which are only available till 2012Q1 (they will be updated on 31 July):

What is clear is that the main driver of capital flight is a drop in securities investments. Money market instruments also show a large drop, mainly in the general government sector, although the relevant positions were already quite small. In my view this is a clear case of an asset class not being considered ‘safe’ anymore (in the Gary Gorton terminology) with investors moving out of it. Both the Spanish government and economy are now viewed as a higher credit risk instrument, with funding dropping both in the bond (Held to Maturity) and money market areas.

The same is evident if one looks at monthly flows of direct investment (with portfolio investment being the one mainly hurt):

Things are much clearer by looking at more specific data from the BdE (balance sheet data for the BdE and credit institutions), as well as the Spanish Treasury:

The first observation is the significant drop in RoW deposits in credit institutions, deposits which should mainly be considered as part of money market funding. The drop in securities liabilities is much lower than the one observed in the balance of payments data, suggesting that resident banks found new domestic sources of funding (most probably with the help of BdE).

On the government debt front, Treasury data show a large drop in RoW (permanent) holdings, which is covered by an increase in holdings by domestic credit institutions. By subtracting the Net position from the outright holdings, one can calculate the outstanding repo funding from the RoW. Repo funding reached a high in September 2011 but has dropped significantly ever since, especially during 2012. This is another indication of elevated counterparty/collateral risk which leads to a large ‘haircut’ in funding.

Adding up the drop in outright holdings and repo transactions, a large part of the external position (and target2 liabilities increase) deterioration can be explained by foreign investors moving away from the Spanish bond and repo market. The repo/money market drawback is evident in the balance of payments other investment data as well:

Clearly a warning sign is the large decrease in turnover in the outright transactions (bond) and repo markets since February. This was the main pattern observed in the Greek case, with outright trading coming to a halt and price discovery moving to the CDS market with bond yields following CDS spreads (instead of the opposite) since the derivatives market became the most liquid. One thing to keep an eye for is the CDS net notional. If that starts dropping with opposite movement in the gross notional that will mean that market participants are not creating any new net contracts (which ultimately require a short position on the underlying instrument) but only leverage existing contracts by shorting CDS while covering the position with an older long position. This would indicate an unwillingness to take the original credit risk and a difficulty in covering a short position in the bond market. The intermediation trade is probably a nice arbitrage trade since collateral will be provided by the original seller or the new buyer of the contract (depending on how CDS spreads move).

This chart for the Spanish CDS net notional (from ftalphaville) is not good. Current gross/net notional is $171.6/13.7bn while they were $163.2/13.9bn a month ago.

A positive number is the total government deposits available which stand at a little over €90bn. Given the current government debt redemptions schedule and net funding needs, the government does have some leverage in the short-term until probably October (when redemptions are €27.4bn), even if it cancelled all new auctions (except for T-Bills) since most of the redemptions actually concern t-bills (which i think can be covered by domestic credit institutions in any case). With that in mind, i don’t see an immediate reason for a full bailout, at least not until the ESM is allowed to be activated by the German constitutional court in September (since financing through the EFSF for sovereign needs would mean removing the Spanish guarantees). One can probably safely acquire (outright or as collateral in a repo transaction) any debt maturing until October.

On Friday, Bank of Spain released its balance sheet data for June which point to large growth in its lending to domestic credit institutions and target liabilities. More specifically:


MROs increased significantly, from €9.2bn to €45bn while LTROs also posted an increase of a bit less than €5bn, from €315.4bn to €320bn. In total, lending to credit institutions is now €365bn.


The larger growth came from Target2 liabilities, which grew €53.2bn, to €371.8bn (almost 35% of GDP), pointing to a continued capital flight out of Spain. Ever since the second 3Y-LTRO, it’s the first time that Target2 liabilities are more than total bank lending from BdE. Banknotes increased somewhat by €3bn to €70bn, while general government deposits decreased further to only €7.3bn. Coupled with the fact that the deposit facility balance kept falling, with June registering a €27.8bn balance, it is clear that the 3Y-LTRO effect for Spain is now officially over and Spanish banks need to access central bank liquidity (especially short-term through MRO) in order to cover their increased liabilities. Net Other Assets kept their steady decline during 2012, registering at €81.85bn in June.

Actually, if one examines the increased liabilities due to Target2 and banknotes and subtracts new lending from BdE and the drop in the general government accounts, there’s still a bit less than €10bn that was needed to cover outflows, with deposit facility balances being used for that. This could be a sign of banks running out of collateral, especially since the ECB will not accept  government guaranteed bank bonds in its liquidity operations any more. I ‘m not sure that Spanish banks will be able to withstand such volumes of outflows for a long time. Target2 liabilities costs will also make it harder for Spanish banks to make reasonable bids in Spanish government securities auctions since their negatve RoW position plays a role in their cost of funds.

The graph below shows the evolution of both the Target2 liabilities and deposit facility balance since August 2011. The fit of the exponential trendline is quite impressive. Projecting the fit to December 2012 points to a negative balance close to €1.1tr. I think it is clear that the current path is quite unsustainable.

Since the ECB released its MFI balance sheet data and monetary developments statistics, it’s very interesting to take a look at the level of (government) bond buying from Italian and Spanish banks in the era of 3Y-LTROs:

Net Change in ownership



S + I

Euro area loans to General Government
























Total Dec – Feb





* I am using credit to government in the form of securities for ‘Euro area loans to General Government’

The move away from government bonds during Oct/Nov is quite visible as is the large reversal after the first 3Y-LTRO (in the case of Spain it seems the reversal might have happened even before the LTRO) on Dec 22. According to the ECB, government debt in the form of securities in 2011Q3 was EU585,2bn for Spain and EU1590bn for Italy. As a result, the total net change for Dec – Feb is equal to 3.4% of government debt for Italy and 11.6% for Spain. The net change for Spain is very impressive.

Compared to total Euro area government debt net issuance, the net change for Italy + Spain is very large, especially for January, signifying a clear increase in holdings (net of new issuance). In total, Italian and Spanish banks acquired as much bonds as there was new debt issuance in the whole euro area for the Dec – Feb period.

Overall, it seems that in terms of lowering pressure in sovereign debt markets of Spain and Italy (which are the main European risks along with Belgium), the LTROs were a success. The open question (especially given the latest increase in bond yields for both countries) is wether this effect will be long lasting, especially since fundamentals have not changed significantly, with both countries in deep recession and with Spain facing large central and regional government deficits, huge unemployment and a significant NPL ratio with a banking sector under serious stress.

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Kostas Kalevras

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