Impoverished Spain Bails out Cash-strapped Bankia

Soon after the Spanish government announcing a €19 billion ($23.78 billion) bailout of troubled  Bankia SA, the country’s 10-year bond yield rose 0.18 percent point to 6.47%, putting the Spanish sovereign bonds under heavy pressure. The Spanish debt insurance costs have pushed to a fresh records and five year credit default swaps have widened 0.1 percent to 5.57%.

Nationalization of Bankia has darkened the sentiments in the market, as the announcement raised question whether the cash-strapped Spanish government can finance Bankia without international help. Bankia is the third largest lender in Spain, which is currently saddled with billions of Euros in toxic real estate loans.

Though it was an expected move, such a hefty bailout package has fueled worries in the market, especially when the state-backed Fund for Orderly Bank Restructuring (FROB) has only €9 billion left to finance the Spanish banking sector. “Instead of injecting cash, the government could give Bankia debt certificates either from the Treasury or from the FROB. Bankia would then be able to use this debt as collateral with the European Central Bank to cover its liquidity needs.” said a government spokesperson on Sunday.

The Spanish Prime Minister Mariano Rajoy said that the take over of Bankia by the government is part part of a wider process to strengthen the country’s financial sector. He added that Spain won’t seek any foreign rescue package and the government will do all it can to revive the troubled banking and real-estate sector.

After the Friday’s rescue plan Bankia shares fell more than 20% as the market re-opened on Monday. S&P also downgraded its rating for Bankia to BBB-. Later today, Bankia announced that it will put aside €12.75 billion to clean up its real-estate assets, which adds up to €55 billion if foreclosed properties and developer loans are taken into consideration. Which is the biggest clean up in the history of Spanish banking sector.

“The Spanish government’s plans for Bankia are worrying,” says Simon Penn, Market Analyst at UBS. “It is recapitalizing the bank with government bonds which can be used in future to borrow money from ECB. It can worsen the health of Bankia by increasing the bank’s exposure to Spanish sovereign debt.” Penn added.

The 10-year government bond yield, an indicator of borrowing costs, is likely to rise again in future.