Spain fears threaten corporate funding, profits

By Sonya Dowsett – Analysis

MADRID (BestGrowthStock) – Fears that Spain may suffer a similar debt crisis to Greece are raising funding costs for companies and threatening to stifle profits, squeeze investment in acquisitions and constrain research.

Analysts say new corporate debt issues will have to offer substantially higher yields, and the cost of debt from wholesale markets would be directly linked to trading on the secondary bond markets, significantly costlier than a few months ago.

“There’s a good reason to be concerned because as sovereign spreads go wider, it’s raising the cost of funding for corporates,” said Aziz Sunderji, credit strategist at Barclays Capital.

The premium investors demand to hold 10-year Spanish bonds rather than benchmark German government bonds rose to a new euro-lifetime high of 150 basis points on Thursday as investors fretted Spain would need a Greek-style bailout.

Credit Suisse estimates this spread should be about 300 basis points higher, based on the country’s risk score. Corporate bond spreads are likely to track sovereign’s higher.

Funding costs have even risen for heavyweight Spanish companies like banks Santander and BBVA and concessions group Ferrovial and utility Iberdrola companies who have limited exposure to the Spanish economy after a decade of diversification.

Santander, the euro-zone’s biggest bank with just 24 percent of its profit from Spain, said last week sovereign fears on Spain were pushing up funding costs in the wholesale markets amounting to around 20 basis points on new issues.

Antonio Ramirez, analyst at Keefe, Bruyette & Woods, pointed out this figure was based on deals during the year to date and would get even less favorable as spreads on Spanish bonds widened.

“If the reason for them to pay a little more was the sovereign, and today the sovereign is more costly than it has been in the first quarter, you would assume this trend is not getting better, it is getting worse,” he said.

Banks are the worst affected by cuts to sovereign ratings because of implicit government backing for its financial system.

“Banks are a leveraged play on an economy. In that respect they are going to reflect concerns on an economy first,” said Daragh Quinn, analyst at Nomura.

Santander Chief Executive Officer Alfredo Saenz said last week the bank was well funded and a price war on high-interest deposit accounts amongst Spanish banks was aimed at capturing market share rather than securing funding.

But some analysts believe a rush by Spanish lenders to attract retail deposits by offering interest rates as high as 4 percent is a way of securing funding in an uncertain economic climate.

“We believe institutions are not so much concerned about gaining market share but about obtaining as much stable funding as possible,” said banking analyst Santiago Lopez.

DEFAULT INSURANCE COST RISES

Although companies like Telefonica and Repsol say they are well-financed and do not have to access the markets in the near future, Spanish companies as a whole have piled on debt over the past decade thanks to cheap credit and a booming home economy.

“If they eventually have to come to the market these higher funding costs will hurt their interest margins,” said Maureen Schuller, credit strategist at ING Bank in Amsterdam.

More expensive funding reins in corporate activity, making companies cut back on acquisitions and research and development spending which will further squeeze an economy already suffering its worst recession in half a century.

“Your cost of living becomes a lot more expensive — you just have to spend less,” said Simon Ballard, senior credit strategist at RBC Capital Markets.

Higher funding costs may even feed into inflationary pressure as companies increase prices to maintain margins.

The signs are all there: the cost of insuring Iberdrola’s debt against default was about 33 basis points wider on Friday, widening to around 227 basis points according to Markit data.

In contrast, German utility E.ON’s five-year CDS were about 3 basis points wider at about 67.5 basis points.

With Spain’s unemployment rate at 20 percent — its highest rate in 13 years, unprecedented levels of household and corporate debt and a budget deficit of over 10 percent, many economists predict the sovereign spread will widen further.

Corporate debt is currently around 150 percent of Spanish gross domestic product (GDP), compared to around 50 percent in the 1980s and 1990s, according to UBS.

Non-financial business debt as a percentage of GDP in Spain outstrips Britain, the United States and fellow eurozone members like France and Germany, according to McKinsey.

DISTANCING THEMSELVES

A decade of boom and bust in the eurozone’s fourth largest economy has created a champions’ league of around 5 companies who dominate the index, but have little exposure to Spain’s sick economy.

Santander and BBVA, Telefonica, Iberdrola and Repsol make up around 70 percent of the weighting of the index, but these companies are being punished by the markets just by virtue of being domiciled in Spain, even though the bulk of their business is in regions like Britain and Latin America.

This could be investors fearing the Spanish government will follow Greece’s example of slapping a one-off tax on corporates to patch up its yawning budget deficit, eating into profits already damaged by any exposure to cash-strapped Spaniards.

Some diversified heavyweights were eager to distance themselves from Spain’s problems as they reported quarterly results last month.

“When we say we are going to reduce costs, we do it, when we say we are going to maintain gearing, we do it. That is why our credit default swaps are trading at 80 (basis) points lower than Spain’s,” Iberdrola chairman Ignacio Galan said after reporting forecast-beating quarterly results last week.

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(Additional reporting by Jane Merriman in London, Editing by Sitaraman Shankar)

Spain fears threaten corporate funding, profits