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7/28/2019 Carmel Asset Mgmt - The Pain in Spain (2012)
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Investment Focus:
The Pain in Spain
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2
Five Reasons Why Spains Problems Are
Worse than the Market Anticipates
1. Spains national debt is 50% greater than the headline numbers
Spains debt-to-GDP balloons from 60% to 90% of GDP with regional and other debts
2. Spains housing prices will fall by an additional 35% Spain built one house for every additional person added to the population during the
past two decades; the fall will decrease GDP by ~2% each of the next two years
3. Spain has zombie banks with massive loans to developers and to
homeowners Banks have not begun to realize losses and are vastly undercapitalized
4. Spains economy has not stabilized and will continue to deteriorate Spain has the highest unemployment in the developed world, one of the highest overall
debt loads, and the most uncompetitive labor market in Europe
5. The EU will not have the firepower or political will to bail out Spain Rescue fund headline numbers are misleading and count capital that is not yet
committed
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The Market Will Question Spains Solvency
as Its Problems Compound Each Other
3
Housing devaluation
These problems will reveal themselves in the next12 months
Spains true debt burden will pass the 90%
tipping point identified by Rogoff andReinhart
Housing prices will fall further and faster thananticipated (consensus is 15%; CAMestimate is 35%)
Banks underestimate the residential realestate loan defaults (consensus estimate is
2.8% vs. CAM estimate of 11%)
Expected housing price depreciation andloan defaults will deepen Spains recession(additional 2% contraction in 2012 and 2013)
Spain will need to refinance 186.1 Billion in2012 alone
10-year Credit Default Swap (CDS) on theKingdom of Spain will move higher as these
surpr ises are announced
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Spains Credit Default Will Widen More than
Other Peripheral European Countries
4
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Spains National Debt Is 50% Greater than
the Headline Numbers
5
0
50
100
150
200
250
Percen
tage
DebttoGDP(AsofYE'11)Source:IMF
0100200300400500600700800900
1,000
SovereignDebt RegionalDebt BankGuaranteed Debt
OtherSovereignGtd.Debt
Localgovernmentdebt
TotalDebt
Spain'sDettoGDPiscloserto90%than60%
Sources:BankofSpainStatisticalBulletinforNational,RegionalandLocalDebt;BloombergforSoveriegnGuaranteeddebt
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Spains Housing Prices Will Fall by an
Additional 35%
6
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Spain Has Zombie Banks with Massive
Loans to Developers and to Homeowners
7
21.8
143.2
382.0
98.5
298.3
656.5
37.7
99.5
1.4
7.7
17.9
17.4
62.4
18.3
2.2
7.2
Total LoansBillions of Euro YE 2011
Doubtful LoansBillions of Euro YE 2011
Agriculture Industry
ServicesOtherThanRealEstate Construction
RealEstate Services PersonalMortages
ConsumerDurable ConsumerOther
6.5%5.4% 4.7%
17.7%
20.9%
2.8%
5.8%7.3%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
PercentageofDoubtfulLoans
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Spains Economy Has Not Stabilized and Will
Continue to Deteriorate
8
1 in 4 Spaniards is out of work. Youth unemployment is 50%.
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Europe Will Not Have the Firepower or
Political Will to Bail Out Spain
9
Numbers as high as 940bn have been touted for the combined European StabilityMechanism (ESM) and European Financial Stability Fund (EFSF)
Germany would increase from 211bn to 401bn This has not yet been approved by the Bundestag or the Constitutional Court
both barely approved the initial allocation
The ESM relies not only on unapproved financing from Germany, but calls initialcapital from Portugal, Ireland and even Greece
The size of the bail out funds is insufficient if Spain and Italy lose access to the debtmarkets
Spain alone would take 60% of the available funds
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10
Summary: CDS on the Kingdom of Spain
Cost / CapitalCommitment
3.5% of notional per annum effectively an option premium on the defaultof Spain during the next 10 years
Rationale
We began buying Spain CDS in Q4 2011 because the country hassignificant structural problems within its economy, a debt load that is
higher than the headline number, and a banking system withunrealized losses
ExpectedReturn
Should the Spanish crisis flare up in 2012 as we expect, we can generatea 300% return on the annual premium
Instrument 10-year CDS on the Kingdom of Spain
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Appendix
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Spains Debt Is 50% Greater than the
Headline Numbers
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Spains Debt-to-GDP Is Higher than Officials
State and Will Likely Continue to Increase
13
A fuller account of Spains debt-to-GDP places the burden at over 92% from theofficial rate of 61%
Official projected budget deficit levels of 5.3% in 12 and 3.0% in 13 are unlikely tobe met
Admitted deficits would add 8.3% of GDP to the debt by YE 13
Levels are likely to be missed so additional debt is likely to higher by morethan 10%
GDP itself is likely to be lower than official forecasts as a vicious combination ofincreased austerity, falling asset prices and high unemployment take hold
IMF forecasts a fall of 1.7% in 12 and 0.3% in 13
Given a negative wealth effect for rapidly falling housing prices, we expectGDP to be lower ~3% in 12 and ~1% in 13
By YE 13 debt-to-GDP will be close to 110%
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14
There are several sources of
additional debt
Spain and the regionalgovernments have 87.5bn ofunpaid bills
There are state corporationswith explicitly guaranteed debtof 55.9bn
Debt held by the social securityfund equals 56.6bn
In total these would bring debt-to-GDP to 90%
Spain Hides Debts at Regional Level, State
Corporations, and Social Security
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15
There are agencies and banks that have beenexplicitly guaranteed by the Kingdom of Spain
The ICO (Insituto de Credito Ofical) is a state backedlender no maximum draw
FROB (Fondo de Reestructuracion Ordenada Bancaria) isa fund for the restructuring of banks - maximum drawcould be 27bn
FADE is the (Fundo de Amortizacion del Deficit Electrico),which covers the amount by which Spain fails to coverelectricity costs Maximum draw 22bn
The banks are getting guarantees so that they can postthis funding to the ECB no maximum draw
AIF (Administrador de Infraestructuras Ferroviarias)operates the rail network in Spain
At these current draw amounts, debt-to-GDP
would increase by 14.8%
Cumulatively Spain approaches 100% debt-to-GDP
Debt Increases Further When Contingent
Liabilities Are Added
Banks, 59.3
FROB, 10.9
FADE, 12.9
ICO, 75.7
AIF, 0.2
DebtGuaranteedbytheKingdomofSpainSource:Bloomberg(Units Bn)
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Spains Surplus in the 2000s Coincided with
a Building Boom
16
Spain budget balance as a percentage of GDP
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Only the Rosiest Projections Reach the 3%
Deficit Goal for 2013
17
The Government had agreed with
the European Union to meet a2012 deficit of 4.4%
On March 2nd , thegovernment adjusted thetarget to 5.8%
It has since agreed to 5.3%
Even this looks aggressive
9
8
7
6
5
4
3
2
1
0
2011 2012 2013
Percenta
geofGDP
SpainBudgetDeficit
A ctu al Tar ge t Bloo mb er gFor ec ast JPMForecast
EUBudgetDeficitTargets
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Even the IMF Does Not Foresee Spain Getting
to a Primary Surplus Any Time Soon
18
IMF Cyclically adjusted primary government balance - Spain
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Controlling Costs Is Difficult Because of
Regional Government Spending
19
Autonomous and local governments havetheir own politics and are often at oddswith the central government
This makes getting their deficitsdown prone to regional politics
Recently, the central government agreedto pay 35bn of local and regional debt
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Regional Government Debt Is Not Counted in
the Countrys Overall Debt-to-GDP
20
As opposed to almost all other Europeancountries, Spains healthcare is paid by
the regions, with limited centralgovernment interference
As the population ages and healthcarecosts escalate, the fiscal pressure on theregions will become more intense
Some regions have started to look to thecentral government to fund healthcaredirectly
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Spains Housing Prices Will Fall by an
Additional 35%
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Compared to the US, the Housing Bubble in
Spain Was Extreme
22
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Housing Prices Have Outstripped Wages
23
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Spain Has Overbuilt its Housing Stock
Relative to its Growth in Population
24
Demographic changes such as fewerpeople per dwelling and more recentsecond home buyers will compound the
problem Implies that Spain has significant excess
housing
Source: Center for European Policy Studies
1.750
1.850
1.950
2.050
2.150
2.250
2.350
2.450
2.550
1 99 9 2 00 0 2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0
Totalpopulation/totaldwelling
s
PeopleperDwellingSource:EuropeanMortgageFederation,IMF,MinistryofInternal Affairsand
Communications(Japan years'09&'10Estimated)
Euro12
Spain
USA
Japan
IncomparisontotheUS
25.0%overbuilt=
6.45mm units
IncomparisontoJapan
17.1%%overbuilt=
4.42mm units
IncomparisontoEurope
9.4%overbuilt=
2.44mm units
18.0
19.0
20.0
21.0
22.0
23.0
24.0
25.0
26.0
27.0
38.0
39.0
40.0
41.0
42.0
43.0
44.0
45.0
46.0
47.0
Homes(Unitsinmillions)
Population(Unitsinmillions)
Spainadded
one
home
per
person
for
almost
two
decadesSources:IMF,Ministerio deFomento,Asociacion Hipotecaria Espanola
Population(L HS) Houses(RHS)
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Housing Has Been a Great Investment in
Spain, but It Is Not Affordable Now
25
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Strong Investment Returns on Housing Have
Boosted Home Ownership Rates
26
Source: IMF
Germany
Denmark
Netherlands
France
Japan
Sweden
UnitedStates UnitedKingdom
Australia
Ireland
Portugal
Belgium
Italy
Spain
0
200
400
600
800
1000
1200
40 50 60 70 80 90
YE2011C
DS
Levels
HomeOwnershipRate
CDSLevelsvsHomeownershipRates
High investment returns tend to drawpeople in
Thus creating a bubble and diminishing returns
Also encouraging speculative borrowing
High rates of homeownership can also reducelabor mobility
Over time housing excesses diminish the
credit quality of the country itself
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Retirees Will have to Sell their Houses but
There Are No Obvious Buyers
27
Already at homeownership age, with few buyers behindthem
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Prices Will Have to Drop Further Before
Homes Become Affordable
28
US homes are far more affordable after the crisis
Source: National Association of Realtors
MoreAffor
dable
More
Affordable
Spanish homes are 30% LESS affordable than99
Source: Bank of Spain
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A Fall in Housing Prices Will Reduce GDP
29
If prices were to fall to match US - ~35%
To match Spanish income growth -~30%
Including a fall in wages to bring in line with Euro labor costs -~45% To match 99 affordability -~30%
To match affordability in US -~55%
Contributing factors
Possible increase in homeownership rate? NO most already own
New buyers? NO aging population and the need to convert homes to fund retirement
Tight inventory? NO there are as much as 20% excess houses
Conclusion housing prices have to drop at least 1/3 from current levels
We believe that this will take place over 2-3 years as housing generally does not devaluefaster than ~15% per annum
The Bank of Spain estimates that the Wealth Effect is about a 0.03 reduction inconsumption for a 1 fall in housing prices1
1 Housing boom and burst as seen from the Spanish Survey of Household Finances, Olympia Bover
A 15% decl ine in housing should reduce GDP by ~2% in both 2012 and 2013
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Spain Has Zombie Banks with Massive
Loans to Developers and to Homeowners
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Banks in Spain Are Holding Devastating Real
Estate Losses
31
We estimate that Spanish banks may need 200bn of additional capital nearly 20%of GDP
Given the losses experienced in the last housing crash of 93-94, we would expectlosses to be much higher than the banks have admitted
This bubble was larger in scope and scale, yet mortgage losses are 50% what they were then they shouldbe much higher
Spain has likely 50% of GDP in commercial real estate assets, many of these are todistressed builders and developers, with minimal recovery value likely
Problem Loans are still below what was experienced in the early 90s while corporatebankruptcies are 10x that period
The LTRO has given Spanish banks some new financing, which they seem to haveput into Spain sovereign debt
If prices on this debt falls even by 0.5%, the banks will be asked for additional collateral this was a similar
situation to MF global
Banks government holdings are now 33% greater then their tangible equity
While banks can be more profitable by adding additional leverage, they would still lose money on theircurrent asset base
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Mortgages Default Rates Will Rise Dramatically
32
During the last housing boom mortgage defaultrates peaked about 5.5%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
Mar07
Jun07
Sep07
Dec07
Mar08
Jun08
Sep08
Dec08
Mar09
Jun09
Sep09
Dec09
Mar10
Jun10
Sep10
Dec10
Mar11
Jun11
Sep11
Dec11
DefaultRates
Current
CrisisSource:AsociacionHipotecariaEspanola
Given the enormous jump in housing prices andunemployment, default rates could double or more
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Spanish Banks Hold Large Exposures to
Commercial Real Estate
33
Not only do German banks have 2/3 theCRE exposure, Germanys economy is2.5x times bigger than Spain
Because the left hand graph does not include non-EBAbanks, It understates the size of the exposure by 60%
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16% of Euro CMBS Is in Special Servicing
34
Funding risk
CRER
isk
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Current Crisis Is Much Worse than 93-94,
but Loan Delinquencies Are Lower (So Far)
35
Corporate bankruptcies are 8x the amount duringthe 93-94 crisis and 20% more than 09
We are likely not even near the peak ofdelinquencies and therefore defaults and losses
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CAM Estimates that Bank Losses are Sizeable
With Even a Modestly Poor Economic Outlook
36
Rationale
TotalLoans Defaultrate LossonDefault LossEuroBn DefaultRate LossonDefault
RealEstateServices 298.3 40% 75% 89 2xcurrent"Doubtful" Effectivelyunsecuredloanstobusinesses
ServicesOtherThanRealEstate 382.0 15% 75% 43 Reflectionofgreatlyincreasedbankruptcyrate EffectivelyunsecuredloanstobusinessesPersonalMortages 656.5 11% 50% 36 2x'93'94defaultrates Lossesmitigatedbyrecourse toborrower
Construction 98.5 40% 75% 30 2xcurrent"Doubtful" ConsiderationtoRealEstatealreadyownedbybanks
ConsumerOther 99.5 10% 75% 7 Increasereflectiveofunemployment Unsecuredloanstoconsumers
Industry 143.2 10% 40% 6 Reflectiveofweakeningeconomyandausterity Reflectiveofmix ofsecuredandunsecuredloans
ConsumerDurable 37.7 10% 50% 2 Increasereflectiveofunemployment Securedloanstoconsumers
Agriculture
21.8 10% 50%
1 Modest
increase
to
current
default
rates Estimate
Total 214
%ofGDP 19.97%
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LTRO Has Relieved Funding Pressure, but
Spreads Are Rising Again
37
CDS spreads on domestically focused Spanish banks
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Banks Have Greatly Increased Exposure to
Sovereign, Likely Via Leverage
38
When the market discovered how much exposure MF Global had to European Sovereigns, a de factobank run occurred. Could the whole system be doing the same now?!?!
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LTRO Allows Banks to Add New Assets
Profitably, but Not Against Current Assets
39
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
12/1/2005
3/1/2006
6/1/2006
9/1/2006
12/1/2006
3/1/2007
6/1/2007
9/1/2007
12/1/2007
3/1/2008
6/1/2008
9/1/2008
12/1/2008
3/1/2009
6/1/2009
9/1/2009
12/1/2009
3/1/2010
6/1/2010
9/1/2010
12/1/2010
3/1/2011
6/1/2011
Perce
nt
Versusthebankscurrentassets,LTROimplies"negativecarry"
IMFRoAEst
ECBRoAEst
LTRO
0
1
2
3
4
5
6
7
LTROallowsbankstoearn"carry"onadditionalassets
3YrSpanishGovtBondYield LTROFundingRate
Currentspreadis223bps
7/28/2019 Carmel Asset Mgmt - The Pain in Spain (2012)
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Spains Economy Has Not Stabilized and
Will Continue to Deteriorate
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Spains Economy Has Intractable Problems
41
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Spains Labor Is Expensive
42
Unit Labor Costs since the introduction of the Euro Source OECD
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Spain Has the Worst Labor Restrictions
43
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Construction Jobs Are Not Coming Back
44
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
%ofWorkforceInvolvedinConstruction
Spain US
Source: Bloomberg
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Exports Are Vulnerable to a European Slowdown
45
i i h d
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Spains Exports Are Getting Cheaper and Its
Imports More Expensive
46
( 50,000)
( 40,000)
( 30,000)
( 20,000)
( 10,000)
0
10,000
MINERALPRODUCTS
MACHINESA
NDAPPARATUS,
ELECTRICALMATERIAL
PRODUCTSFROM
CHEMICALINDUSTRIESAND
TEXTILEMATERIALSANDTHEIRPRODUCTS
CO
MMONMETALSANDTHEIRPRODUCTS
OPTICS,
PHOTOGRAPHYANDFILM.
PRECISION
ME
RCHANDISEANDDIFFERENTPRODUCTS
LIVEANIMALSANDPRODUCTSOFTHEANIMALKINGDOM
ARTIFICIALP
LASTICMATERIALS,
RUBBERANDTHEIR
FOOD
PRODUCTS,
BEVERAGESANDTOBACCO
WOOD,C
ORKANDTHEIRPRODUCTS
HIDES,
SKINSANDTHEIRPRODUCTS
PAPE
R,
ITSRAW
MATERIALSANDPRODUCTS
FINEPEARLS,
PRESIOUSSTONESANDPRECIOUSMETALS
FOOTWEAR,
HATMAKING,
UMBRELLAS,
ARTIFICIAL
WORKSOFARTFORCOLLECTIONSANDANTIQUES
FATSANDOILS,
PRODUCTSOFTHEIRSEPARATION,
PRODUCTSOFSTONE,
CEMENT,...
CERAMIC,
GLASS
PRODUCTSOFTHEVEGETABLEKINDGOM
TRANSPORTMATERIAL
2008netexports
Foodstuff
Oil
Oil prices rising
Food prices falling
M f i i S i I W k i E
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Manufacturing in Spain Is Weakening Even
Relative to the Rest of Europe
47
Eurozone PMI and GDP Spain PMI and Production
Th IMF P j t S i Will B i R i
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The IMF Projects Spain Will Be in Recession
in 2012 and 2013
48
Only one of twocountries in recessionin 2013
Most severe change ofany nation from the Sept11 WEO to the J an 12
WEO =World Economic Outlook last published J anuary 24, 2012
S i H L t C t l f I t t R t d
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Spain Has Lost Control of Interest Rates and
Currency by Being in the Euro
49
Source: Center for Economic Policy Research
Effective interest rates are 4% too high The currency needs to fall 15%
Spain Has Too Much O erall Debt Which Is
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Spain Has Too Much Overall Debt Which Is
Owned by Foreigners
50
0%
20%
40%
60%
80%
100%
120%
Netexternaldebtasa%ofGDP(YE'10)
Source:McKinsey
Global
Institute
&
The
World
Bank
These two countries have control of their own currency
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Europe Will Not Have the Firepower or
Political Will to Bail Out Spain
The Headline Numbers for the European
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The Headline Numbers for the European
Firewall Are Unrealistic and Misleading
52
The headline numbers on the combined European firewall is as large as 940bn
This counts 220bn of funds already committed to Portugal, Ireland and Spain
Germany would owe a total of 401bn they currently only have approval both bythe Bundestag and the Constitutional Court for 211bn
Greece would owe 20bn impressive for a country that just was bailed out
Spain would owe 176bn which is 16% of GDP and 154% of the expected
Government tax revenues for 2012
Obviously if Spain needs to be bailed out the size of the Fund will be much smallerthan the headline
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Details on the Firewall Size Are Uncertain
53
There are two rescue mechanisms
European Financial Stability Facility (EFSF) commitments from members are
undrawn until needed and funds to this point have been lent directly to nationalgovernments
German commitment capped at 211bn which has been approved by the legislature and theConstitutional Court
European Stability Mechanism (ESM) Initial drawn capital has been set at
80bn which will be funded by the members, additional capital can be drawnup to a total of 500bn
Unclear at this point if weak countries will have to pay the initial funding
Initial capital call equals ~0.9% of GDP would this count against the budget deficit? The 9.5bncapital call on Spain equals almost 10% of LTM government revenues
German commitment capped at 190bn which if is part of the 211bn has been approved
If the programs are to run concurrently, would Germany need approval by theBundestag? Would it face another challenge in the Constitutional Court?
If Spain Unravels the Size of the Problem
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If Spain Unravels, the Size of the Problem
Grows and the Rescue Funds Shrink
54
Should all of the GIIPS countries be forced to drop out of ESM and EFSF, roughly1/3 of the commitments would disappear
Should Spain lose complete access to the markets like Greece, Ireland andPortugal have, the worst case funding needs are very large:
MaturingDebt 2012 2013Bills 60.4 21.1
Bonds 45.1 60.4
International bonds 3 1.5ICO 10.4 15.4FROB 3 2.1
FADE 2.1 2.7
Deficit(estimatedbyCITI) 70.1 43.8BankdebtguaranteedbySpain 26.1 5.5
Total 220.2 152.5
Su mfor '12and'13 372.7 In this worst case, Spain would take up nearly 60% of the fully drawn headline
numbers leaving less for Italy, Portugal, Ireland and Greece