Canadian bank investors, beware Spanish default fears

Share

A series of blunt statements by Spain's Budget Minister are likely to increase anxiety levels for investors in Canadian banks. Minister Cristobal Montoro's admission that Spain "would have collapsed" without European Central Bank bond buying has implications for Canadian financials, which have been tracking solvency fears for Spain's major banks, Santander and BBVA, although thankfully with less volatility .

Thursday's government bond auction in Spain showed much weaker demand than expected and prompted Mr. Montoro's remarks. Debt markets were able to absorb the almost €3-billion issuance of new Spanish debt, but the bid-to-cover ratio, a measure of institutional demand, plummeted from 4.3 to 1.9.

There are two reasons why we are affected. The performance of Canadian bank stocks has closely tracked the price of debt issues of dominant, globally active Spanish banks. (Take a look at the accompanying chart from Bloomberg.) The negative effects of the European debt crisis are also dampening economic growth for Europe as a whole, pressuring demand for imports from emerging markets -- which has, in turn, has led to slower manufacturing growth in Asia and Latin America and depressed the commodity prices on which many Canadian companies depend.

Market reaction to Thursday's bond auction in Spain was negative but reasonably well contained. The ten-year Spanish bond yield jumped 10 basis points, but at 6.93 per cent remains below the 7 per cent level that has signaled panic in recent months. Credit default swaps on government and bank debt showed similar marginal moves.

The most recent meeting of prominent European bureaucrats ended with plans to provide Spanish banks with €30-billion in financial support, to be paid at the end of July. Discussions regarding the remainder of the estimated €100-billion of necessary support are expected to continue in September, after the traditional European month-long August vacation period.