Spain's rescue loan sows debt fears

(MADRID) - Investors' euphoria over a huge eurozone rescue loan for Spain's banks evaporated Monday as they fretted over the details and feared a stormy Greece exit of the eurozone.

Spain's eurozone partners agreed Saturday to extend up to 100 billion euros ($125 billion) to salvage a banking sector weakened by reckless lending to a property market that crashed in 2008.

The rescue, which represented a U-turn by Madrid, eased concern about the risk of a Spanish financial sector calamity, but the sheer size of the loan fed anxiety over Spain's fast-growing public debt.

After an initial warm welcome by the markets, the atmosphere turned nasty for both Spain and Italy on the fear that Sunday's elections in Greece could mean Athens quitting the euro, with unknown consequences.

Spain's 10-year government bond yields eased at first, but by mid-afternoon they had surged to 6.508 percent -- well above Friday's close of 6.216 percent before the eurozone agreement.

Italy's yield leapt to 6.035 percent from 5.77 percent.

Spain's risk premium -- the extra rate investors demand to hold its bonds over their safer German counterparts -- shot to 5.20 percentage points after closing last week at 4.89 percentage points.

A rally on the Madrid stock market also wilted. After soaring by 5.93 percent in opening trade, the IBEX-35 index of leading shares ended 0.54 percent lower.

Daniel Pingarron Salazar, market strategist at IG Markets, said the lack of details over the Spanish banking rescue fed doubts, with the size and full conditions still unknown.

It is also still unclear whether the eurozone bailout will tap the incoming bailout fund, the European Stability Mechanism (ESM), whose debt takes priority for repayment over ordinary investors in a time of crisis.

Several analysts warned that a Spanish banking rescue using the ESM could have the unintended effect of scaring ordinary investors away from Spanish government bonds.

"If the amount borrowed from the ESM were to materially exceed the currently expected 100 million euros, the ESM's self-declared preferred creditor status could, in our view, constrain Spain's access to the capital markets and therefore reduce the likelihood of bond holders being paid in full," said Standard & Poor's rating agency.

The big spectre, however, is Greece, and the fear that anti-austerity party Syriza will win elections on Sunday.

"The possibility of a Syriza win is causing great fear in the market because that would mean Greece not complying with its rescue plan from July last year, and then there is a major possibility of Greece having to abandon the euro," Pingarron said.

"That is what is causing this enormous fear not only in the Spanish market but also in the American market, which has slumped."

Spain's Treasury had sought to ease concerns over the impact of the rescue loan on Spain's sovereign debt.

Far from undermining Spanish public debt, it would "reinforce its overall solvency," the Treasury said in a joint statement with the economy ministry.

Spain vowed to carry on tapping the debt markets after raising 56.8 percent of the total 86 billion euros it plans this year through regular auctions of medium- and long-term bonds.

A formal request for the rescue loan is expected by the next eurozone finance ministers meeting scheduled for June 21, European Economic Affairs Commissioner Olli Rehn said Sunday.

The final figure will be known after the European Union, European Central Bank and IMF finish a review of the situation, and a formal accord will then be signed, he said.

A report by Barclays Capital analysts said that a loan of 70-80 billion euros would push up Spain's public debt by 7.0-7.5 percentage points from the end-2011 level of 68.5 percent of economic output.

Under this scenario, Spanish public debt would likely peak at 95 percent of economic output by 2015, they predicted, meaning that fundamentally the state would remain solvent.

Lee Hardman, currency analyst at Bank of Tokyo-Mitsubishi UFJ, said the increase in debt levels would leave Spain "even more vulnerable to a further negative shock."

Spain's Prime Minister Mariano Rajoy told reporters Sunday the deal ensured "the credibility of the euro" and insisted that rather than buckling to pressure for the rescue, he had sought it all along.

His government has vowed to slash Spain's public deficit from 8.9 percent of total economic output last year to just 5.3 percent this year and 3.0 percent in 2013.

But economists say Spain faces a daunting task achieving those goals in a period of recession, which reduces tax income, and with unemployment at 24.4 percent, which raises welfare costs.