Spain borrowing costs hit euro-era high

(AP) MADRID - Spain's benchmark borrowing rate hit its highest since the country joined the euro currency after Fitch credit ratings agency downgraded 18 domestic banks on Tuesday.

Spain's 10-year bond yield rose to hit 6.81 percent in late afternoon trading according to data provider FactSet, while stocks seesawed and began to dip just before markets closed, indicating that investors continued to find more questions than answers in Spain's decision to seek help for its ailing bank sector.

Spain agreed last weekend to take a European bailout for its banks, tapping into a $125 billion euro area bailout fund, but investors are worried it will not solve the country's problem as the government may have trouble paying the money back.

Fitch said in a statement that its downgrade of the banks was a result of a previous downgrade of the Spanish sovereign debt on June 7. Fitch said it had conducted stress tests, both on the Spanish banking sector as a whole and on individual banks, updating results from tests done in 2011.

The ratings agency said the weakness of the Spanish economy would continue to have a negative effect on business volumes "which, together with low interest rates, will place pressure on revenues."

There has been growing concern that an increasingly large amount of Spanish government debt is being bought by its banks as the country finds fewer and fewer international buyers for its bonds. As Spain's banks continue to struggle, weighed down by their toxic property loans and assets, the government is finding it increasingly harder to sell its bonds.

One hope among eurozone politicians is that the euro100bn loan facility will help shore up Spanish banks' balance sheets, thereby giving them back the ability to loan out money to businesses and individuals and also buy more government debt. However, Spain is in danger of being trapped in a vicious debt circle. The euro100 billion loan facility will increase the Spanish government's debt load and it will have to find more buyers for its bonds which will send borrowing costs even higher. This could push Spain's government to ask for a bailout of its own.

The rescue package for Spain's crippled lenders was announced Saturday by finance ministers from the 17-country euro area, but the exact amount the country's banks will receive has not yet been published.

It is not yet clear where the euro area bailout loans will come from. If the money comes from the existing eurozone rescue fund, the European Financial Stability Facility, its repayments will have the same priority as the all the other private bond investors. However, if the funds are to come from the new bailout facility, the European Stability Mechanism, its bond repayments will be given a higher priority than everyone else's which could mean that other debt would be less likely to be paid off. That could make bondholders less willing to buy Spain's debt or demand a higher interest rate to compensate for the added risk of losses.

Spain will wait for the results of two independent audits of the country's banking industry before saying how much of the euro100 billion it will tap. The bailout loans will be paid into the Spanish government's Fund for Orderly Bank Restructuring (FROB), which would then use the money to strengthen the country's teetering banks.

In a report released late last week, the International Monetary Fund estimated Spain needs around euro40 billion to prop up banks hurting from an unprecedented real estate boom that went bust.

Investors also want to know whether Spain will ask for a safety margin of extra money to cushion itself against a further shock, such as a deterioration in the economy.

While Spain's bailout is designed to prop up its banks, investors are also worried that the Spanish government might eventually be forced into asking for a bailout to help it pay its way. Recession-hit Spain, which has the eurozone's fourth-largest economy with unemployment of nearly 25 percent, may be too big for the eurozone's rescue funds to handle.

Spain is also getting punished because of fears Greek elections on Sunday will hand a victory to the radical left-wing Syriza party, campaigning on a pledge to refuse to comply with terms of that country's bailout package. This could eventually push Greece out of the euro, further destabilizing the currency group.

"The idea of the Spanish bailout was to calm the market in case the Greek elections do not turn out as the EU would like," said Gary Jenkins, director of Swordfish Research Ltd.

"However the end result was to create more volatility and create more concern."

Once it became clear that the rescue money for Spain's banks would not solve that country's problems, investors have turned their attention to Italy, whose economy is larger than Spain's.

Italy didn't suffer through a real estate bust, so its banks are in better shape. But like nearly half of the countries in the euro, its economy is shrinking, making it difficult for the government to chip away at a mountain of debt. Italian bond yields also rose to worrying highs on Tuesday, hitting 6.02 percent, its highest level since January.

"Although Italian banks are relatively sound compared to the Spanish counterparts, without the heavy weight of toxic real estate bubble and are much less exposed to the government bonds, the real question is whether the country can grow itself out of the recession," said Anita Paluch of Gekko Global Markets.