Spanish 10-Year Yields Rise as Merkel Allies Oppose Spanish Bailout

Yields on benchmark 10-year Spanish bonds rose Monday as German politicians expressed concern over the Spanish bailout. Members of Chancellor Angela Merkel's political party voiced opposition to the plan to bailout Spain's banks and this raised concerns for investors.

As the largest contributor to the joint bailout funds and one of three nations yet to have ratified the European Stability Mechanism (ESM), the permanent bailout fund, reluctance from German coalition MP's does not bode well for the bailout. Should Merkel's coalition break down or at least fail to ratify the ESM, all hopes of a bailout that avoids adding leverage to the Spanish government could be dashed.

Spanish 10-year yields rose to 6.737 percent Monday on the news. Should Germany oppose the bailout, the only way to bolster the failing banks would be to give Spain a loan to use to recapitalize its banks. Analysts estimate that such a bailout would increase Spain's debt load by approximately 10 percent of GDP, depending on the size of the loan needed.

Spanish banks such as Banco Santander SAN fell on the news. Also, headlines from the European Central Bank stating that any bailout would not protect senior creditors spooked bond investors out of Spanish financial debt securities. This stance from the ECB is contrary to the one it took on the Irish bailout, where senior creditors were protected.

Finance ministers have rejected the ECB's stance, stating in the draft of the Memorandum of Understanding (MOU), set to be signed by July 22, that only junior bondholders and equity owners would be subject to losses under the bailout plan. Should senior creditors be subject to losses, bonds would probably sell off, sending yields higher. If yields on corporate debt rise, companies would have to finance themselves at higher rates. For the Spanish banks, who are seeing asset values depreciate, higher funding costs would exacerbate an already large crisis and likely make any bailout needs larger.

If the MOU is signed without problems and senior creditors are protected, another uncertainty may be lifted from markets. Analysts at Deutsche Bank last week highlighted that the first bailout payment would not be made until at least the end of August. Until then, it seems likely that uncertainty will reign and rumors will continue to swirl.