EU may avoid private creditor issue in Spain rescue

The euro zone's temporary EFSF (European Financial Stability Facility)  bailout fund, rather than its permanent ESM (European Stability Mechanism)  facility, could fund Spanish bank recapitalisation to avoid investor concern over the ESM's preferred creditor status, a senior euro zone official said on Monday.

Yields of Spanish 10-year bonds jumped to 6.47% from 6.07% on Monday after Germany said the ESM was more likely to provide money for the Spanish bailout than the EFSF.

"It makes a difference whether the funds will be provided by the EFSF or the ESM, as ESM loans will be senior to other loans to the Spanish government," ABN Amro bank said in a note.

"This gives extra guarantees for the countries that participate in the ESM, but make Spanish government bonds less attractive to private investors, which could push yields on government debt higher," the bank said.

Some investors even believe that loans from the ESM could trigger the payout of Spanish credit default swaps - insurance against default - because the appearance of a preferred creditor such as the ESM would worsen the conditions for existing Spanish debt holders.

The senior euro zone source said that such an interpretation was going too far and that CDSes would not be triggered, but that to avoid such investor concerns, the loan for Spain could be originally made by the EFSF, which does not have preferred creditor status.

The bailout could then taken over by the ESM, which is expected to become active from July 9, but under current rules, the transferred loan would not become senior to other Spanish debt because it originated in the EFSF.

If the bailout is made from the EFSF, however, Finland has said it will require collateral from Spain to guarantee its part of the loan, which would be difficult and time-consuming politically.

This obstacle, the senior euro zone official said, could be sidestepped by, for example, allowing Finland not to take part in the initial stage of the bailout handled by the EFSF.

Helsinki could only join the effort once the bailout is taken over by the ESM, the official said.

Euro zone finance ministers offered on Saturday up to 100 billion euros for the recapitalisation of Spanish banks, with the exact amount and conditions to be determined only once Madrid makes a formal request for the money.

Two euro zone sources said the most likely solution was that the EFSF would give Spain EFSF bonds, rather than cash, which could then be injected into banks as additional capital.

The aim is to shore up Spain's weakest banks, which are stricken with billions of euros of bad property loans and other non-performing debt.

Using EFSF bonds rather than raising cash on the market would be much quicker, one euro zone official said, and it is a method already successfully tested in the recapitalisation of Greek banks.

The interest on the EFSF loan would be the market rate plus EFSF costs at the time of the issue, with no punitive margin, the official said.

The maturity of the bonds would be determined through the assessment of the Spanish banking sector. Greek banks were recapitalised with EFSF bonds of 7-10 years.