Cédulas headache

Although ECB support creates a credible bulwark against a systemic collapse of Spain’s banking sector, it makes necessary a colossal reliance on short-term funding — which can create treacherous imbalances.

Of the €418bn of registered Cédulas, roughly three quarters have been issued in benchmark format, and as much as €200bn will need to be redeemed within three years.

But without an externally supported credible recapitalisation of the country’s banks, issuers will remain firmly shut out of the public Cédulas market. Spanish banks will increasingly be forced to redeem publicly issued deals with ever larger proportions of retained Cédulas pledged to the central bank.

Because ECB funding is inherently short term, dependency on it to finance assets that have a long duration presents a mismatch of epic proportions. Rollover risk hardly begins to describe it.

It seems highly unlikely that the ECB will raise interest rates soon, but there will come a point when monetary tightening commences. Banks that remain disproportionately reliant on the ECB could, at that time, experience a rapid erosion of their margins. Insolvency could follow.

But, it was not long ago that Santander drew a blistering €8bn-plus book for its only public Cédulas benchmark deal of this year — a scale of demand that surpassed any other covered bond deal this year. The transaction showed that conditions can change and could change again if Europe has the mettle to break Spain’s negative loop.