Three Developments in Spain

With Brexit, the pressure on Italian banks, and the surge and then sell-off in the yen, Spain may have been pushed off some investors’ radar screens.   There are three important developments to note.

The first is related to Spanish banks.  The Advocate-General of the European Court of Justice (ECJ) opined today that Spain could impose a time limit on claims of unfair mortgage terms.  If the ECJ concurs with the Advocate General as is frequently the case, Spanish banks may avoid refunding potentially billions of euros to a customer who paid too much for mortgages.

Spain had mortgage rate floors that prevented borrowing costs from falling in line with key benchmark rates.  In May 2013, Spain’s Supreme Court ruled that such rate floors were illegal.  In April a Spanish court ruled that around 40 lenders had to refund borrowers the extra interest they paid since the May 2013 judicial decision.

The bottom line is that ruling if upheld, will save Spanish banks billions of euros. BBVA appears to have been the most exposed, according to reports, estimated to be nearly two bln euros in retroactive payments.  Banco Popular and Caixa Bank also appear to have significant exposure.   Their stock prices responded favorably to the unexpected decision.

The second development involves Spanish politics.  |It appears that Rajoy, whose PP did a bit better in the June election compared with December, is getting closer to securing another term.  The latest development was a signal by the Ciudadanos head Rivera that the party could be willing to abstain in a confidence vote, which would allow for a minority government.  Ciudadanos ruled out entering a coalition with Rajoy.

Ciudadanos abstention would be helpful but not sufficient.  The Socialists would also have to be willing to abstain. Internal diplomacy is working overtime today, and some indication whether Spain will have a minority government or if must go to the polls again is likely before the weekend.

Third, the Spain, along with Portugal, have a ten day period to plea for clemency before the EC considers the sanctions for failing to do enough to meet their budget targets last year.  EMU Finance ministers confirmed the EC’s findings yesterday.  The EC can fine Spain and Portugal up to 0.2% of GDP, and they can cut off some EU aid.

It seems clear that the EC is trying to balance the importance of the rules and recognizing the efforts that both countries have made in recent years.  There also seems to be recognition that several other countries are in similar position.  Also, the EC recognizes with the Brexit vote, the integration of Europe has been challenged.  It does not want to take action that will aggravate the situation.    Many also will recall how Germany and France dodged a similar problem several years ago and were not fined.

We anticipate the EC to ultimately decide on symbolic action.  The EC does not want to appear as a harsh taskmaster, but an ally in coordinating policy and getting the fiscal houses in order, which not-so-incidentally appears to be a prerequisite for German agreement for more burden sharing.    The EC has no interest in sabotaging the fragile Portuguese recovery or undermining the stronger Spanish recovery.

Both the head of the Eurogroup of EMU finance ministers (Dijsselbloem) and the European Commissioner for Economic and Financial Affairs (Moscovici) have separately suggested that the fine may be zero.    In effect, if Spain and Portugal are contrite and pledge to take some corrective measures, no fine will be levied.   Portugal, which had a 4.4% deficit last year, has a new (left of center) government that is targeting 2.2% deficit this year.  Spain’s deficit was 5.1% in 2015, despite being among the fastest growing European economies.  The market expects the Spanish deficit to be around 4% this year.  Thus, both countries will be able to argue that they will show more progress this year.

This would be the first time that a member would be fined for the failure to hit the budget target.    In some ways, the idea of fining a country for too large of a budget deficit has the same absurd quality as a debtors prison.   Country A has not done enough to reduce their deficit so it will be fined and have a bigger deficit and more debt, requiring more counter-measures.  This would be the first time that a member would be fined for the failure to hit the budget target.

All three of the developments discussed here could be positive for Spain.  The banks may not take as large of a hit as it seemed like for overcharging mortgages.  Spain looks likely to escape without a fine (or perhaps the EC will call it a fine but of zero value).   Lastly, Span appears to be moving toward a minority government, though the confidence of this may be the weakest of the three.