Spain stress test
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Investors are awaiting the final details of size and conditions of a Spanish bailout after the results from independent auditors assessing the state of Spanish banks concluded that the country's banks alone will need up €62bn in extra capital.

This month, the International Monetary Fund (IMF) granted Spain up to €100bn worth of aid, although the details of the fund conditions have not been clarified or confirmed, after the nation's lenders have been hit hard by bad debts produced from the property bubble.

The Bank of Spain has hinted that the country may formally request the full €100bn amount as it would "give a wide margin for error and that Spain's three largest banks would not need extra capital, even in a stressed scenario."

Analysts have voiced concerns over the last few weeks that a €100bn may not be enough.

RBS has vehemently reiterated that "blanket support is unsustainable [and the] banks can break Spain's back."

"European banks need surgery, after the LTRO anaesthesia," say RBS analysts. "Only a systematic restructuring approach can fix peripheral banks, which in Spain alone we estimate will need €134-180bn of capital over the next three years. This is too much to bear for public finances alone. But a comprehensive restructuring and resolution framework still looks far away in time, and for now the strategy continues to be blanket public support to all banks. Without external help, bank liabilities may push Spain's debt to 110 percent of GDP, repeating what Ireland experienced in 2009."

In addition to this, RBS, as well as other analysts have said that a full European Stability Mechanism (ESM) is needed to stay afloat.

"We expect ESM access to bailout Spanish banks is another red line that has to be crossed. Spain will probably seek a precautionary ESM credit line rather than full ESM access with heightened conditionality, but this is unrealistic in our view. A full ESM package size of €370bn to €455bn is needed to take Spain to end 2014," add analysts at RBS.

In Luxembourg finance ministers debated whether Spain should initially apply for the Eurozone's temporary rescue fund and then transfer the loans to the ESM once it is up and running as of 9 July. A formal request from Spain is expected on 25 June.

"The financial assistance will be provided by the EFSF until the ESM becomes available, and then it will be transferred to the ESM," said Jean-Claude Juncker, chair of the Eurogroup of finance ministers.

The move could quell investor concerns that as the debt issued by the ESM must be paid back first in case of a Spanish default, relegating private creditors lower in the pecking order. Although questions will remain after the transfer.

"While we still believe that the most likely route is for the Spanish sovereign (via its The Fund for Orderly Bank Restructuring (FROB) fund) to shoulder the debt, there might be a late move to have the ESM recapitalize the banks directly," say analysts at Barclays Capital. "This may be possible, in our view, if there is strong enough political will to modify the existing (but not yet fully ratified) ESM framework. A number of voices have been highlighting this possibility, including at the ECB. Such a direct recapitalization would have the benefit of cutting the negative feedback loop between the sovereigns and the banks, although it would involve some explicit cross-border mutualization of debt, would require some cross-border banking regulations and therefore would not be easy to approve in the very short term. Our base case thus remains that the ESM will not lend directly to banks."

Spain's second audit

While the next week will see all eyes on Spain's formal bailout request, market participants are still awaiting the second Spanish bank audit that is due to be published in July.

Investor concern incresed this week on speculation that the second detailed assessment of Spain's banking sector was going to be delayed until September from July this year, in order to give the four auditors more time to conduct the stress tests.

While the rumour was later dismissed by European officials, the group of auditors, PricewaterhouseCoopers, Deloitte, Ernst & Young and KPMG Europe complete assessment of Spain's 14 main banking groups' balance sheets will be a key factor in determining the final extent of aid the country needs.

The Oliver Wyman and Roland Berger assessment is already much higher than the European Banking Authority's (EBA) assessment six months ago.

The EBA's benchmark capital requirements report, which comprised its formal recommendation and the final figures related to banks' recapitalisation needs said Spanish banks had a €26.1bn shortfall in banking capital requirements - the bufferzone needed to keep them afloat.

Spain's banking stocks are enabling Spanish stock index, the IBEX 35 to be the only main European index trading in positive territory this morning, rising over 1 percent higher at 6841 points as of 1000 GMT.