Spanish regions are often described as Prime Minister Mariano Rajoy's biggest headache: they're highly indebted and decentralized. But RBS has found a sweet spot in Spain's strongest regions: Madrid, Navarre, Castilla y Leon, as well as the Canaries and the Basque Country, with returns of 14 percent over the past three months since the bank initiated the trade.
The strongest regions operate under better conditions than Spain as a whole: they're on track to meet their 1.5 percent deficit target for 2012-well below the country's national target of 6.3 percent.
In land regions such as Castilla y Leon, Navarre and the Basque are less risky than coastal ones and benefit from an industry-orientated economy rather than construction and tourism. Navarre posted limited growth of 0.6 percent, compared to a 2.7 national contraction throughout the recession.
"These regions are among the safest and most stable in terms of their fiscal outlook, with deficits below 3 percent," analysts led by Alberto Gallo at RBS wrote in a note to investors. "GDP per capita in each of these regions is more than 35 percent higher than the average for the other regions."
Unlike Catalonia or Valencia, which are among the most indebted regions subjected to central government conditions after seeking a bailout last year, none of the strongest areas have used the national credit line (ICO) that was set up for cash-strapped regional governments.
They're also among the most "resilient" to further economic stress and trade at a heavy premium to Spain's sovereign debt- ranging from 5 percent to 11.5 percent yield-to-maturity on the five-year notes, according to the bank.
However, RBS expects spreads to tighten among the strongest regions as investors discriminate on the basis of credit quality.
The London-based bank is short Spain's sovereign notes and its banks.
Head of European Macro Credit Alberto Gallo warns that Spain is facing a combination of economic and political risks as the outlook for the country continues to deteriorate and its finances remain "unsustainable".
All of the Spanish regions, including the stronger ones, which trade wide and present better characteristics than the sovereign itself, depend on Madrid for funding.
The central government has extended a 23 billion euro credit line for the regions in 2013 at the expense of its own fiscal health.
The Spanish contracted 1.8 percent in the fourth quarter from a year earlier and the country is expected to miss its deficit target of 6.3 percent for 2012.