Europe calibrates its bailouts, comforts markets

Posted by Tracy Alloway on Jun 21 10:38. 4 comments | Share

Well, you can’t say the European Union isn’t flexible.Eurozone authorities have been busy tweaking their bailout programmes this week.
First, the European Financial Stability Facility, which we’ve said for ages would need to be increased to match its €440bn headline lending figure. More…

Well, you can’t say the European Union isn’t flexible.

Eurozone authorities have been busy tweaking their bailout programmes this week.

First, the European Financial Stability Facility, which we’ve said for ages would need to be increased to match its €440bn headline lending figure. On Tuesday, the EU said it will raise EFSF lending capacity from €225bn to that €440bn number by (surprise) upping guarantees from guaranteeing countries.

Here’s Michael Michaelides and Frank Will at RBS with the details:

In addition to increasing the overall size of the EFSF to EUR 780bn, the guarantee ratios of each country will be increased from 120% to 165%. This means that the EFSF will no longer need any loan specific buffer to protect the AAA rating of its bonds. Currently the rating agencies demand that the EFSF provides additional triple-A collateral for the proportion of each EFSF bond which is not guaranteed by AAA countries. The shares of the six AAA rated Euro area countries (Germany, France, NL, Austria, Finland and Luxembourg) amounts to 62.4% if you exclude Greece, Ireland and Portugal. Given the 120% ratio, almost three-quarters of each bond issue currently benefit from AAA guarantees. Taking into account the new 165% guarantee ratio, 102.9% of any issue would be guaranteed by AAA countries making any additional credit enhancements unnecessary. The rating agencies will certainly welcome this move. The likes of S&P & Co assume in their models that in the event of a borrowing country default, all non-AAA countries will also fail to honour their guarantee commitments and that the EFSF will have to rely on the AAA countries to ensure the timely payment of its liabilities … The EFSF confirmed to us that the increase of the guarantee ratio from 120% to 165% will only apply to new bonds, i.e. for bonds issued after approvals of the national parliaments. The existing bonds (and bonds issued before the introduction of new guarantee ratio) will continue to benefit from a loan specific buffer. This means that the market will be split into ‘EFSF bonds backed by loan specific buffers’ and those ‘completely guaranteed by AAA countries’.

Interestingly, RBS think the change will mean more invest-able EFSF bonds since the portion of each issue that’s guaranteed by Germany and France will increase from 61.2 per cent to 84.2 per cent. They even think newer EFSF bonds will trade inside their older, collateral-backed EFSF counterparts.

They do note, however, that “initial client feedback seems mixed,” with some preferring to be protected by AAA collateral rather than the higher reliance on guarantees by France and Germany.

One to watch — if only as an indicator of whether investors favour collateral or guarantees.

——

Meanwhile, the eurozone’s other (later) bailout vehicle — the European Stability Mechanism — has also been tweaked. A sticking point in the ESM plan has always been the fund’s planned ‘preferred creditor status,’ which would mean ESM bonds would get paid back before other (private) debt.

Well, no longer! As the FT reports on Tuesday, bonds issued by the ESM will rank the same as other any other debt, according to comments made by Eurogroup president Jean-Claude Juncker.

That’s subordination slain — not too much of the burdensharing.

Of course, the bond market is pretty happy about this. Here, for instance is Evolution’s Gary Jenkins:

The only real development of merit was the reversal of the idea that the ESM would benefit from preferred creditor status, at least for the countries that are already recipients of bailouts. Whilst this is undoubtedly positive for bond investors the ESM does not actually commence until mid 2013 and Greece is just trying to get through the next few weeks. However this does demonstrate once again that the EU is prepared to be extremely flexible in their approach to the crisis which bondholders will certainly note when it comes to future negotiations…

Others however, coming from a more public perspective, have decidedly different opinions.

Here, for instance, is financial consultant Achim Dübel:

The right approach to ESM seniority … would not be to deprive the public sector, who provides fresh money in a critical situation, of its straightforward seniority status, but to differentiate between old debt and fresh money generally. Old debt, which created the debt crisis, must not be given pari passu status with any sort of fresh money. However, different investor classes of fresh money can be treated pari passu among themselves, in full seniority. This ‘solution’ of yesterday – a classic Juncker – will increase calls in net creditor countries to vote one by one over each rescue operation.

Well. No one ever said this bailout policy stuff would be easy.

Related links:
That tricky ESM seniority – still tricky – FT Alphaville
The incredible increasing EFSF – FT Alphaville

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