A couple of stories out of Europe that I didn’t catch in my morning post.
The changes to the EFSF has been ratified by the European Finance ministers:
Euro area Finance Ministers agreed on 29 November on the terms and conditions to extend EFSF’s capacity by introducing sovereign bond partial risk participation and a Co-Investment approach. Ministers also adopted amended EFSF guidelines concerning intervention in the primary and secondary debt markets and precautionary credit lines in order to use leverage. Klaus Regling CEO of EFSF commented “Both options are designed to enlarge the capacity of the EFSF so that the new instruments available to the EFSF can be used efficiently”.
Under the partial risk protection, EFSF would provide a partial protection certificate to a newly issued bond of a Member State. The certificate could be detached after initial issue and could be traded separately. It would give the holder an amount of fixed credit protection of 20-30% of the principal amount of the sovereign bond. The partial risk protection is to be used primarily under precautionary programmes and is aimed at increasing demand for new issues of Member States and lowering funding costs.
Under option two, the creation of one or more Co-Investment Funds (CIF) would allow the combination of public and private funding. A CIF would purchase bonds in the primary and/or secondary markets. Where the CIF would provide funding directly to Member States through the purchase of primary bonds, this funding could, inter alia, be used by Member States for bank recapitalisation. The CIF would comprise a first loss tranche which would be financed by EFSF.
Chris Frankel CFO and Deputy CEO of EFSF commented “Following extensive discussions with investors covering all types and geographical regions, a number of them have given their positive views and signalled their willingness to participate.”
EFSF will now implement these two approaches to be ready early in 2012 to use them effectively in the context of the guidelines for the new instruments on market interventions.
So the EFSF will now become a dual CDS and CDO, possibly with some IMF involvement. I have explained previously the issue with the facility is the conditions that come with its use:
The trouble with the EFSF is that it is backed by sovereign nations that have already been locked out of conventional markets. This obviously assumes that they are under significant financial stress and there is the high likelihood of default. This has been the case of Greece which has been under instruction from the IMF to implement economic adjustments very similar to the ones specified in the EFSF charter. For highly indebted non-export driven nations such as Italy, Portugal and Spain these measures are likely to make their underlying economies worse while they are attempting to meet their obligations to the EFSF loan. Under these circumstance there is a fair chance that something will eventually go wrong, and if recent history is anything to go by CDOs have a funny habit of under-performing, leading to the requirement for re-capitalisation and more incentives from guarantors to stop the funds from imploding. Just imagine if Greece had been under an EFSF loan over the last 12 months… Now imagine if that was Italy.
And it seems even the creators of the facility now admit that is will be an inadequate fix for the Eurozone:
… Even so, Rehn, Juncker, and Regling were quick to admit that “no one single silver bullet that will get us out of the crisis.” This statement suggests that EU leaders might already be thinking about more radical intervention—likely by the European Central Bank or in the form of eurobonds.
Rehn told reporters that the facility will fall short of its €1 trillion ($1.4 trillion) firepower goal. Journalists and investors have argued that the fund would need to be expanded further even if it reached that unlikely goal.
In other news Greece has got a little more cash:
Euro-area finance ministers approved a 5.8 billion-euro ($7.7 billion) loan to Greece under last year’s bailout after eliciting budget-austerity pledges from Greek political leaders backing a unity government.
The go-ahead for the sixth disbursement of funds under the fully taxpayer-funded package of 110 billion euros shifts the spotlight to a second rescue of Greece that foresees 50 percent losses for private investors in Greek bonds. The new aid plan, crafted at an October summit, also includes 130 billion euros in extra public funds.
After initially endorsing the next loan for Greece on Oct. 21, the euro area froze the payment this month because former Socialist Premier George Papandreou announced a referendum on the second rescue plan. He later called off the vote, resigned and was succeeded by ex-central banker Lucas Papademos, whose interim government has the support of three parties to press ahead with budget cuts needed for continued aid.
And what an amazing soap opera it was. Obviously the problem for Greece is that, as the IMF have all but admitted, austerity continues to make their economy worse so there is no doubt they will continue to require even more money in the future. They are attempting asset sales, but these have been very underwhelming to date. The 50% haircut is now in focus, although there are doubts whether it will actually occur, but even if it does, 50% isn’t really half:
Even if all private investors, banks, and insurers write down half of their Greek debt holdings, they would only reduce Athens’ liabilities by about 100 billion euros – or less than 30 percent of the total debt pile.
With almost 80 billion euros invested in Greek sovereign bonds, Greek banks hold a large portion of the 200 billion euros worth of debt currently in private hands. It remains to be seen whether these troubled lenders are really in a position to take a voluntary haircut.
“A writedown would leave Greek banks requiring somewhere between 11 and 14 billion euros in fresh capital to keep afloat,” financial analyst Peter Leotsakos wrote on the online portal Bankingnews.gr.
“They wouldn’t be able to raise that kind of money on the markets. The banks would need to be taken over by the European Financial Stability Facility (EFSF) until new capital becomes available,” he added.
If all Greek banks opted out of the writedown plan, the amount of debt wiped in the EU rescue plan would fall from 100 billion to just 60 billion euros – or 17 percent of total Greek debt.
There will also be some substantial flow-on effects to other nations if the haircut goes through:
Cypriot banks are badly exposed to toxic debt in Greece, and must face a write-down of Greek bonds, a so-called haircut, of 50 percent.
On Tuesday, the Bank of Cyprus, the country’s biggest lender, posted an accumulated net loss of 801 million euros for the first nine-months of 2011.
In the results, the bank announced a write-down of 1.06 billion euros on Greek debt holdings as part of its agreement to take part in the latest bailout of Greece agreed at a eurozone summit in October.
Economist Fiona Mullen said although Bank of Cyprus may be able to survive the write-downs required to cover the voluntary losses on Greek debt, Marfin Popular Bank will struggle to raise the additional cash needed.
“Marfin at the very least will have to beg for money from the government, which doesn’t have that kind of spare cash,” Mullen told AFP.
On to the ECB->IMF->EFSF->sovereign bond Euro swap plan!