EU – Problem Solved?

Aqui fica a análise da Hawkeye Wealth após a reunião de lideres europeus.

Yesterday’s EU Summit* resulted in a step towards the short-term stabilization of the Euro Area and its Member States. The crucial breakthrough was to end the deadlock over private sector involvement demanded by Germany but opposed by the ECB which allowed an increase of funds available for the Greek bail-out as well as an improvement of the flexibility of the European Financial Stability Facility (EFSF).

 

According to the statement made after the Summit the following key measures were agreed by the member states and the government and institutions of the Euro Area:

 

1)      The support of a new programme for Greece and, together with the IMF and the voluntary contribution of the private sector, to fully cover the financing gap being the total official amount an estimated EUR 109 billion. The programme was designed through lower interest rates and extended maturities and the EFSF will be used as the financing vehicle for the next disbursement.

 

2)      The maturity extension of the existing Greek facility as well as the extension of future EFSF loans to Greece to the maximum extent possible from the current 7.5 years to a minimum of 15 years and possibly up to 30 years with a grace period of 10 years and also the provision of loans to the EFSF at lending rates equivalent to those of the Balance of Payments (currently at approximately 3.5%), without going below the EFSF funding cost. The EFSF lending rates and maturities agreed for Greece will also be applied for Portugal and Ireland.

 

3)      The set-up of a Task Force to work with the Greek authorities in order to target structural changes, competitiveness and growth in order to re-launch economy.

 

4)      The decision of a private sector involvement with a net contribution of EUR 37 billion plus a commitment from the financial sector to contribute with a EUR 12.6 billion to the debt buy-back programme bringing the total net amount to EUR 50 billion.

 

5)      The improvement of the flexibility of the EFSF and the ESM allowing them to act on the basis of a precautionary programme, finance the recapitalization of financial institutions through loans to governments including in non-programme countries and intervene in the secondary markets when financial markets circumstances apply to avoid contagion. A collateral arrangement could be put in place to cover the risk arising to Euro Area Member States from their guarantees to the EFSF.

 

6)      Finally, the reliance on external credit ratings in the EU regulatory framework will also be reduced.

 

Although we think that the output from the EU Summit may bring some peace to the financial markets for the short term as finally the authorities admitted that there is a problem of solvency to be assessed we think that one more time the presented solution lags in time and is not efficient enough due to several fragilities. Structurally, we would say that the mutualization of the sovereign debt through the EFSF will not be put in place without risks as in opposition to the ECB funding facility (SMP), the EFSF needs to issue bonds backed by the Euro Area State Members in order to be able to fund the countries in trouble. The interesting points to be noticed are that the EFSF ability is very limited per comparison to the ECB as this last can just replace the credits on its balance sheet (sterilized operations) or monetize (issue Euros and repurchase debt), per opposition to the EFSF where the Members States that are in trouble (Portugal, Greece and Ireland) and the ones on the edge (Spain and Italy) will also be part of the guarantee states and these guarantees will be taking into account in their public debt increasing even more the debt burden struggling. We would just say “what goes around comes around”!

 

 

The fact that the EFSF needs to fund itself in the primary market may contribute for the convergence of sovereign yields on the upside and not on the downside as the authorities expect, not having the effect estimated in the debt burden reduction. We consider that the fund size, EUR 780billion backed by sovereign guarantees, is definitely small for all the functions that the European authorities attributed as for example only the fact that a reschedule of the Greek debt would trigger a selective default, as per Moody’s and S&P, and consequently the non-acceptance of these issues as collateral by the ECB which would put great pressure on the EFSF as many European financial companies would require collateral arrangements in the face of such an event in order to maintain its short-term funding. We believe there is no other way of solving the size issue without bringing the ECB into the equation. The plan presented will add contribution to a growth slowdown which in conjunction with the non-synchronized ECB interest rate action and a strong Euro will not help the countries in trouble to come “out of the hole”. Finally we would say that this Euro-Brady** version will likely achieve a transfer of risk to the common stabilization facility and a potential reduction of Greek debt owned by financials with an NPV impact of 21%, far away from the 50% haircut needed for the Greek sustainability, but will definitely not be enough to stop the crisis as the solvency issue is now not only regarding Greece. Politicians and authorities need to understand that the only way to repay debt is through wealth creation, meaning economic growth!

 

 

*Statement by the Heads of State or Government of the Euro Area and EU Institutions (pdf format in attachment).

**Euro-Brady Bond Program – Banks will convert their current holdings in Greek bonds in equal terms into 4 instruments:

1) a par bond exchange into a new 30 year instrument collateralized by 30yr zero coupon AAA rated bonds at rates of 4pc for year 1 to 5 then 4.5pc for year 6 to 10 and then 5pc for year 11 to 30. The zero coupon bonds are purchased using EFSF funds. The principal will be repaid to the investor using the proceeds of the maturity of the zero coupons.  Implied interest rate of 4.5%

2) a par bond offered at par value to roll into a new 30yr par bond as the time the current claim matures. The principal is collateralized using same zero coupon mechanism as 1). Same coupon than 1).

3) a discount bond exchange offered at 80pc of par into a new 30 year instrument. Principal collateralized with zero coupon as 1/. Coupon paid is 6pc in year 1 to 5 then 6.5pc in year 6 to 10 then 6.8pc in year 11 to 30.

4) a discount bond exchange offered at 80pc of par for a 15yr instrument. Principal is partially collateralized with 80pc of losses being covered up to a max of 40pc of notional value of new instrument.

 

Source: Natixis, Credit Suisse, Morgan Stanley, Council of the European Union

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