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Nomura on Greek Debt 27 10 11

Nomura on Greek Debt 27 10 11

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MGM Mirage
Credit Research | United States
Euro area Comment
Nomura Global Economics
Nomura International plcSee Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures
27 OCTOBER 2011
EU Summit: Progress made on EFSF and Greek debt PSI
Contributing AnalystsLaurent Bilke Dimitris Drakopoulos Nick Firoozye Jens Sondergaard
+44 20 710 30022 +44 20 710 33611 +44 20 710 25846 +44 20 710 21969-
 A late-night deal with banks and insurance companies appears to secure a 50% loss on Greek debt holdings.
European leaders agreed last night on plans to recapitalize banks and leverage the EFSF.
- Total firepower of the leveraged EFSF will only be clear once finance ministers complete their work by November.
The European leaders tonight announced a number of policy measures intended to address the sovereign debtcrisis in the euro area. Our take is that the outcome is marginally better than anticipated on the EFSF, in line withrather low expectations on banking sector recapitalisation, but better than expected regarding the Greek debt relief.We had very low expectations for these meetings, but on several accounts, the announcements appear better thanthe 21 July package, which fell short of bringing significant debt relief to Greece or ring-fencing Spain and Italy.Some important step towards addressing Greek debt sustainability could have been made and a few criticalquestions for financial markets remain in the background.
What was actually announced?
On Greek PSI,
the leaders have apparently struck a deal with private banks and insurers late in the nightto accept a 50% loss on holdings of Greek government bonds, with a objective to lower Greece’s debt-to-GDP ratio to 120% by 2020, as suggested by a leaked IMF debt sustainability report last Friday. Thiscorresponds to a 100bn reduction, and is supposed to occur in January. Euro area member states areexpected to contribute up to EUR30bn to the PSI, and a new EU-IMF multiannual programme, which willfinance up to 100bn, is expected to be put in place by the end of the year.- The EU-27 heads of state agreed that
should have 9% core capital level by June 2012, withspecific plans – agreed with the national supervisors - for achieving that goal. The recapitalization plansshould take into account sovereign write-downs (based on end-Q3 2011 market prices) and must not leadto excessive deleveraging. Separately, the European Banking Authority announced that this would amountto a capital injection of €106bn. National governments are allowed to recapitalize banks, but only if thebanks cannot find the capital via private sources. EFSF resources should be used only as a last resort. EUleaders also called for a plan to guarantee bank liabilities in an effort to support banks’ access to termfunding.- On increasing the firepower of the
, the euro area heads of state announced plans to leverage up theEFSF “several fold” by opting for the two model approach – the credit enhancement option and the specialpurpose vehicle (SPV) option – both being deployed simultaneously. The IMF could potentially play a rolein terms of the total resources available. The Eurogroup is to finalize the precise details in November.- The euro area heads of state welcomed the steps
took to reduce its budget deficit, restructure thebanking sector, implement structural reform and adopt a constitutional balanced budget amendment. Butthe euro area leaders also called for more measures as well as further structural reforms. Italy also madenew commitments to structural reform.- The leaders agreed that further economic integration is needed for the “completion” of the economic andmonetary union. More economic governance, which may involve limited Treaty changes, is beingconsidered.
The positive elements in the package:
Nomura| Euro area Comment 27 October 2011 2
Some elements of the package are actually better than we anticipated last week.- We had anticipated that the Greek debt PSI was moving toward a 50% haircut, but did not expect a deal tobe struck with the private sector and certainly not at this stage. It remains to be seen exactly whoparticipates, whether CDS will be triggered in the event that participation does not reach a required leveland whether the 120% target by 2020 is realistic (but it seems to be as first glance), but this is decisiveprogress which we did not think would come at this stage.- On the credit enhancement option, the guarantee mechanism for new issuance by Spain and Italy will bestrippable, so the guarantee certificates can trade freely from the BTPs and SPGBs, thus reducing thepossibility of a two tier bond market while also likely reducing the cost of default protection. The secondoption, the SPV, would seek funds from outside investors – possibly the IMF – offering credit enhancementfrom the EFSF to purchase exiting bonds issued by Spain and Italy. While the SPV option could somewhattemper concerns that the guarantee mechanism would result in a two-tier bond market, it will certainly noteliminate it, as only a very large SPV could do that (the outstanding of Italian and Spanish bonds totalapproximately €2.5trn).- The political hurdles to get the enhanced EFSF up and running appear to have lessened compared to the21 July package, when the August holiday break and difficult discussion regarding the size increase of theEFSF implied that any package would take months to come into force. The German Bundestag alreadyconsulted and agreed upon today’s EFSF measures. This pre-emptive consultation process – initiallythought to be an obstacle to today’s decision – actually cleared the way for a deal.- Today’s announcement paves the way for an actual increase in the total firepower of the EFSF through“leverage”. Depending on the investor take-up of the SPV option and the degree of credit enhancement, wethink it is possible for the EFSF’s firepower to reach €1trn.
The negative elements in the package:
- As we expected, however, the announcement falls short of details on the actual firepower increase of theEFSF. This will be unknown until there is clarity regarding who will invest in the SPV; be it the IMF (if that ispossible at all) or some SWF. Already, Brazil has declared it had no intention of participating. In any case,it cannot be taken for granted that seeing more individual countries joining the dance to rescue theEuropean periphery will stabilise the framework.- Another important drawback of the plan is that it offers no clarification regarding the continued involvementof the ECB in secondary market operations. Actually, if anything, more questions are raised by theBundestag call for the ECB to end its bond buying programme once the enhanced EFSF is up and running.If bond buying by the EFSF SPV facility is meant as an alternative to the ECB’s SMP, then we doubtwhether it can perform the tasks as efficiently as the central bank. That’s a concern. But in any case, thisissue will not be cleared for several weeks.- The bank recapitalization plans were in line with our expectations for a slow strategy with a June 2012deadline and that capital would be met by first by private, then public, and finally by EFSF funds. The ideaof guaranteeing bank funding is an interesting new idea that has potential to unblock the bank fundingmarkets. But whether this has a beneficial effect depends on the precise details on how it will be done. TheEuropean Commission has been “urgently” tasked to explore options.
The bottom line:
Overall, we acknowledge that some important missing parts from the July agreement have been included here (e.g.,lowering Greece’s debt burden as well as ring-fencing Italy and Spain). Last night’s agreement alone will probablynot resolve the euro area issues once for all, but if the details of the new PSI are confirmed in the coming weeks,this marks an important moment in the resolution of the crisis. Most crucially now, we will see whether a CDStrigger is required.
Market implications:
The market take is likely to be positive, in our view, given that expectations were generally very low ahead of themeeting. Even though the outcome falls well short of the “leverage” expectations that initially triggered the rally inrisk sentiment about three weeks ago, the PSI part is better than expected, if indeed a substantial voluntary dealhas been reached.
Nomura| Euro area Comment 27 October 2011 3
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