Peter Tchir

Spanish Bank Bailout Analysis – According to EFSF FAQ

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Peter Tchir

Peter Tchir

 

Okay, it is a bit scary that the only details that have made it to the public on what a Spanish bank bailout might look like are from the EFSF’s FAQ page. But it seems to have addressed a lot of the questions and the answers seem reasonable. Here is the entire FAQ if you want, and below is the part addressing Spanish bailouts, along with my thoughts.

 

 

Section I – Financial assistance for Spain

 

  • I1 – How much is the financial assistance for Spain?

 

On 25 June 2012, the Spanish government made an official request for financial assistance to the Eurogroup. The loan amount will cover estimated capital requirements with an additional 25 June 2012 safety margin that may amount to a total of up to €100 billion.

 

Nothing unexpected

 

  • I2 – When will the actual amount be known?

 

Reviews carried out by independent consulting firms Oliver Wyman and Roland Berger concluded that the Spanish banking sector would require up to €62 billion in capital. The specific amount will be finally determined based on thorough bottom-up audits of the individual financial institutions.

 

Number still very much in doubt as the consulting firm reports seemed pretty poorly done, so expect full €100 billion to be used and some people to scream it is nowhere near enough

 

  • I3 – Will the financial assistance be provided by EFSF or the future ESM?

 

It was stated at the press conference following the Eurogroup meeting on 21 June 2012 that financial assistance for Spain would initially be provided by the EFSF. The assistance would then be taken over by the ESM once the ESM has entered into force upon ratification of its treaty.

 

EFSF at first, then likely ESM, though with current capital call schedule, ESM might not have enough availability, and EFSF looks available for new projects until July 2013

 

  • I4 – Will EFSF/ESM provide loans directly to Spanish financial institutions?

 

The Eurogroup considers that the Fondo de Reestructuración Ordenada Bancaria (Fund for Orderly Bank Restructuring, F.R.O.B.), acting as agent of the Spanish government, could receive the funds and channel them to the financial institutions concerned. The Spanish government will retain the full responsibility of the financial assistance and will sign the Memorandum of Understanding.

 

Clearly using FROB as the receiver of the funds and the administrative agent. It is positive in that they are trying to deal with the banks separate from the government, but negative in that it is clear they are relying primarily on the state guarantee rather than the FROB’s assets

 

  • I5 – Will there be conditions attached to the financial assistance?

 

Yes, the Commission in liaison with the ECB, EBA and IMF will define the conditions affecting individual financial institutions, but will also propose reforms targeting the financial sector as a whole, including restructuring plans in line with EU state-aid rules, and the overall supervisory structure.

 

Supervision and conditions yes, but primarily for the banks that receive money, and to a lesser extent the financial sector, but clearly NOT for the state level. That is a positive as Spain is not yet on a forced diet of German policies.

 

  • I6 – Will EU state aid conditionality apply for the programme?

 

State aid conditionality will not apply for the whole programme, but only apply for the banks which receive financial assistance. The Commission will treat each capital injection or other financial assistance as state aid for the bank concerned, and will apply the same rules as for other European banks in the crisis.

 

A second attempt to clarify that conditionality is only for the banks that receive it. They clearly realize that concern about how it will impact Spain is an issue and are trying to avoid causing that problem.

 

  • I7 – What are the conditions for the Commission to approve state aid for banks?

 

The approval process is linked to the existence of a credible restructuring plan, which demonstrates in a convincing manner how the bank will return to viability without needing further state aid. The plan has to show as well how the bank minimises the cost for the taxpayer and measures for mitigating competition concerns. The plan has to be submitted in the form of a legal commitment by Spain. In that context, the Commission has provided detailed guidance regarding the pricing of State guarantees, recapitalisations and asset relief measures respectively in the Banking Communication, the Recapitalisation Communication and the Impaired Assets Communication as well in the Communication from December 25 2011

 

Definitely conditions for the banks receiving it, but that is necessary for the EFSF and ESM, and ultimately should reduce the risk that there is a loss that the Spanish government has to pay for. If good investments are made, the banks are improved without impairing the sovereign.

 

  • I8 – Will Spain be required to step out as a guarantor of EFSF?

 

According to the framework agreement it is expected that Spain will remain as a guarantor of the EFSF.

 

Another positive sign. The nature of the guarantee structure makes it easy for Spain to stay in, although in reality they aren’t providing any comfort to EFSF bond buyers. It is another step towards trying to define this specifically as a Spanish Financial Sector bailout and not a Spanish bailout. That is subtle, but is different than how it was handled in Greece.

 

  • I9 – When will the financial assistance start?

 

The Spanish government made an official request to the Eurogroup for financial assistance on 25 June 2012. Necessary assessments will now be completed by the European Commission in liaison with the ECB, EBA and the IMF, and a Memorandum of Understanding (MoU) setting out the modalities of the assistance and policy conditionality will be signed by the Spanish government and the European Commission. In parallel a Financial Assistance Facility Agreement will be prepared by the EFSF. Once the Facility Agreement and the MoU have been signed, the financial assistance can then be provided rapidly.

 

Okay, this is weak. Always with the further study, blah blah blah. Would be better to see some concrete initial steps taken and deadlines, since the EU only seems to respond to deadlines – and barely then in many cases.

 

  • I10 – Who will determine which financial institutions receive funds and the amount that each will receive?

 

This will be decided following the assessment from the European Commission in liaison with the ECB, EBA and the IMF, in agreement with the Spanish authorities.

 

A few too many entities involved for my taste, but I think the IMF will try to ensure that money isn’t thrown away and help ensure that FROB assets will not be worthless on day 1, and may even pay back the loans over time.

 

  • I11 – How will the funds be raised?

 

EFSF and ESM once ratified stand ready to provide financial assistance to Spain. The funds may be raised through cash, bills or bonds. However, in a similar manner to the recapitalisation of the Greek banking sector supplied by EFSF in April, it is expected that EFSF/ESM mostly provide bonds, without raising the full extent of the funds in the market.

 

Nothing unexpected but a bit vague. Leaves open the possibility to FROB getting EFSF bonds, then paying for stakes in the banks with EFSF bonds. A bit dodgy, but on the other hand cuts out a bunch of “middle men” all trying to extract some value. Real cash would be better, but once you’ve gone ponzi you might as well go all in. Probably an efficient way to do it, in spite of leaving a bad taste in my mouth.

 

  • I12 – Will the IMF be involved?

 

Yes, though only in an advisory and monitoring capacity. The IMF will not make a financial contribution because it does not have a sectoral financial assistance tool matching the one being used.

 

Another attempt to make it clear that this is at the bank and not the sovereign level. Making it clear no financial assistance coming from IMF. Could have been more clear, but again, I think it is restricting involvement to the use of these proceeds and not the Spanish government overall.

 

  • I13 – What would be the difference between EFSF and ESM loans?

 

ESM support has no impact on the debt of ESM members, while the debt issued by the EFSF is rerouted onto the guarantors.

 

Not sure this is right on ESM. To the extend ESM largely issues bonds against guarantees I think it is fairly similar. This is another one of those where the non credit people and politicians can pretend there is no impact, and the real world will assess what risk the guarantees pose, and it will affect borrowing costs.

 

  • I14 – Will ESM take over any EFSF issuances within the Spanish financial assistance?

 

The Framework Agreement and the ESM Treaty allow for the possibility to transfer EFSF Financial Assistance Facility Agreements to ESM. It is expected that the loan is transferred to the ESM once it is established.

 

Not sure if there is a purpose of transferring after it is created. I would expect ESM to provide the financing once it is set up, but I doubt they go through the effort of redoing loans to change to ESM. If they do, that is a small negative as implies they are more likely to use subordination as a tool if necessary.

 

  • I15 – Would the use of ESM trigger CDS?

 

Though the decision belongs to ISDA, the use of ESM to grant financial support is not expected to have any impact on CDS.

 

Nothing unexpected and EFSF and IMF involvement so far haven’t caused a Credit Event.

 

  • I16 – Will Finland want Spain to post collateral?

 

Finland has indicated that it will require collateral for its share of the loan should the money come from the EFSF.

 

Not new, as Finland has already requested it for Greece, and possibly in general.

 

  • I17 – What would be the financing cost for Spain?

 

EFSF’s financing cost for Spain would be the market rate of bonds issued plus a small operational service fee. The cost would therefore be determined by the maturity of the bonds issued and market conditions.

 

This is very interesting. No attempt really at profit or punitive rates. This is really trying to pass on the benefit of cheap EFSF (and possibly cheaper ESM) funds. The EFSF February 2022 bonds yield 2.65%. With more issuance those yields could go up, though they are already at a premium to the average of the primary backers. In any case, the FROB may get sub 3% money for 10 years. A far cry from some of the rates in early bailouts and much better than when ECB buys bonds on the secondary market where there is no provision.

 

  • I18 – What would be the impact of the bank rescue package on Spanish government deficit and debt?

 

According to a statement by Eurostat, issued on 12 June 2012, the loan taken by the Spanish government will directly increase the Spanish government debt. There will also be a direct deficit impact for Spain for the interest expenditure on the loan. As regards the impact of the recapitalisation, the deficit impact depends upon whether or not the capital injections are considered government expenditure.

 

A capital injection will be considered as a financial transaction, with no impact on government deficit, when the government is acting in the same manner as a private investor, by seeking a market rate of return. A capital injection is considered as government expenditure, with an impact on the government deficit, when it is de-facto covering the losses of a bank.

 

Honestly, this is probably important to some people, but for anyone trying to do actually credit work on the countries the Eurostat figures went into the Eurotrash a long time ago. Investors will decide on what the loans do to the Spanish balance sheet, but if the investments are actually good investments, the market may care less than Eurostat for a change.

 

If the FROB makes the investments seeking a market rate of return (which it should be doing) then it wouldn’t count as a government expenditure. That might be important as it might impact Germany’s view of the deal and not interfere with the Fiscal Compact.

 

  • I19 – What is the Basel risk weighting for EFSF and ESM loans?

 

The Basel risk weighting for EFSF and ESM loans is 0%.

 

Stupid but probably helps. They might avoid selling bonds to the market and just pass them through the chain, but if they do choose to sell, then the risk weighting makes it easy for banks to buy as no real increase in leverage and I’m sure the ECB is happy to fund any bank that wants funding for these notes/loans.

 

  • I20 – What is the remaining lending capacity for EFSF/ESM?

 

The macro-economic assistance programmes for Ireland, Portugal and Greece correspond to €192 billion in commitments from the EFSF. The EFSF has therefore €248 billion in remaining capacity.

 

The ESM is expected to enter into force in July 2012. The ESM’s maximum capacity will be €500 billion. The first two tranches of the capital – each tranche worth €16 billion – are expected to be paid in in July and October 2012.

 

I remain a bit confused. It does look like they try and reset to a fresh €500 billion once ESM goes on-line, but I thought they were more constrained by prior EFSF issuance. This could be accurate or it could be sloppy documentation on their part. I have to dig out latest version of treaty to see what was finally agreed upon. But with bank recaps there will not be much money left to play in the secondary market or help the primary market unless they can get internal leverage – get margin lending from someone (cough ECB cough) to let them use capital to massively leverage a bond portfolio.

 

Seems like a pretty powerful tool

 

Not as good as a program that didn’t rely on Spanish guarantees, but most of the questions are answered as positively as possible, and do fit within the treaty’s that are in place and the mechanisms that are at their disposal – a key point as it will be hard to change treaty’s or mechanisms in a timely manner.

Ultimately the test will be getting the money and seeing what investments they make. Injections that look like a waste of capital will hurt the Spanish government debt, but if the FROB starts making investments on the sort of terms that Buffett gets, people may warm to the idea that the banks have enough capital and that the FROB will pay for itself without dragging the Spanish guarantees into play.

Again, I wish I had an actual document to go from and we will see what finally gets approved, but this FAQ gives me comfort that the EU is changing their tactic and is being much more progressive and actually helpful.

Copyright © 2012 · Peter Tchir

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