Wednesday, July 18, 2012

Surprisingly little collateral damage as Spain and Finland reach a deal

Spain and Finland last night reached a deal on the provision of collateral for the Finnish share of the Spanish rescue package. This is the second collateral deal which Finland has struck, following the one on the second Greek bailout, although thankfully this one seems slightly simpler and much more transparent.

The full presentation on the deal is here, unfortunately in Finnish, (an English summary can be found here), but we’ll outline the key points for you and also add some of our reactions in bold:
  • Finland will receive €770m from Spain’s deposit guarantee fund which will be invested in Triple-A eurozone government debt and held in an escrow account. The idea here is that the deposit guarantee fund isn’t part of the state therefore no issues will arise in terms of subordinating existing debt holders (see here for a fuller discussion on this issue of ‘negative pledge clauses’). A technicality but it should hold and at least it allows more transparency since the deposit fund is still a somewhat public institution (rather than private commercial one as in the case of the Greek banks which provided the collateral for the previous deal). 
  • The amount covers only 40% of Finland’s contribution to the Spanish bailout, based on the largest expected losses under a default. Logically this may seem to be enough given the size of the Spanish economy and historical recovery values from defaults. Unfortunately, if it gets to the stage of a Spanish default (a very unlikely scenario), the implications for the eurozone are likely to be huge (possibly a full break up) meaning 40% collateral would be of little value. Although in that scenario Finland would have a lot more problems to worry about that just recovering the bailout loans. 
  • The collateral will stay in place even if the loans are transferred from the EFSF to ESM. This is a result of the transferred loans not having seniority, if they did we’re sure the collateral deal would be unwound once the ESM was in control. 
  • Finland has also agreed to forgo any potential profits form the loans and pay in its capital to the ESM, the eurozone’s permanent bailout fund, in one instalment rather than five. The forgoing of profits is an interesting precedent, although given the incredibly low premium charged on the Spanish loans (as we discussed here) it is unlikely much will be made in this instance. The paying in of capital will force Finland to stump up cash quicker than expected but will amount to only €1.44bn, which should not be a problem given the strong state of the Finnish economy. 
  • The Finnish parliament will debate the deal on Thursday and likely vote on it on Friday. Any euro debate in the Finnish parliament is always heated but this one seems likely to pass without incident. It also means the deal will be ready for the eurozone finance ministers’ discussion on Friday afternoon where the Spanish deal is expected to be finalised. 
All in all, it’s fairly similar to the Greek deal and despite being more public still fairly limited on precise details. One further point to note is the speed and relative ease at which the deal has progressed – particularly in that objections from other member states have been muted. This is to be expected, the rubicon had already been crossed with the Greek deal, but we also think the points which Finland gave in on (profits and speeding up ESM payments) may have played a role - both points which countries with higher debt levels may have been keen to avoid.

1 comment:

Rik said...

HIstorical recovery rates are often much lower than 60%. Probably 30% is a better guess.

If it comes to a recovery-situation imho we will either have a soft one:
-only termstructure is changed so there is no direct cash-flow problem anymore for roll overs. Possibly also as a starter, to avoid AAAs and Co having to take bookkeeping losses/budget expenditures. The latter would mean real cuts in the North and the support that is left under even greater pressure.
Another sort of haircut means also transferring a lot of the problem to the European banking sector. As these would have to account for losses as well in the latter situation. Lower capital etc.

-optimalisation solution. Enough to make the consideration worthwhile but as low as possible for local reasons. (Heavily depending on the financial situation of that moment(primary surplus or not basically, in which case EZ support would be needed or better hoped for)).
In which case 30% recovery sounds like a good guess.

But this is no financial problem, this is purely an internal Finnish political one. So it is basically whatever the Fins can live with.

Problem is that Spain and Italy look different financially at the moment. Italy iso its much higher debt looks much better under control. However they will likely play at more or less the same time. Simply forced by markets.
So if say Italy has a primary surplus and it would go for Iexit. Basically forcing Spain into it as well, although it is not ready at all or a huge and direct EZ intervention.