From structure to size
FT columnist Wolfgang Münchau muses in Monday’s paper that the EFSF largely resembles a giant CDO, albeit one with a triple-A rating. Moody’s, Fitch and Standard & Poor’s granted the facility AAA ratings last week. That top-tier rating will help keep the EFSF’s funding costs low, but it does come at a price.
You can see the issue in the below diagram, from Barclays Capital:
In order to achieve the triple-A rating, the EFSF has to overcollateralise.
That is, in this case, it guarantees 120 per cent of the bonds it wants to issue. There’s also a cash reserve, and a loan-specific cash reserve. That total credit enhancement is the ‘BCD’ bit sitting at the top of Barclays’ illustrative structure, and along with ‘potential additional support,’ gives the EFSF its triple-A.
But a consequence of the overcollateralisation is that the funds available for disbursement are less than they would otherwise be — the ‘ABCD’ minus the ‘BCD.’ Münchau reckons a “realistic” ceiling would be about €250bn — far less than the touted €440bn. BarCap reckons it’s about €255bn. There’s also the already-mentioned issue that as more countries tap the EFSF, the more other members’ obligations rise, since facility-requesting members, for obvious reasons, are excluded from contributing.
It’s worth noting the EFSF itself has said that lending capacity is dependent on “a number of variables,” but that eurozone members “will provide guarantees for EFSF issuances up to a total of €440bn . . . the available amounts under the EFSF will be complemented by those of the European Financial Stability Mechanism (€60bn) and of the IMF. They are sufficient to deal with possible needs.”
An expensive exercise
There’s also the issue of rates. The total rate paid by EFSF borrowers is meant to cover the cost of funding, plus a margin to remunerate the guarantors, the other eurozone member states. However, any EFSF takers would be paying for the overcollateralisation.
Under the terms of the facility, borrowers have to make interest payments on the entirety of the loan (‘ABCD’ in the above) and not on the actual amount received (‘A’). As BarCap notes, given the difference amounts to some 20 per cent, this could (at current market rates) add up to around 150 basis points in extra cost per year.
The charged interest rate itself is meant to be similar to the Greece emergency loan package put together in the spring. For variable-rate loans, the basis is three-month Euribor, while fixed-rate loans are based upon the rates corresponding to swap rates for the relevant maturities. There’s also a charge of 300bps for maturities up to three years, and an extra 100bps per year for loans longer than three years, as well as service fees.
Münchau comes up with a rough estimate that borrowers could end up paying a total interest rate of about 8 per cent — far above and much more than the 5 per cent Greece paid when it tapped its €110bn European Union emergency loan back in May.
BarCap’s back-of-the-envelope calculations has the total borrowing cost above 8 per cent. That’s about 80bps (3m Euribor) + 300bps (EFSF mark-up) + 150bps (due to the fact that the interest has to be paid on the whole loan) + 300bps (service fees). As BarCap also note, requesting EFSF funds would also likely entail some strict policy conditions, similar to IMF conditionality.
In other words, tapping the EFSF is not a cheap or easy option at all. The facility, perhaps unsurprisingly, was structured largely to benefit the guarantors, often at the expense of potential borrowers.
There’s still some uncertainty as to what degree the EFSF’s AAA depends on the ratings of individual members. Münchau believes “the whole edifice would collapse if France was downgraded.” These are improbable events but, needless to say, the same could well go for Germany. For smaller EFSF contributors (Austria, Netherlands) the impact is up in the air.
As a structured finance side note, the correlation assumptions here are interesting. Moody’s for instance, seems to be using an ‘asset correlation’ number (a judgement of the “the link between the environment surrounding” multiple credits) of 50 per cent. If that were to rise, to say 80, or 90, or 100 per cent, the EFSF rating could also be affected.
Not saving anything
Even if a eurozone country were to swallow the high costs of an EFSF loan, and request funds, it might not be enough to stave off a wider eurozone crisis. The potential for an EFSF request to trigger panic and contagion is there, we think. Note that the facility is not pre-funded, which means if a request were made, it would have to issue bonds precisely when markets might be most in turmoil.
Given the high costs associated with requesting EFSF funds, and the potentially limited amounts it might offer, Europe’s best chance is that no one — Ireland or otherwise — is ever actually forced to tap it.
That’s probably exactly what the EFSF’s architects were hoping for when they drew up the blueprint for it earlier this year.
And it shows.
Superfund pill fails to remedy the SIV illness – FT
Europe’s SPV – not saving anything? – FT Alphaville
SPVery complicated in Europe – FT Alphaville
The EU’s very own AAA SPV – FT Alphaville