The paid-in Spain | FT Alphaville

The paid-in Spain

“If the Spanish state has difficulty in financing itself outside Spain, then the difficulties will be even greater for those in the private sector…”

– BBVA’s chairman and chief executive, two years ago

Circularity. Reinforcing the sovereign-bank loop. However you’d put it – this weekend’s ‘rescue’ deal for Spain’s banks seemed designed to avoid doing this. Or at least to avoid appearing to do so.

Spain borrows up to €100bn from the EFSF and later, the ESM, presumably at generous rates compared to what the market will charge (key point this). Spain’s bank recap vehicle ‘could receive the funds and channel them to the financial institutions concerned.’ Loan conditions are targeted at fixing banks. No programme for the sovereign. The loop is broken, Spain is freed from bearing its banks’ recap, etc. (More on what the conditions really mean in our next post…)

So who’s backstopping the eurozone loans in the first place?

To a certain extent — Spain.


First of all, just in case anyone’s still confused, it’s worth pointing out here that the Kingdom of Spain remains the borrower for loans from both the EFSF and the ESM.

  • The bank recap fund, FROB, enjoys the “explicit, unconditional and irrevocable guarantee of the Kindgom of Spain.”
  • The EFSF’s loan is likely to come under its bank recapitalisation tool. This means the funds would be “consistent with the pricing of a standard EFSF loan to a beneficiary Member States since the latter will remain the ultimate liable counterparty.” (The loan rate pricing is incidentally crucial to the whole enterprise, and to Spanish bonds rallying from here. The market had already been pricing €100bn of banking recap funds, but pricing them borrowed at closer to 6 per cent rather  than 3 per cent.)
  • The ESM can only make bank recap loans “to an ESM Member” under Article 15 of its Treaty (which is still pending full ratification). If FROB is receiving the funds, the ESM must be equating FROB’s credit with Spain’s. We’ll come back to this point at the end of the post.


Who guarantees?

Now though let’s turn to the sovereigns who guarantee the EFSF when it issues debt to cover loans, and who subscribe capital to the ESM. More to the point — how one might stop guaranteeing or providing capital.

Although the EFSF will likely only be needed until the ESM Treaty is fully ratified and therefore its lending to Spain won’t be much compared to the ESM’s, you can see how a Spanish operation might turn attention back to its guarantees.

We don’t need to go into the correlation flaws of the ‘scratch my back, I’ll scratch y–I’m broke, can everyone else take over?’ guarantee structure of the EFSF, when guarantees turn bad, or sovereigns ‘fall out’ of the structure. Tracy did it ages ago. (Also see here.)

But we should note the EFSF framework provisions for ‘stepping out’ from guarantees. Starting with Article 2(7):

Article 2(7)

If a euro-area Member State encounters financial difficulties such that it makes a demand for a Financial Assistance Facility Agreement from EFSF, it may by written notice together with supporting information satisfactory to the other Guarantors request the other Guarantors (with a copy to the Commission, the Eurogroup Working Group Chairman) to accept that the Guarantor in question does not participate in issuing a Guarantee or incurring new liabilities as a Guarantor in respect of any further debt issuance by EFSF…

Article 8(2)

In the event that a Guarantor experiences severe financial difficulties and requests a stability support loan or benefits from financial support under a similar programme, it (the “Stepping-Out Guarantor”) may request the other Guarantors to suspend its commitment to provide further Guarantees under this Agreement…

Reading this, the case for Spain stepping out from guaranteeing EFSF ops on its own behalf seems clear. Until you go back and read clause 4) of the EFSF framework’s preamble. We might be seeing things, but it appears to rule out ‘stepping out’ under Article 2(7) with the kind of loan which Spain intends to ask for. Here it is in full (emphasis ours):

EFSF shall finance the making of Financial Assistance by issuing or entering into bonds, notes, commercial paper, debt securities or other financing arrangements (“Funding Instruments”) which are backed by irrevocable and unconditional guarantees (each a “Guarantee”) of the euro-area Member States which shall act as guarantors in respect of such Funding Instruments as contemplated by the terms of this Agreement. The guarantors (the “Guarantors”) of Funding Instruments issued or entered into by EFSF shall be comprised of each euro-area Member State (excluding any euro-area Member State which is or has become a Stepping-Out Guarantor under Article 2(7) prior to the issue of such Funding Instruments). It is not anticipated that a request under Article 2(7) of this Agreement would be made by a euro-area Member State which has requested Financial Assistance in the form of a precautionary facility, so long as such facility is not drawn or utilised, a facility to finance the recapitalisation of financial institutions in such Member State by way of a loan made to such Member State or a facility for the purchase of bonds of such Member State in the secondary market.

So would Spain really step out of guarantees on EFSF debt? Debt issued to finance loans to Spain to transfer to FROB to transfer to Spanish banks. Thoughts on a Luxembourg postcard.

Now turning to the ESM. This vehicle dispenses with guarantees and instead issues shares to member states, providing it with initial paid-in capital over a series of instalments: the first instalment will come due 15 days after the ESM is ratified. It’s more flexible as a structure. The ESM will lever this capital base to issue debt. It’s also authorised to call extra capital.

Compared to the EFSF framework however, Article 8(4) of the ESM Treaty has no stepping-out clause on states’ undertaking to provide capital:

ESM Members hereby irrevocably and unconditionally undertake to provide their contribution to the authorised capital stock, in accordance with their contribution key in Annex I. They shall meet all capital calls on a timely basis in accordance with the terms set out in this Treaty.

In that case, Spain will go on providing capital to the ESM throughout the bailout for its banks.

The first paid-in capital instalment we mentioned would probably arrive in July at this point, assuming the ESM is ratified on schedule, and would come to €32bn. Spain’s share would be around €3bn. Hardly an enormous burden, even for a sovereign with market access as ropey as Spain’s.

But surely both this and (possibly) the EFSF guarantee thing show that the lines between banks, sovereign, and bailout fund remain seriously smudged. That ultimately leaves us with the question of how much longer Spain does have market access, even with this operation to separate recap funds for its banks.

Finally, while we’re on the subject, there’s the small matter of Spain and the ESM’s preferred creditor status… FROB might receive ESM funds but as noted above, this appears to be on the understanding that FROB has the full faith and credit of Spain. Therefore, we’d assume ESM loans will be senior to the stock of Spanish government bonds. The yields on these bonds should arguably now price in relief from Spain not having to recap the banks all by itself. What price potential subordination though?

At any rate — pending an actual request from Spain and clarification on terms by the Eurogroup, the Spanish bank bailout doesn’t seem to be the happy severing of sovereign and bank which you might think it is.

And that’s before we get to the bailout conditions…