Or, how many acronyms can we fit in a single headline?
Part of the European Union’s bailout package involves setting up a special purpose vehicle (SPV) to make funds available to eurozone countries that need them. It has grabbed fewer headlines than the European Central Bank’s government bond-buying adventure, even though it’s currently the biggest component of the bailout package at up to €440bn over the course of three years.
What’s interesting here — as with many SPVs — is the rating and pricing of the structure. The better the rating, the lower the entity’s cost of funding and the easier it is to attract investors.
What makes Europe’s SPV especially interesting is the fact that the debt being issued by the SPV will be guaranteed by the same eurozone countries that might well have to draw on it. In other words, the bailout facility is being guaranteed by some of those being bailed out. Some circularity there.
How well will that go down with the rating agencies?
David Mackie over at JP Morgan attempts to answer that very question. He notes that:
When rating a structure, rating agencies may focus on 1) the probability of loss, without regard to the potential size of the loss, or 2) the expected loss on the assets in the SPV. Under the first methodology, the “severally liable” feature would imply that the probability of loss would be determined by the weakest country, Greece, currently rated BB+ by S&P. Thus, debt issued by the SPV under this methodology could be rated sub-investment grade, assuming no credit enhancement. Under the second methodology, 5Y debt issued by the SPV could price around Libor+40 to Libor+50bp and could be rated between AA+ and AA. We arrive at this conclusion by estimating expected loss using the average yield of each country weighted by the country’s contribution to the SPV guarantee, and adding 30bp of illiquidity premium.
How, then, to achieve that elusive (cheaper) triple-A?
Here’s what Mackie suggests:
In their negotiations with rating agencies, however, the EMU may be able to convince them to bestow a AAA rating on the SPV, by making adjustments to the SPV structure, including credit enhancements. Additionally, rating agencies may be less stringent in rating an SPV that is publicly owned and has the full faith and credit of various sovereigns behind it. In our opinion, there are two potential ways for the EMU to achieve a AAA rating on SPV debt:
• Joint and several liability for the member states. This is unlikely to be acceptable to countries such as Germany which would have to sell it to an electorate that is already fighting the Greece bailout package
• Capitalize the SPV in order to cover a potential loss from lower rated countries. In addition, the countries requesting aid may be left out of the SPV guarantee. We estimate that the capital required to achieve AAA rating will be of the order of €15-20bn (Appendix 2) – and so should not pose a significant problem to the funding of the SPV.
By Mackie’s calculations then, an AAA-rating should allow the European SPV to fund itself for five-years at about Libor plus 15 basis points — or roughly where supranationals like the European Investment Bank and Germany’s development bank KfW fund themselves.
The market for euro supranational debt, incidentally, was about €175bn in 2009, according to JP Morgan.
Can you say crowding out?
Related link:
Governments to control loan guarantee scheme – FT
Eeek, ICO is getting riskier – FT Alphaville