Once again July and August instead of being months of rest
and sunbathing are becoming months of uncertainty and stress. Last year it was
the Greek PSI. It seems so long ago but on the 21st of July 2011 the
first PSI deal was stuck to save Greece at the expense of private bondholders.
This year we have Spain. Sooner rather than later Europe would have to come to
terms with the Spanish yields.
Spain bond pain?
We first had a hint that bondholders of Spanish bank debt
may suffer losses. This is a significant change of position for the ECB.
Draghi’s predecessor Mr Trichet vehemently opposed banks inflicting losses on
the holders of their bonds (See Ireland). Now, it does not seem to be such a
bad idea. Forcing senior bond holders to
accept losses would ease some of the money needs of the Spanish banks. It would
also be according to the principle of private sector burden sharing that
Germany insisted for Greece too.
Of course there is also the issue of the Tier1 equity
instruments. There are about 67billion Euro worth of subordinated or hybrid
capital bonds issued by Spanish banks. You know the ones. The Tier 1 perpetual
with a step up call in. Those that were sold by investment banks back in the
boom years as the best investment since Dutch tulips. Many are also structured
with 10Y minus 2Y constant maturity swaps (10Y-2Y CMS).
Who owns these beauties? Well many have been sold to retail
investors or private banking clients as they had huge profit margins. So, taking
a haircut on these might not hurt European banks much.
Is this a precondition for recapitalizing the Spanish banks?
We do not know. We can only suspect that this is one of the ideas. In an
indirect way this is already happening. The buy-back of these bonds by the
issuing banks at knock down prices has identical effect on the balance sheet of
these banks. Greek banks did the same by buying back some of their hybrids.
Paella options
The market rejoiced at the
recent comment by Draghi regarding action that needs to be taken. Let me repeat
his words “These premia have to do, as
I said, with default, with liquidity, but they also have to do more and more
with convertibility, with the risk of convertibility. Now to the
extent that these premia do not have to do with factors inherent to my
counterparty - they come into our mandate. They come within our remit”.
By “convertibility”, Draghi means, you guess it, exiting the Euro and
reintroducing national currency. I guess the word “exit” is prohibited from the
ECB vocabulary so an acceptable alternative had to be used to confuse us. So,
if a country defaults, or wishes to exit the Euro, it becomes a monetary policy
issue and thus ECB can act under its remit. In the same way they baptised the
Greek SMP holdings a monetary policy instrument. We now have the basis of the
excuse of introducing a massive buying program.
