Spain, seniority and the ticking clock
From the moment Spain announced that it will need EU support for the recapitalisation of its banking system the immediate market reaction was to seek clarity over the details and most importantly the level of seniority of the official sector over existing Spanish bondholders. The debate has intensified over the last two weeks.
Sony Kapoor’s, from Re-Define, is probably the most coherent piece on the matter, where he summarises that a senior bailout is a much better option than no bailout, adding that all previous IMF bailouts have been senior so there is precedent. Sony’s post is highly recommended for anyone interested in the debate and wants to get a better understanding over the seniority topic.
Is the issue of seniority then overblown, as Juncker also suggested in the press conference after last week’s Eurogroup?
Here is the view of a market participant who understands this sovereign debt crisis like very few:
The precedents, I would say are more mixed. IMF rescues worked (especially) in Mexico 1994, Turkey 2001, Brazil 2002, Uruguay 2002, Iceland 2008. On the other hand in Greece 2012 and Argentina 2001, the bailouts failed and as a result, recovery values to private creditors were much lower. So it’s absolutely clear – seniority matters most when default is realistic. I agree with Sony, a bailout for a sovereign that is solvent but illiquid is price-positive for private assets.
In Mexico, Turkey and Brazil, entry Government Debt:GDP ratios were pretty modest. For Iceland, the contingent liability to the sovereign makes the situation opaque. In Uruguay, the ratios were nasty but entirely dependent on the exchange rate as the debt was $-denominated. Even then, Uruguay needed a modest restructuring, and enjoyed a massive boost from a hugely positive terms of trade shock and a booming external environment, especially in major trade-partner Brazil.
Now apply to Spain – the debt:GDP ratio including any realistic estimate of bank recap costs is high, before any putative devaluation so the chance of positive revaluation effects is zero. I suggest the growth outlook is also weak. I think the chances of this bank recap being the last lump of aid that Spain needs is low, and the terms of this first lump are likely to be the same, or better (from a bondholder point of view) than subsequent tranches.
Worth noting as well that none of the above sovereigns had a prayer of market access (as opposed to Spain’s slightly punchy borrowing costs) when the bailouts were agreed. A senior bailout has to (a la Portugal and Ireland) take the borrower out of the market until health is restored. Forget “we’re lending senior to you, but please buy some bonds”.
This is a view that should not be taken lightly. Most notably, it reflects the market’s concern over Spain’s macroeconomic fundamentals and a worry that this bailout to address the banking sector issues is only the start, to be followed by a broader official sector support where all private bondholders will find themselves subordinated to the official sector and exposed to significant losses in the event that Spain loses market access and private bondholders are bailed in.
It further highlights the disconnection between market participants and Brussels officials, especially in light of the recent Greek debt restructuring and the obvious market irritation over the ECB’s preferential treatment and the overnight exchange of its old Greek bold holdings with new ones that were exempt from the restructuring process.
Most importantly, as European leaders head into yet another critical summit, it raises concerns over Europe’s response and how much attention is paid to voices from around the globe that call for decisive and urgent solutions to this crisis that now threatens the very existence of the European project.
Monti last week gave Europe ten days to save the euro, George Soros yesterday just three days, the clock is ticking…