Goldman's Take On The Irish Bailout

For what it's worth, here is Goldman's take on the Irish bailout. Since it was Goldman's endless currency swaps that allowed Europe to lie about their deficits and true debt levels, this should certainly be required spin.

From Francesco Garzarelli

Earlier tonight, Ireland applied for conditional funding assistance and will therefore be the first Eurozone sovereign accessing the EU-IMF support framework instituted in May. The latest European Economics Analyst provides background. There are still several uncertainties surrounding the deal, including the government’s political support (a by-election is due this Thursday), and negotiations on the banks. The yield spread between 5-yr Irish government bonds and their German counterparts has fallen by around 100bp from the 600bp highs reached on 11 November. At this point, we see scope only for a further 50bp tightening. That said, we think that this represents an important step towards a resolution of EMU sovereign woes, and a gradual relaxation of the risk premium that has built up in Italy and Spain, and in Eastern Europe.

Main Points

According to EU sources quoted by the newswires, the size of the package will be in the region of EUR 80-90bn. But this has still to be finalized, including the implications, if any for the Irish banks’ debt.  The amount is broadly in line with our estimates, and can easily be covered. Consider that the EFSM is endowed with EUR 60bn and EFSF has borrowing capacity of EUR 428bn (the portion guaranteed by Germany and France amounts to EUR 220bn). Additional IMF funding is available for up to 50% of the total amount drawn from the EFSM/EFSF with a ceiling of EUR 250bn. Both the UK and Sweden have announced they stand ready to provide bi-lateral loans.
Discussions on the cost of funds are also underway. We expect the EFSF (AAA-rated) to borrow in the region of 2.5% at the 5-yr maturity.  Assuming the terms are in line to those applied to Greece (which should represent a ceiling, given the different credit position of the two countries), the funding cost to Ireland would be along these lines:

  • EFSM/EFSF: Up to 3-yr maturity, Euribor or fixed swap + 300bp; Above 3-yr, Euribor or fixed swap +400bp; 50bp handling fee; (3-mth Euribor is currently 97bp)
  • IMF: Up to 3-yr maturity, SDR rate + 200bp; Above 3-yr, SDR rate + 300bp; Commitment fee, 50bp (est.) + 50bp service charge; (the Euro SDR rate is linked to 3-mth Euripo and is currently around 26bp)
    Using these figures and under a no IMF funding hypothesis, the savings for Ireland relative to the secondary market rates as of last Friday’s close would be in the region of 100bp (notice that the ECB has been intervening in this market, and that this is not indicative of primary access costs).
  • Ireland April 2013 yields 6.30% (bid); corresponding Eurozone funding 2.00%+300bp=5.00%
  • Ireland April 2016 yields 7.40% (mid), corresponding Eurozone funding  2.40%+400bp=6.40%

These, we stress, should be taken as ceilings. A ballpark of 60-30 from the EFSM/EFSF and IMF would result in funding cost closer to 3.5% on a 3-yr horizon.

Broader Market Implications

As discussed in our notes over the past fortnight, and in our latest Fixed Income Monthly, EMU Spreads: Navigating the Issues, we are of the view that the activation of external help should not lead to an escalation of systemic risk as seen in the aftermath of the Greek multi-lateral ‘bail-out’. A pre-agreed institutional framework is now in place, and the ‘stress tests’ have provided information on the distribution of risks across the Euro-zone banking sector.

Other than the evolution of the Irish discussions (size of the package and terms), the near term focus will also remain the Iberian peninsula. A workers strike in Portugal this Wednesday will re-kindle the debate on the much needed structural reforms. Spain unveiled a list of these last Friday, but investors remain uncomfortable about the contingent liabilities stemming from the non-listed cooperative banks.

Our opinion is that Portugal remains a possible candidate for external help, should market pressures remain high. But its systemic relevance is much smaller than that of Ireland’s or Greece’s (the largest foreign creditor is Spain). We remain of the view that Spain is in a different debt sustainability position, and the depth of its domestic market should allow it to withstand market pressures.

We continue to recommend holding 30-yr Greek paper, and would look for opportunities to re-establish long positions in intermediate maturity Italian and Spanish government bonds relative to the ‘core’ countries.

Finally, it is worth recalling that the EFSF will not pre-fund, and its funding instruments will have broadly the same profile as the related loans to Ireland. Its issuance program could lead to a marginal cheapening of bonds issued by supra-national institutions such as the European Investment Bank, the German-based KfW and the French CADES. Note, however, that these institutions have borrowing programs of EUR 60-70bn per annum, while the corresponding annual EFSF issuance would be likely quarter of that amount.