June 2012

29 June

As the EU Summit drew into the late hours of yesterday, in a bit of a coup, Italy joined forces with Spain to boycott the endorsement of the EUR 120 bn growth pact until there was clarity on the immediate financial measures that would be taken to secure Spain and Italy’s short-term positions. After 14 hours of negotiating into the night, Eurozone leaders emerged with a statement covering the key decisions:

• A joint banking supervisory system for the Eurozone is to be established;
• The EFSF/ESM will be allowed to recapitalise banks directly, avoiding increases to sovereign debt; and
• The ESM will not have preferred creditor status with regard to the Spanish banking sector bail-out.

Leaders also agreed to use the EFSF/ESM in a “flexible and efficient manner in order to stabilise markets for Member States” (which basically means the funds can buy sovereign debt to help lower bond yields). EC President, Herman van Rompuy said the measures would “break the vicious circle” between the banking sector and sovereign debt problems. Fitch rating agency said “[It] marks a positive step that eases near-term pressure on sovereign ratings”. The Eurogroup is tasked to begin implementing these decisions by 9 July. However, it could take until the end of the year for any new money to become available. You can download a copy of the Euro Area Summit Statement here.

Van Rompuy also announced the new approved growth package today. This includes:

• A EUR 10 bn capital injection for the European Investment Bank (expected to raise overall lending capacity to EUR 60bn);
• Targeting EUR 60bn of unused structural funds to help SMEs and create youth employment; and
• The pilot of “project bonds” (see our post on project bonds on 23 May.

The markets soared and bond yields plummeted (Spain’s 10-year bond yield came down to 6.34%) as the markets reacted to this better than expected EU Summit outcome. Some analysts and experts are doubtful as to how long the rally will last and were quick to point out that the maximum lending capacity of the bail-out fund(s) EUR 500 bn may not be enough to cover costs if Spain and Italy need bail outs and want their bonds bought up. The fear that the EFSF/ESM funds could soon be depleted, could even further spook the markets, in their opinion. But, at least for the meantime, most agree that this outcome is a positive one, although much remains to be seen at the end of the year when the measures agreed are supposed to be implemented.

The Italian Prime Minsiter, Mario Monti, announced today, at the EU Summit press conference, that its 2012 budget deficit could be worse than expected and that it may need to apply for help to stabilise bond spreads but does not intend to do so now. Portugal announced its budget deficit for Q1 2012 was 4.3%, on course to meet the Troika target (although some may argue that this was only achieved due to the one-off transfer on bank pension funds to the State). To find out more about Portugal’s financial programme and its recovery, read our guide on the Third Review of the programme here.

Germany voted to ratify the ESM treaty today. The ESM is due to enter into force on 1 July but has not yet received sufficient ratification from its members.

28 June

EU leaders began their 20th EU Summit since the crisis began 2.5 years ago today. Pre-meeting, Spain had been warning that it cannot sustain its funding at the prices it is paying for very long and Italy reiterated that there will be “potential disaster” if Europe’s leaders don’t club together and find a way to keep Italian debt interest rates down. Spain’s 10-year bond yields pushed above the 7% mark again today and Italy’s also rose to the highest levels since December. Germany responded by warning against “exaggerated panic mongering” and the UK reminded leaders that it will use its veto (again) if it feels the need to as leaders also prepared to discuss the implementation of a financial transaction tax, something the UK is vehemently against as it believes it would be detrimental to its financial services market unless introduced on a global scale. The growth pact and short and medium term solutions to the Eurozone crisis are the main topics of discussion on the agenda, although the markets are not optimistic about anything concrete coming out of the summit.

The IMF confirmed it will send a team to Athens next week, suggesting that it was open to ideas from the new government about how to achieve the objectives of the already agreed programme. 

27 June

Angela Merkel and Francois Hollande are due to meet this evening ahead of this week’s Euro Summit, to try and come to some agreement on plans for the Eurozone. In the meantime, Spain has already issued a warning in its monthly bulletin that it expects a faster rate of economic contraction over Q2 compared to Q1 of this year. The head of Greece’s privatisation fund, Yiannis Koukiadis resigned for “personal reasons” today. The fund is responsible for Greece’s privatisation programme which forms part of the bail-out measures. The fund has been put on hold during the political stalemate since the May 6 elections and, as a consequence, it is unlikely that Greece will meet privatisation targets for this year.

The Eurogroup accepted Spain’s and Cyprus’ requests for bail-outs today. In its statement on Spain, the Eurogroup confirmed that Spain meets the eligibility criteria and that the estimated amount of EUR 51-62 bn will fall within the previously established envelope of EUR 100 bn. It confirmed that there will be conditionality for the banking sector in the form of specific and targeted reforms, including restructuring plans and horizontal structural reforms of the domestic financial sector. It also confirmed that the EFSF will initially provide the funds with the ESM eventually taking over and that the Spanish government will remain liable for the bail-out with the funds being channeled through its agent, the Fund for Orderly Bank Restructuring (FROB) to the banking sector where needed. In its statement on Cyprus, the Eurogroup invited the Troika and Cyprus to sit down and hammer out a comprehensive adjustment programme for Cyprus that would include: ambitious measures to ensure the stability of the financial sector, determined action to carry out the fiscal adjustment and structural reforms to support competitiveness and balanced growth. The funds will be provided by the EFSF or the ESM on the basis of its financing instruments.

You can download a copy of the Eurogroup’s statement on Spain here.
You can download a copy of the Eurogroup’s statement on Cyprus here.

26 June

Yesterday, rating agency Moody’s downgraded 28 Spanish banks citing its lowering of Spain's sovereign credit rating by three notches earlier this month and its view on the banks ability to pay their debts, as the reasons. The downgrade comes just days after a similar global scale downgrade occurred in respect of some of the worlds largest banks, including Bank of America, JP Morgan Chase and Goldman Sachs, reflecting general concern in global financial markets regarding their exposure. Moody's also cut the ratings on seven German and three Austrian banks this month. Moody's did say, in its statement on the present downgrade, that it was encouraged by the broad measures being introduced by Spain to support its banks. Spain did manage to successfully sell short term bonds today, but at nearly three times the cost compared to a month ago; yield on three-month bonds was up from 0.85% in May to 2.36% in June.

Greek Prime Minister, Antonis Samaras, announced that Yannis Stournas will replace Vassilis Rapanos as finance minister. Stourans, like Rapanos, is a technocrat. He is Oxford-educated, the professor of economics at Athens University since 1989 and director of IOBE (economic think tank: Foundation for Industrial and Economic Research). He has also worked as a special advisor to the Greek ministry of economy and finance (1986-1989) and to the Bank of Greece (1989-1994). As special economic advisor to the Greek government at the time, he participated in the negotiations for Greece's entry into the Eurozone. He is known for his strong opinions on the need for reform and opening up the Greek market.

Italy’s Monte dei Paschi di Siena bank (MPS) is to receive a EUR 2 bn state bail out. MPS (which is the oldest bank in the world, founded in 1472 and based in Siena) has been ailing for some time and is the latest victim of the Eurozone banking sector crisis. MPS’ main problems began after its acquisition of rival Italian bank Antonveneta, which it purchased from Santander in 2007. The purchase stretched MPS’ balance sheet at a time when the financial crisis was just gathering steam. In addition, MPS also bought high-yielding Italian sovereign debt which has pushed its “Available For Sale” (AFS) assets up from EUR 5 bn to EUR 25 bn causing its core Tier 1 capital ratio to drop. It now needs to plug a gap of, reportedly, between EUR 1.3 bn and EUR 1.7 bn before 30 June (when strict new EU capitalisation rules come into force). 

Herman Van Rompuy, President of the European Council, released a report setting out his and the Presidents’ of the EC, the Eurogroup and the ECB vision for the future of the Eurozone. The report looks at how the Eurozone can best contribute to growth, jobs and stability. The report proposes “to move, over the next decade, towards a stronger EMU architecture, based on integrated frameworks for the financial sector, for budgetary matters and for economic policy”. Van Rompuy stressed that the report is not a “blueprint” and that it just identifies the building blocks and suggests a working method. He confirmed that he did, however, expect leaders to reach a common understanding on the way forward for the Eurozone at the EU summit this week. The report proposes banking, fiscal and economic unions, resulting in a “political union”. A copy of the report can be downloaded here

June 25

Spain: Spain formally requested European aid for its banks today although it avoided giving a specific amount; requesting “an amount sufficient to cover the capital requirements, plus a margin of additional security, up to EUR 100 bn”. The Spanish authorities will provide support in respect of the evaluation, monitoring and conditions of the loan, with the aim to have the memorandum of understanding finalised by 9 July so it can be discussed at the next Eurogroup meeting. Some experts have accused Spain of dragging the bail-out process out as much as possible, in the hope that they will eventually be able to convince Eurozone leaders that the European funds should lend directly to the banks (rather than to the Spanish government which would increase its sovereign debt load); something that is currently not possible under the relevant documentation, vehemently opposed by Germany, but being discussed as a viable option to break the cycle between banking sector and sovereign debt problems.

Greece: Greece’s new finance minister, Vassilis Rapanos, formally resigned (before he was even sworn in) today due to health problems after being take ill last week. The Prime Minister is also still unable to perform his duties after having emergency eye-surgery. He will also be unable to attend the EU Summit this week and. discussions are ongoing regarding who will represent Greece. The Troika monitors, who were due in Athens today to begin a review of Greece’s financial programme, which is expected to be considerably off-track as a result of the recent political turmoil, have postponed their visit for the same reasons and will wait until a new finance minister is appointed and the Prime Minister can resume active duty, which is expected to be next week.

Cyprus: Cyprus formally applied for a bail-out today, shortly after its credit ratings were cut to junk status (from BB+ to BBB- with negative outlook) by Fitch. Cyprus had hoped to be able to organise a bi-lateral loan from one of its business partners (possibly Russia or even China) but it could not manage it in time. “The purpose of the required assistance is to contain the risks to the Cypriot economy, notably those arising from the negative spill over effects through the financial section, due to its large exposure in the Greek economy” the Cypriot government confirmed. Cyprus’ debt is estimated at 72% of GDP, or EUR 12.7 bn. For more background information on Cyprus’ situation, read our post from 13 June.

22 June

The leaders of the Eurozone’s four largest economies; Spain, Italy, Germany and France, met today in Rome, to align their thoughts ahead of the EU summit that takes place at the end of next week. At the press conference, the four leaders revealed plans to propose a EUR 130 bn, or 1% of Eurozone GDP, growth package. They confirmed they had reached an agreement to use “any necessary mechanism” to obtain financial stability in the Eurozone and that they expected the conclusions of the EU summit next week to be more solid and credible compared with previous summits, as far as growth is concerned. Hollande and Merkel publicly voiced their preference for a financial transaction tax. Over in Luxembourg, at the Ecofin meeting, Germany’s finance minister, Wolfgang Schäuble, backed this sentiment up saying that, although he realised that is was unlikely to be possible to get all 27 EU members on board with the concept (something he had previously wanted), at the Ecofin meeting in Luxembourg, 10 countries had voted in favour of such a tax, and he thought it was they should “give it a go”.

The IMF increased pressure on the Eurozone countries to do more. Lagarde, head of the IMF, delivered her message at the Ecofin meeting in Luxembourg, urging them to come up with a unified approach to tackle the Eurozone including Spain's struggling banks. She also urged the 17 Eurozone countries to consider jointly issuing debt and helping troubled banks directly and suggested relaxing the strict austerity conditions imposed on countries that have received bailouts. There is increasing support from among Eurozone leaders as well as the financial institutions to allow some form of direct lending to banks to break the cycle of the banking sector problems and sovereign debt.

The Eurogroup announced today that Greece can expect the Troika next week. Official representatives from the ECB, EU and IMF will be back in Athens on Monday to review Greece’s programme to see how far off track they have come as a result of the political instability over the past weeks. Depending on their findings, they will release the (previously withheld) next tranche of the loan of EUR 1.5 bn. However, both the new Prime Minister, Antonis Samaras and finance minister, Vassilis Rapanos (who hasn’t been sworn in yet) were taken to hospital today (respectively a detached retina and collapse) and it is likely that this will prevent them from attending next week’s crucial EU summit.  

Portugal’s 10-year bond yield declined again this month, down from 12.3% to 9.5% in the last 30 days. Although still above the “magic” 7% mark (at which point debt is deemed unsustainable), it is a significant drop. Portuguese 10-year bond yield spiked at 17.4% at the end of January this year and has been steadily decreasing since then. Spanish 10-year bond yield, however, has risen slightly again to around 6.6% as the initial benefits of the bail-out announcement begin to wear off and the markets start to consider how the bail-out will be funded and where the money will come from. If the funds are provided via the ESM, then this debt will be ranked senior to all other debt, subordinating market creditors to bail-out creditors.

Slovakia approved the ESM today joining Portugal, France, Greece, Finland and Slovenia. The ratification requires the backing of countries representing at least 90% of the funds capital. It is due to commence on 1 July this year, although it is looking increasingly likely that the start-up will be several weeks later as a result of delays in the ratification process in several key countries (including Germany).

21 June

Spain revealed the results of the first phase audit into its banking sector today which was undertaken by two independent firms: Oliver Wymann and Ropland Berger. The audit is based on 9% core tier one capital in the base scenario and 6% in a stressed scenario. The stressed scenario is tougher than the IMF report from about three weeks ago (which estimated Spanish banks would need around EUR 37 bn). The Wymann report shows that Spanish banks will need an extra EUR 16 bn to EUR 25 bn in the base case scenario and EUR 51 bn to EUR 62 bn in the stressed scenario. The Berger report estimates the figure at EUR 51.8 bn in the worst case scenario. The Bank of Spain has said, in its press conference releasing the results of the reports, that the three biggest banks will not need further capital. The problems with the country’s banks, according to the Bank of Spain, are limited to a group of institutions in respect of which it has already begun to take measures. A more detailed audit is being undertaken by PWC, Deloitte, KPMG and Ernst & Young and those results are due in September. In the meantime, the Spanish economy minister, Luis de Guindos, confirmed that they have “started working on the design of the aid with the Commission, the ECB and the IMF” and that they will present the formal request in the next few days. Spanish 10-year bond yields have remained below the 7% today, dropping 23 basis points to 6.532% during the day. However, at a much anticipated auction of 5-year bonds, although Spain did manage to auction more than expected, EUR 2.2 bn, it was forced to pay the highest interest rates in 15 years; a sign that the markets are still nervous about Spanish debt.

Greece’s new cabinet were sworn in today. Of the 20 ministerial and key posts, 25% will be filled by technocrats, rather than politicians. The posts: (i) Administrative Reform and E-Governance, (ii) Environment, Energy & Climate Change, (iii) Finance, (iv) Justice, Transparency and Human Rights and (v) Rural Development and Food, will be filled by a mixture of academics and field experts. Notably the post of finance minister will be filled by Vassilis Rapanos, the highly regarded economist and head of the National Bank of Greece.

The ECB announced that it has decided to loosen collateral rules to make it easier for banks to access funding. In particular it will allow banks to use more mortgage-backed securities as collateral which will be important to the Spanish banks. 

20 June

Antonis Samarais, leader of the Greek party New Democracy, was sworn in today as Prime Minister of Greece after successful negotiations with Pasok and the Democratic Left (DL) to form a centre left government. Discussions are ongoing regarding the make up of the cabinet. The cabinet will be made up of politicians with potentially one or two technocrats where appropriate, confirmed one insider in an interview with newspaper the Guardian. Almost certainly the highly regarded economist and head of the National Bank of Greece, Vassilis Rapanos, will be offered the post of finance minister. DL has confirmed it will not participate directly in the cabinet but will support the government. Evangelos Venizelos, leader of Pasok, said in a televised address that the new government’s top priority will be the formation of a national team to renegotiate the EUR 130 bn bail-out agreement signed with the Troika. Mr. Venizelos also commented that he thought it was a ptiy that Syriza had declined to be a part of that team, preferring to maintain their self imposed role of “strong opposition”. The markets responded to the news of the new government positively, including Spanish 10-year bond yield which back came down below the 7% mark to 6.75%.

19 June

As the G20 meeting in Los Cabos, closed today, the following declaration was released here.

G20 leaders have committed to further action on growth, increased resources for the IMF and there were fresh commitments from the European Union to do more to solve the current problems. Among the commitments is a pledge to “consider concrete steps towards a more integrated financial architecture” in the Eurozone and the declaration confirms that the Eurozone leaders will “take all necessary measures to safeguard the integrity and stability of the (Eurozone) area, improve the functioning of the financial markets and break the feedback loop between sovereigns and banks”. The G20 policy commitments, including those for the Eurozone, can be found here.

The IMF announced during the G20 meeting that its lending capacity has almost doubled to USD 456 bn following an increase in contributions. The funds are available for crisis prevention and resolution and to meet the potential financing needs of all IMF members as a second line of defence and are not earmarked for a specific area.

The second phase of the Spanish banks audit, to be conducted by the “Big Four” (PwC, Deloitte, Ernst & Young and KPMG) has been delayed from July to September. The monitoring committee, which includes representatives from the Ministry of Economy and the Bank of Spain, made this decision in order to have more complete information on the balance of Spanish banks. The first phase assessment, being conducted by Oliver Wyman and Roland Berger, is on schedule and the results are due to be announced on 21 June.

Germany’s constitutional court has upheld the case against the European Stability Mechanism (the ESM), ruling that Angela Merkel’s government had “not consulted parliament sufficiently” about the scheme. The ESM is due to come into effect in July (target date of 9 July) this year but has not yet been ratified by many Eurozone member states, including Germany. To become operational, the ESM needs countries representing 90% of its paid in capital to ratify it. While this German ruling will not prevent the ESM from taking effect, the fact that Italy, which represents just under 18% of the fund, will almost certainly be late with its ratification, will potentially delay the start up date.

Spain’s bond yields remained above 7% again today, although slightly lower than yesterday at around 7.15%. If bond yields remain persistently high, experts are concerned that Spain could be looking at a “full” bail-out rather than just one for its banking sector. This is the fourth day that 10-year bond yields have remained above 7%, the mark which is generally accepted as representing unsustainable debt.

Recognising the power that credit ratings agencies have in the markets when it comes to changing sovereign’s debt ratings, the European Parliament has voted in favour of some proposals to try and regulate them. The proposals broadly suggest regulating the quality, timing and frequency and should reflect each country’s specific characteristics. MEPs have suggested that rating agencies be required to prepare and publish an annual timetable of rating dates and have also looked at developing an internal public rating capacity at EU level. The effectiveness of these proposals is moot for now, but reflects the frustration at a governmental level with the effect rating agencies have on the markets.

The full statement can be downloaded here.

18 June

In Greece, New Democracy leader, Antonis Samaras will begin talks during the next couple of days with Evangelos Venizelos of Pasok and potentially one or two smaller parties, most likely including the Democratic Left, in order to see if a coalition can be formed. Both Samaras and Venizelos have publicly confirmed their understanding for the need for a swift government formation. Think tank Open Europe has estimated that EU countries currently have a total exposure (including bail-outs, central bank lending and various other sources) of EUR 552 bn; an increase of 67% in comparison to last year. Eurozone finance ministers have confirmed that Troika officials will travel to Greece as soon as a new Greek government is in place to discuss the next steps for the bail-out programme which is already off track, mainly due to the weeks of political paralysis caused by the elections.

World leaders will meet today in Los Cabos, Mexico for the two day G20 meeting where European leaders expect to come under pressure to “fix” the Eurozone crisis.

Spain’s 10-year bond yield hit a high of 7.26% today and Italy’s yield remains up at just over 6%.

17 June

Greece went to the polls today for the second time after the failure to form a government based on the results from the first elections held on 6 May 2012. While nothing changed in the order of the top 3 parties; New Democracy first, Syriza second and Pasok third, the percentages of votes did change as Greeks turned out in larger numbers this time to vote. This election was largely seen as a vote either “for” or “against” the biting austerity measures imposed by the Troika as a result of Greece’s second financial bail-out and as a consequence, an informal referendum on whether Greeks wanted to remain in the Eurozone. New Democracy and Pasok were seen to represent the pro bail-out camp and Syriza who, off the back of the last election results has been campaigning to “tear-up” the Troika memorandum of understanding, represented the anti-bail-out camp along with some of the smaller parties. The charts below show the results from the 6 May elections and today’s elections in more detail:

Today’s vote in favour of New Democracy is widely seen as a vote in favour of the Eurozone and the acceptance of austerity measures in exchange for financial aid. However, as experts point out and can be seen from our charts, 45.8% of the population voted for one of the anti bail-out parties. That’s 3.9% more than those who voted for one of the pro-bail-out parties.

Under Greek law, the winning party, in this case New Democracy, receives a bonus 50 seats in parliament. But even with this bonus, plus the increase in percentage of votes (an increase of 10.6%), New Democracy will still need to form a coalition with other parties if they want to form a pro bail-out government. Experts agree that the most likely candidates for the coalition with New Democracy will be Pasok and one or two of the smaller parties, possibly the Democratic Left. New Democracy leader Antonis Samaras will be called to meet the President tomorrow and given a three day mandate to try and form a government. If he fails to do so, the mandate will fall to Syriza who, despite having come second, are claiming these elections as a victory as it will allow the party to continue in its position of strong opposition. They ruled out the possibility of joining in a coalition with New Democracy.

Below we have also set out the number of seats awarded to each party based on the 6 May 2012 election results and the election results from today. As we can see New Democracy have gained 21 seats since the last election with Syriza gaining 19. The Communist Party (KKE) is the biggest loser having lost more than half of their seats.

The election results were met with relief and encouragement from global leaders and institutions, including the IMF, all of whom urged the parties to swiftly form a government that could take the reins of Greece.

France also went to the polls today in a run off election to elect parliament. The socialists won an absolute majority in the National Assembly, further strengthening Francois Hollande’s position.

15 June

The Bank of England announced various measures aimed at protecting the UK economy from (further) Eurozone contagion. It will make up to GBP 100 bn of cheap credit available in a programme reminiscent of the ECB’s LTRO programme. A new “funding for lending” scheme is also announced making around GBP 80 bn available to banks in cheap loans at below market rates in exchange for the banks lending the money to households and SMEs. The measures are met with mixed feelings from analysts although most agree that this is a signal that the Bank of England is more concerned about the economic outlook than before.

In Greece, French supermarkets chain, Carrefour, announced it was pulling out of Greece after 21 years, selling its stake to its Greek joint venture partner, Marinopoulos, for just EUR 1. Carrefour, which saw first-quarter sales plunge 16% in Greece, said it was taking a EUR 220 million hit as a result of the deal. Crédit Agricole, the European bank most exposed to Greece at the moment, also announced it is transferring assets to France from its Greek subsidiary Emporiki bank as it puts measures in place to minimise its exposure. The moves come as other companies being to struggle to cope with the slump in demand in Europe's indebted countries, including Ireland, Greece, Portugal, Spain and Italy. Italy's biggest utility company, Enel, said it was selling its Irish business. Last month the UK’s Marks & Spencer took a GBP 44.9 million write-off on its Greek business.

14 June

Spain woke to find that Moody’s had downgraded it by three notches to Baa3 – just one notch above junk status, citing the EUR 100 bn Spanish bank bail-out, which will increase Spain’s debt pile, as the reason for the downgrade. Spanish 10-year bond yields broke through the 7% mark today although they did edge back from 7.1% to 6.95% by the end of the day. Spain’s finance minister, Luis de Guindos, said Spain would take further action to reduce the country’s debt premium and foreign minister José Manuel García Margallo, was quoted saying that “the future of the European Union will be played out in the next few days”. He is also said to have called on the ECB to buy Spanish bonds. The results of Spain’s independent banking sector audits will be brought forwards from their initial due date on 21 June, to ensure the results are available for the upcoming G20 and EU summits. Early indications show that between EUR 60 bn and EUR 70 bn will be needed to shore up Spain’s banks.

In the meantime, regarding Greece, speculation mounts in the markets as the elections on 17 June loom closer. Various analysis show that if Syriza win the elections, it would be more likely for Greece to exit (orderly or disorderly) the Eurozone – a 70% chance according to the Berenberg Bank, Germany’s oldest bank, than if New Democracy win. Analysts believe that if New Democracy do win, it is more likely that a pro-bail-out coalition can be formed leaving a 25% chance of Greece exiting. Election polls are not permitted in Greece in the two weeks before elections.

Italy managed to sell EUR 4.5 bn of three-year bonds today, but at a higher price of 5.3% versus 3.91% in mid-May. Italian 10-year bond yields were tracking the rise in the Spanish yields today, climbing 7 basis points and peaking at 6.294%. Both prices indicating the markets’ nerves that Italy may be the next “domino” to fall.

13 June

Cyprus’ two largest banks, Cyprus Popular Bank and Bank of Cyprus, were hit heavily by the Greek debt write-down earlier this year (for more information on the Greek debt write-down, download a copy of our Update here, and Cyprus has been unable to access the debt markets for almost a year now. While Bank of Cyprus has almost managed to finance its recapitalisation privately, Cyprus Popular Bank has not and will need recapitalising before 30 June (when strict new EU capitalisation rules kick in). Cyprus will need to come up with EUR 1.8 bn (an amount equal to around 10% of its GDP) to finance the recapitalisation of the banks and address public spending issues. Hinting at the beginning of this week that it may need a bail-out, Cyprus has now indicated that it is in the market for a bi-lateral loan on “more favourable” terms. In the past Russia (a close business partner) has provided loans of around EUR 2.5 bn, but China has also been tipped to foot the bill. Cyprus’ economy represents just 0.2% of the Eurozone economy and any bail-out would expect to be limited to just a few billion Euros. Nonetheless, it may be seen by the markets as further indication of the contagion of the crisis.

Italian borrowing costs have risen. German finance minister, Wolfgang Schäuble and the OECD have been quick to defend Italy this morning amidst rumours that it would be “next” in the line of the Eurozone crisis fire. Pier Carlo Padoan, the OECD’s chief economist, said that “Italy is among one of the closest to stabilisation if its debt” and Schäuble has been urging Italians to stick to the “Monti Path” of reforms.

Fitch published its report on the impact of a “Grexit”. It says that a hypothetical Greek exit would have “limited direct cross-border impact on neighbouring countries”. Fitch believes that. While a Greek exit is not their base scenario, the impact of a Greek redenomination on banks throughout the Eurozone could be severe, most notably in other bail-out countries as well as Spain and Italy. Download a copy of the report here.

In Greece, Greeks are continuing to withdraw large amounts of cash ahead of the elections on 17 June. Bloomberg reports that, yesterday, more than EUR 700 mn in cash was withdrawn. At the moment daily withdrawals are averaging between EUR 600 mn and EUR 900 mn up from an average of between EUR 100 mn – EUR 500 mn.

12 June

Amidst rumours that the ESM would be used to fund the Spanish bail-out, which would cause investor debt to become subordinated to the bail-out debt, Spanish 10-year bond yields rose to nearly 6.8%, once again dangerously close to the 7% mark. Yesterday and today Fitch downgraded a total of 20 Spanish banks’ ratings (including Santander and BBVA - from A to BBB+ with negative outlook in their case) citing the same concerns as it has with regard to the sovereign debt downgrade last week. ISDA (the International Swaps and Derivatives Association) has said that the Spanish bail-out is unlikely to trigger payouts on Spain’s credit default swaps. For more information on credit default swaps and how they might be triggered in connection with a bail-out, download a copy of our Update on the Greek credit default swaps dated 6 March 2012 here. 

The ECB confirmed today that it is not considering a third round of the LTRO (Long Term Refinancing Operation – its liquidity programme) and that the SMP (Securities Markets Programme – its bond-buying programme) is on hold for now. In its financial stability review (download a copy here) it said it saw three key risks: (i) failing bank profits, (ii) excessive deleveraging by banks and (iii) potential aggrevation if the debt crisis. The ECB once again ugred the Eurozone and its leaders to do more to address the Eurozone crisis without relying on the ECB’s financial programmes to prop them up.

Over the last few weeks the concept of a European Redemption Fund (ERF – initially proposed by the German council of economic experts), as a credible alternative to Eurobonds, has been discussed by experts and politicians. According to analysts at Morgan Stanley, the ERF may have several practical advantages over Eurobonds as it would be limited in its scope and subject to strict conditionality. It would also not necessarily require constitutional changes. In addition, the ERF could make the fiscal compact more credible by reducing refinancing costs and by providing a clear debt-redemption path. The ERF would create a very large pool of high-quality euro-denominated assets, attracting international capital and strengthening the euro. Countries with high debt levels, elevated funding costs and primary surplus positions would benefit the most. Countries benefitting from safe-haven inflows at present would likely face slightly higher funding costs. If the ERF had a 25-year lifespan, it could also extend average debt duration. Germany is still opposed to any form of collective debt pooling and the ECB and the EC would likely prefer a full fiscal union and true Eurobonds, but the ERF is maturing into a credible and perhaps more ‘palatable’ alternative.

11 June

Stock markets around the world initially rose and Spanish bond yields dropped, but only briefly, after the news of the Spanish bail-out took effect in the financial markets yesterday. According to the official Eurogroup statement, Spain must “shortly” present a formal request, after which an assessment will be provided by the European Commission, in liaison with the ECB, European Banking Authority (EBA) and the IMF. It is likely that this will happen after the results of the independent audits have been received on 21 June or any formal request made earlier, would probably be made subject to those results. Download a copy of the official Eurogroup statement, dated 9 June 2012, here. Any funds received, will be routed through the Spanish FROB - the Fund for Orderly Bank Restructuring, which means that the costs of the loan will be borne by the government and added to the Spanish debt to GDP ratio, potentially increasing it by as much as 9 percentage points on top of an already large increase form 68.5% last year, to a predicted 80% for this year. This bail-out has been dubbed a ‘lite’ version as it will likely not be subject to the biting austerity conditions of the other bail-out programmes. The funds from the bail-out will be used solely to recapitalise the ailing Spanish banking sector and not to aid sovereign debt problems. Spain also already has a self-imposed austerity programme, similar to those required by the Troika, to get its public spending under control.

The other bail-out countries have responded to the bail-out ‘lite’ differently. Ireland was “less than pleased” with the Spanish bail-out with Irish ministers publicly stating that they would like to see the terms of their bail-out renegotiated. Portugal’s Prime Minister, Pedro Passos Coelho, warned that “conditions must be equal for all” and that any special condition applied to one bail-out country, should be made available to all.  The two leading parties in the upcoming Greek elections responded differently, with Syriza seeing it as a sign that the austerity imposed by Eurozone leaders has failed and New Democracy taking the view that the Spanish bail-out proves that more can be achieved by (re)negotiation than by conflict with the Troika.

For more background information and FAQs on the Spanish bail-out, see our latest update here.

9 June

During the scheduled Eurogroup call on Spain, announced yesterday, Eurozone ministers agreed to lend Spain up to EUR 100 bn to help its ailing banks. Spain has been quick to reiterate that the loan is not a “bail-out” in the same sense as Greece, Portugal and Ireland, but a simple “loan” not subject to the same biting austerity conditions as past bail-outs have been (conditions that will be imposed are, as yet, unclear but will include conditions regarding control of the financial sector). It is also different from previous bail-outs in the fact that the IMF will not be putting up any of the funds. It is limiting it’s role to that of “monitor”. Spain also confirmed that the exact amount to be accepted would depend on the results of the independent audit of the financial sector, due on 21 June and that the EUR 100 bn is a ‘maximum’ amount only with Spain’s finance minister, Luis de Guindos, commenting in a press conference that “it includes a considerable margin of security”. European policy makers have been keen to shore up Spain’s position ahead of the Greek elections on 17 June and hope this bail-out will prevent a wider deterioration of the Eurozone’s fourth largest economy which has been suffering under crippling sovereign bond yields. Recapitalising the Spanish financial sector should ensure that Spain can return to the markets to fund its government spending making it a different style of bail-out to the previous ones.

It is not immediately clear where the funds will come from for this latest bail-out; the EFSF or the ESM. The EFSF is due to ‘retire’ and the ESM will ‘open’ this year. The difference between the use of the two funds is an important one to the markets; funds from the EFSF do not have preferential creditor status, whereas loans from the ESM do. If the funds come from the ESM this could unsettle the markets regardless as investors may respond to the fact that their debt has become superseded by the ESM debt. For more information on the EFSF and the ESM, download a copy of our update here.

8 June

Spain’s utilities are also downgraded by Fitch today, reduced to A- with a negative outlook, following yesterday’s sovereign downgrade. Fitch also estimates the cost of recapitalisation of Spain’s ailing banks to be in the region of EUR 60 bn and EUR 100 bn. Spain continues to play down the possibility of a bail-out plan, confirming it intends to wait for the results of the independent audit of its banking sector before it makes any announcements on its plans for the banks. However, the Eurogroup (the group of the 17 Eurozone finance ministers) have scheduled a call on Saturday 9 June to discuss the situation. An EU spokesperson (Amadeu Altafaj) responded to rumours in the market that the call would be used to ask for a bail-out by saying “If such a request were to be made, the instruments are there, ready to be used, in agreement with the guidelines agreed in the past”.

7 June

During a telling Spanish debt auction today, although bond yields were up slightly (10-year bonds trading at 6.044% up from 5.743% at the last auction), the bid-to-cover ratio (which shows investor demand for the bonds) was also up. This auction was seen by analysts an important test on Spain’s access to the debt markets. However, there was some speculation in the market on how much of the take-up was down to Spanish banks agreeing to help out the government and bid heavily at the auction. In contrast, French debt, which is considered a “safe haven” at the moment, sold at its lowest levels today with 10-year yield dropping to 2.46% (from 2.96%). Rating agency Fitch downgraded Spain from A to BBB, a three notch downgrade leaving Spain two notches above “junk” status. Spain was also left on “Negative Outlook”. The agency blamed the downgrade on (i) the cost of recapitalising its banks, (ii) its rising national debt, (iii) the likelihood of a deep recession this year and (iv) further contagion from Greece.

Away from the Eurozone, while the ECB and the Bank of England did not cut borrowing costs this week, China cut its interest rates in an attempt to stimulate its economy and protect itself from the effects of the global economic slump. Some analysts see this as a sign that the Chinese economy may be in worse shape than expected as a result of the general global economic slow down and spill-over from the Eurozone.

6 June

Germany: Moodys cuts its rating on six German banks (mostly only by one notch), blaming the impact of the Eurozone crisis. Moody’s warned that German lenders could see their assets shrink in value if the Eurozone crisis deepens. However, German 5-year bond’s hit an all time low, selling at just 0.41% (down from 0.56%).

Spain: An investigation is being opened into Bankia by the anti-corruption unit of Spain’s public prosecutor. It allegedly sold shares at a time when it knew it was in serious financial difficulty. Finance minister Luis de Guindos has been attempting to calm speculation that a Spanish bail-out request is close. He confirmed to reporters in Brussels that nothing would happen regarding the recapitalisation of the Spanish banks until the audit of the sector had been completed. Speculation continues over how Spain’s banks might be recapitalised if it cannot find the funds itself. Many Eurozone countries, including France, are in favour of allowing the EFSF to recapitalise Spanish banks directly without Spain having to formally request a bail-out, subjecting itself to austerity conditions imposed by the Troika, like Ireland, Greece and Portugal; the so-called “bail-out LITE”. That would, however, most likely require amendments to EU treaties and therefore also parliamentary approval in some countries. Luis Maria Linde is appointed as the new governor of the Bank of Spain. He will replace Miguel Ángel Fernández Ordóñez, who is stepping down (early) in a month’s time.

Greece: One week ahead of elections and Alexander Tsipras is invited to private talks with G20 Ambassadors. Some analysts see this as a sign that Syriza policy may be “softening” as the chance of them gaining power increases. Syriza’s strong anti-bail-out policy has been popular among the Greek people, but is causing uncertainty among Eurozone leaders and creditors as they threaten to “tear-up” their financial programme with the Troika if they win the election. It now seems they may be rethinking the consequences that action may have for Greece wanting to renegotiate rather than renege on the terms of the bail-out. Former Greek technocrat prime minister (Lucas Papdemos) warns that Greece leaving the Eurozone would be “catastrophic” for the country and suggests that Greece should be given an extra year to meet its targets (much like Spain was given by the EC last week).

According to Eurostat, Eurozone GDP was flat in Q1 2012 compared to Q4 2011 (although on a year-on-year basis GDP fell by 0.1%). That suggests the economy in the Eurozone was stagnant rather than actually shrinking, although much of that should be attributed to strong growth in Germany, while many countries including, Italy, Spain, Greece, Portugal and the Netherlands, all contracted. The ECB leaves Eurozone interest rates at 1%, largely as expected by analysts and experts. The ECB (Mario Draghi) stated in a conference that it now sees “increased downside risks to economic outlook”. It expects growth of between -0.5% and +0.3% this year. For 2013, it predicts growth between 0% and 2.0% (a downgrade on the last forecast of 0% to 2.2%).

5 June

Both the Spanish Prime Minister Mariano Rajoy and finance minister Cristobal Montoro publicly signal that Spain is in “extreme difficulty” and needs international help, but that Spain is not prepared to formally request an official bail-out. Montoro explains that Spain cannot currently access the debt markets adequately to recapitalise its banks itself. The EFSF is not big enough to bail-out Spain as a country and it doesn’t need to, according to Montoro, Spain’s debt is only at 70% of GDP, lower than Germany’s. Just the banks need financial help. Spain’s problems, like Ireland’s, lie in the private, not the public sector. The collective private and public debt is estimated by experts at closer to 90% of GDP, in the same league as Greece, Ireland and Portugal. Rajoy stated that “Europe must clarify what path it wishes to follow to ensure greater unity”. But Germany is sticking to the rules; Spain cannot access the European bail-out funds without making a formal request for aid. In fact, Germany has even urged Mariano Rajoy to “hurry up and ask for help” before it is too late.

Many Eurozone and non-Eurozone countries have been declaring their support for the suggested “banking union” as a potential solution to the Eurozone. Spain, France, the UK and the EC (Olli Rehn) are in favour of a banking union concept, whereby the current general idea seems to be that national debt and banking liabilities should be pooled and then backed by the financial strength of the Eurozone as a whole (which is basically Germany at the moment), including potentially using Eurobonds, in return for Eurozone governments surrendering sovereignty over their budgets and fiscal policies to a central authority. Germany is not in favour of this concept. They want more fiscal union before any other structure is considered.

4 June

It was announced that three of Portugal's largest banks -- Millennium bcp, Banco BPI, and Caixa Geral de Depositos -- will tap funds from the EUR 78 bn bailout package initially provided by the “Troika” creditors (the EU, ECB, and IMF) in May 2011. Millennium will use 3bn euros, while Banco BPI and Caixa Geral will use 1.2 billion and 1.65 billion euros, respectively. Portuguese banks, like others across the Eurozone, face difficulties meeting capital requirements under new EU legislation. Under Portugal's current bailout terms, banks need to have core Tier 1 capital ratios of 10 % of assets by the end of this year". The recapitalisation plan is, in part, to address these needs.

Herman van Rompuy, president of the European Council, Mario Draghi, head of the ECB, Jean-Claude Juncker, head of the Eurozone Group and José Manuel Barroso, head of the EC are charged with the task of delivering a Eurozone integration plan at the next EU Summit held on 28-29 June. The plan will focus on the possible solutions for further integration within the Eurozone, including Eurobonds, a banking union and further fiscal and political integration.

3 July

The Troika arrived in Athens today to begin the (re)assessment of the state of Greece’s financial programme. The Greek government is hoping to convince representatives of the ECB, EU and IMF that the current austerity drive is not having the desired effect. At the very least, officials are hoping for an extension to the current timing of the programme, but even this may be difficult to negotiate as it could mean that creditors will need to come up with an estimated extra EUR 20 bn in additional rescue loans. Evangelos Venizelos, a former Greek finance minster and leader of the socialist Pasok party, spoke today about his hope that the EFSF/ESM may also be used to directly recapitalise banks in other debt-stricken countries, like Portugal and Greece, as it has been allowed to do for Spain. Some experts believe that this could reduce Greece’s mounting sovereign debt pile (currently estimated at EUR 330 bn) by as much as EUR 50 bn.

The Netherlands senate approved the ratification of the ESM today. Ireland announced it will return to the debt markets for the first time since September 2010. On Thursday, 5 July, it will auction EUR 500 mn of treasury bills. Irish bonds rallied on the news with 9-year bond yields dropping to 6.34%, the lowest since October 2010.

1 June

Unemployment in the Eurozone is at an all time high of 11% according to Eurostat, although the differences between the countries are great; for example the Spanish unemployment rate is at around 24% while in Germany it is currently at 6.7%.