EFSF Bonds, Eurobonds and ECB: German Caution Results

Back Ground of EFSF, Public/Private Organization, Overcapitalization

Germany’s continued resistance to a Eurobond highlights all of the already existing “agency” bonds circulating through Europe. Origins for these bonds are a plethora of acronyms identifying various quasi-governmental facilities and funds.

The European Financial Stability Facility (EFSF) is a quasi-public/private bond issuing entity. Agreed upon by the 17 countries that currently use the euro, EFSF is organized as a corporation based out of Luxembourg and is subject to Luxembourgish law. It’s overseen by various finance ministers with representatives of the European Union and ECB acting as observers.   

Organization of EFSF is based on the euro currency countries making commitments of guarantee to back the loans and bonds EFSF issues. Countries make commitments according to their paid up capital balances with the European Central Bank (ECB). Strongest countries such as Europe's largest economies have the largest ECB balances, resulting in higher contributions to EFSF.

According to its current reports, EFSF has commitments of 780B euros. These commitments guarantee the loans and bonds, which fund distressed countries. EFSF is not allowed to exceed its loans to distressed countries beyond the full amount of country commitments.

Agreements among euro countries allow only 440B to be loaned. This leaves some 340B for capital reserves, which sustains free capital to absorb potential losses. These reserves also contribute to EFSF’s high credit ratings—even though S&P cut the facility by a notch as with the U.S. and others, while Moody’s and Fitch did not.

Exposure of European Countries to EFSF Risk, or EFSF Risk to European Countries

Euro countries committed their EFSF contributions in 2010 when U.S. banks were experiencing their trouble. Since 2010, Greece, Ireland and Portugal have been removed--for obvious purposes-- from being continued guarantors. This has resulted in commitment totals being amended down to 726B, or an overcapitalization of 165%.

By removing Greece, Ireland and Portugal from commitments, percentage exposure of other more productive European countries increased. According to the Framework Agreement of the EFSF, once a country is removed as a guarantor, they remain liable only for loans and bonds issued prior to removal, not after removal.

Following removal of the above countries, Germany has the highest commitment at 29% of fund totals followed by France’s 21.83%, Italy’s 19.18% and Spain’s 12.75%. Percentage increases for the major contributors amount to more than a 1% increase in commitments and for Germany more than a 2% increase.

Credit rating among the respective countries did not matter in reallocating commitments following the removal of Greece, Ireland and Portugal. From a basis point perspective, Austria saw an increase of 21bps with Belgium at 25bps, Finland found 13bps, France 152bps, and notably Germany encountered 201bps. Contrast this with Italy at 132bps versus Spain’s 88bps.  A basis point can be viewed as 1.00% = 100 basis points (bps), or 0.01 = 1 bps. When looking at billions of dollars, a basis point by itself becomes profoundly significant.   

Of all commitments, Germany, France, Austria and Finland have top credit ratings compared with Italy and Spain. Italy is at BBB+/A3/A- while Spain has a rating of BBB+/A3/A, both considerably less than the other named countries.

Distribution of Risk to Europe's Highest Credit Ratings

Concerning is that Italy and Spain account for 31.9% of EFSF commitments, or 232B euro between the two of them. Should both Spain and Italy be removed as guarantors, as occurred with Greece, Ireland and Portugal, EFSF's overcapitalization rate would decline to 112% from 165%. A rating cut would certainly occur.

Removal of just Spain would result in a reduction of overcapitalization to 144%. A result not as dramatic as both Spain and Italy being removed.  

ESFS has made 147.9B (196.4B euro when including European Financial Stability Mechanism funds) euro in total loans and has issued about 50B in bonds. This reaches nearly 200B euro of the 440B EFSF may issue. IMF has contributed 78.5B of the known 250B it has availabe. The European Financial Stability Mechanism's (EFSM) contribution is at 48.5B euro of its 60B available euros.

Estimates on supporting Spain, should the event arise, are between 430 to 520B euros. The various entities that have been engaging in financial assistance have spent 325B euros of their original 750B euro total. By such calculations, an inadequate supply of only 425B euros remain to cover a Spanish bailout.


IMF has, however, been raising money. IMF director Christine Lagarde reported in April that the fund had raised an additional $430B to support distressed countries. This suggests available money is now at $770B. Counting what's already been spent, grand total bailout money that's currently been spent or otherwise available is essentially at the trillion dollar mark. Important is that currently only 325B has been spent.

Not accounted for in money already spent is an April 2010 80B euro loan to Greece (1st bailout) by Euro Area Member States. This loan appears to be individual country loans to Greece outside the EFSM, and the EFSM which is funded by the EU's budget, and prohibits any deficit spending. 

Also not included are individual loans to the Ireland bailout from the U.K. providing 3.8B euro (probably actually denominated in pounds), .6B euros from Sweden and Denmark loaning .4B euros. Resulting in total amounts not otherwise accounted for above of 84.8B euros. Results of all cash spent so far amounts to 409.8B euros.

 Strains Remained for Europe Even After Huge Cash Infusion

To date 409.8B euros have been spent on resurrecting Greece, Ireland and Portugal. Prior to their removal from the EFSF they accounted for a combined 6.9% of commitments, or 53.8B euros. Compare this with Spain at 12.8% or 93B euros. If it took 409.8B euros to save and protect contributions to the EFSF of only 53.8B euros, Europe's exposure to Spain's dynamics could be substantially more than the efforts expended so far.

Add to considerations the freezing of bank liquidity prior to ECB's LTRO operations. Where the loans of the past are strengthening stability in the weakest of euro countries, ECB'S liquidity operation of about 1T euro also girded the entire continent. Currently, one of the euro's largest economies could challenge deeply and command considerably more in support than previously experienced.

Eurobonds Could Compromise Quality of Collateral, What Really Leverages Europe's Efforts

If evolution in the EFSF is any indication of eurobond propositions, risk does accrete to the most stable. Where ESFS commitments are restricted by identified contributions, a eurobond would be a guarantee on all amounts issued, with joint and several liability in the event of default--meaning the most capable of payment are the first to be tapped for promised payments.

With both Germany and France being obvious targets for ultimate payment, and with potential financial challenges still pending from the weaker countries, it seems prudent to see how the existing structures play out. Existing structures still have major cash, if needed in the end.

Complicating issues are that bond markets will heavily influence liquidity, still the vigilantes can be held off. Fundamental strength through the euro area is the deepest challenge, especially with still existing proposals of austerity, missed targets and declines in GDP.

Overall, quality of collateral and credit ratings look to be the prime propositions of what Europe needs to accomplish. Float a bond from every new idea, turned bond issuance, where will European bonds go and the quality of their available collateral? Major crises is one thing, multiply crisis against any relative stability among the very strong countries against each other, is another thing.

It seems that challenges are finding a balance, even with speculation of another shoe dropping.