Article / 30 January 2015 at 12:30 GMT

Will Moody's go negative on the EU bailout fund?

Blogger / MoreLiver's Daily
Finland
  • Moody's could adjust Europe's bailout funds' ratings outlook today
  • A Greek haircut would create a big loss for the bailout fund
  • Uncertain how member countries would deal with a loss
By Juhani Huopainen

The credit rating agency Moody’s has a pre-scheduled opportunity to make a ratings announcement on the European Financial Stability Facility and European Stability Mechanism today. If any announcement will be made, it will be published after the markets close – probably during late US hours.

Moody’s could produce a note stating that the risk of Greece defaulting or having its debts restructured has increased notably because of Syriza’s election win. As majority of Greece’s debt is held by the EU’s official sector, and EFSF’s exposure is roughly 245 billion euros (minus the last tranche due in the first quarter), even a partial default would make a huge dent in the rescue vehicle’s balance sheet.  

Syriza

As far as credit ratings go, Syriza is the elephant in the room right now. Photo: iStock

The European bailout funds depend on guarantees from the euro area members, and have relatively little paid-in capital. In case of a large loss, the funds would make a call for more capital. 

Developed countries do not need to include their guarantees as part of their total debt. A capital call would stop the European "extend-and-pretend" that says Greece can and will pay its debts and would force the euro area members to book losses in national accounts.

On September 24, 2014 Moody’s wrote:

The EFSF’s debt rating is closely linked to that of its key guarantors, given the lack of own capital and the close economic and financial linkages in the euro area... a deterioration in the creditworthiness of significant guarantors, particularly a multi-notch downgrade of France’s rating (Aa1 negative), could cause downward pressure on the EFSF’s rating. Indications of a waning political support would also be credit negative, although Moody’s considers this unlikely.

While Moody’s did not lower France’s rating last week, it retained France’s negative outlook, keeping the door ajar for a downgrade at a later point. Standard & Poor’s has EFSF on negative outlook, but Moody’s has a stable outlook. 

While a French prerequisite for Moody's to change the outlook is not in place, Moody's could consider the increased risk of a Greek default and the deteriorating political mood and still go ahead with the change.

While many seem to think that “Greece is no longer of systemic importance for the euro”, it remains an open question how the euro area would proceed with a Greek loss. Perhaps the European Central Bank’s upcoming asset purchase programme could buy bonds issued by the bailout funds.

Political fallout or a blessing?

Better yet, perhaps the Stability and Growth Pact that limits the use of more expansionary fiscal policy would be updated so that booking the eventual losses from Greece could be accommodated. This would provide a face-saving way for European leaders to modify a pact that does not in its current form make much sense. It would also make Germans much more understanding toward ECB’s willingness to expand the size of its balance sheet.

Sure, there could be political damage. Having to admit that the “only guarantees” ended up being real losses would be an embarrassment to the political establishment and increase the support of the eurosceptics and outright populists. Besides, demands for a similar haircut would increase in other crisis-ridden countries. Elections in UK and Spain are due soon.

Market implications: short-term negative

In the short term, increased attention toward the European rescue funds could be negative for the bonds of euro area’s weaker members, as these countries would in effect get a margin call from the fund in case of a Greek default. This could create a good opportunity to go long the bonds, as some sort of measure to move the losses to the long end or again off their balance sheets will surely be made.  

-- Edited by Michael McKenna

Juhani Huopainen is is a blogger and a macro analyst at More Liver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform

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