Juin 2015 – Crédit – Drame grec, Drachme grecque – Une occasion historique de mettre fin à la pollution périphérique des marchés de crédit européens

Published on 3 July 2015 at 2pm GMT

Since the beginning of the peripheral sovereign crisis in Europe 5 years ago, we refrained ourselves from (i) giving macro views on the outcome of such crisis – macro and sovereigns are not our core skillset – and (ii) taking long or short positions in situations no longer driven by their standalone credit fundamentals but more by the macro and political outlooks of their home countries. As time passed, fiscal consolidation and structural reforms were implemented to various degrees within the region and the economic performance not only started to improve, but also became less divergent between the various geographies. Such positive view on the economic outlook, combined with the powerful technical factors currently in play in Europe, framed our constructive investment thesis for 2015, i.e. broadly positive for HY and banks while cautious on IG.

A historical moment for European credit: the EM way or the DM way

Today, the whole Greek saga is back to the front pages like never before. For once, we choose to make an exception to discuss our view on the situation, as we believe that we are at a historical moment that will shape the long-term outlook of European credit markets: either (a) kick the can down the road another time, be there again in x-month time and let European credit markets be subject to a sovereign situation like EM assets do; or (b) accept that Greek membership to EMU was a mistake at the time for Greece, the rest of the Eurozone (EZ) and the rest of the EU, help the country exit the euro – not the EU –, and refocus the EZ region on structural reform and growth initiatives. In other words, isn’t it time to try something else as the kind of economic agenda that seems to have worked in Spain, Ireland and Portugal – to name a few – has failed in Greece? This is in the interest of the EZ and the EU, which should refocus their efforts and resources from never-ending crisis management to a reform agenda aiming at enhanced economic competitiveness via long-term levers, such as a deepened common market for goods, services and labor, productive infrastructure projects, research and education initiatives, and more efficient capital markets geared towards long-term investments.

Aren’t Grexit risks overstated? Kicking the can down the road another time is actually the riskier strategy

Proponents of the status quo/kick-the-can-down-the-road approach highlight 3 major objections. Each of them seems pretty weak to us in light of facts and a politically-agnostic assessment of the situation.

1. The EZ has to show solidarity with Greece – When the Greek situation started to unfold, the country’s fiscal deficit was at 15.2% of GDP, its primary deficit was at 10.2% and its debt to GDP was at 127% (2009 figures). At the time, Greece also received 3% of its GDP from the EU budget annually, i.e. a fiscal transfer. After years of painful fiscal consolidation, recession and debt restructurings, Greece achieved a primary surplus position around the end of 2014 – probably not the case anymore at this writing – but public debt still stands at 175% of GDP. So, has Greece borne the brunt of the effort alone? Not really. In three consecutive steps, private and public creditors have reduced the country’s debt to the tune of 100% of GDP via face value haircut and net present value adjustments. Public creditors – mostly Europeans – now carry more than 85% of Greece’s unsustainable sovereign debt as they have been the sole providers of funding to the government over the past few years. They will take the losses. The ECB is the only provider of liquidity to Greek banks, its Emergency Liquidity Assistance programme (ELA) skyrocketed to €116bn since it started in February 2015 and such total level of exposure to one single country relative to its size is unprecedented. Let’s also look at Greece’s funding costs. The country’s total interest charge amounts to ca. 4% of GDP today, i.e. less than what Italy and Spain carry. Its current borrowing costs for term funding via the various public creditor entities (EFSF, ESM, bilateral) is probably around 1.5% annually, i.e. cheaper than where many EZ countries (Italy, Spain, Portugal, Ireland) currently issue in the bond markets. If there is no doubt that Greece’s pain has been extremely high over the past five years, there is equally no doubt that the rest of the region has also shared significant pain and has provided life support.

2. Contagion risk is too high – We would argue that contagion risk has actually never been that low and that there may never be a better time for Grexit than now. The economic recovery now seems well anchored in Europe, with much less dispersion between countries, in particular in the periphery. There are also supportive macro factors, such as a more favorable exchange rate, lower oil prices and low interest rates. Importantly, the European banking sector is much less vulnerable to a Greek default or to Grexit than before: exposure to Greek assets is now negligible among European banks, the sector’s standalone credit profile has improved tremendously – especially with regards to solvency and liquidity – and its access to various ECB’s funding tools in normal and stressed circumstances remains huge – TLTRO, purchase programme of covered bonds and ABS, etc. Last, the ECB has both the tools and commitment to maintain financial stability in the event of significant market stresses. Bear in mind that the ECB has embarked on its large-scale QE programme only 4 months ago and that last month’s ECB decision to validate the legality of the OMT is seen by many as enhancing the ECB’s flexibility to use non-conventional tools – existing or not.

3. Grexit creates a precedent that will damage the EMU in the long run – Well, we would rather say that it might be more Greece’s euro membership and the handling of the crisis situation that may have created risk aversion vis-à-vis the region – among other factors. With regards to the EZ governance, isn’t it more appropriate to let a member decide for itself whether it is prepared to remain part of a currency union with the sets of economic policies that have been agreed by all its other members? And if Greece goes, the transition and the economic prospects for the country will likely be so terrible and chaotic that we doubt it will enhance the chances of euro exit political parties in other countries. In our view, Grexit should actually act more as a deterrent to future potential euro exits and hopefully encourage the remaining members to focus their efforts on the future economic prosperity of the region.

Our purpose here is not to make predictions on how the situation will unfold in the next few weeks. It is simply to say that there is a unique opportunity to solve the Greek crisis in a permanent and beneficial way for all parties. Of course, it will cost a lot of money to Greece and to the EZ sovereigns, but as credit investors know it too well the alternative – i.e. kicking the can down the road – is always more costly when the main roots of credit problems do not lie in the balance sheet structure. So, isn’t it high time to try something else? In the meantime, European credit markets would continue their transformation towards increased disintermediation, greater sophistication and better efficiency. That’s what we are pleading for.