Sovereign risk" are the words driving pricing in the European securitization market as the troubles in Greece unfold.
After a brief period characterized by healthier spreads and a budding primary pipeline, European securitizations are bracing for the impact of Greece's fallout on the whole of Europe.
For the ABS world, the most difficult risks to guard against are those that are not immediately on the radar. And for ABS specialists, this mostly means risks originating from outside the asset class, Barclays Capital analysts said.
"In Europe, securitization as a viable long-term asset class is facing daunting regulatory challenges," said Reto Bachmann, co-head of ABS research at Barclays. "Faced with such an ABS-specific risk, it is especially easy to miss risks originating outside our asset class. Sovereign risk serves as a pertinent example of how 'outside' risks can affect ABS."
The most immediate cause of Greece's current fiscal crisis is the Hellenic Republic's primary balance of -7.7% in 2009 (estimated), combined with an already very high debt-to-GDP ratio of 113.4% and a GDP contraction of 1.2% last year.
"In other words, the Republic's debt mountain is rising, but its economy's ability to produce enough value to service it is declining," Bachmann said. "As the risk of default rises, investors demand a higher risk premium to buy Greek government bonds - but a higher premium means the Republic debt-service costs rise, making it even more likely that it will default on its debt, implying that the risk premium should be even higher."
Bachmann said it is easy to see that the Greek sovereign could slide into a situation where it cannot fund itself in the capital markets at any price.
The situation is compounded by the fact that the Republic has debt coming due in April and May, which it will be able to pay only if it can devise, at the very least, a partial refinancing.
"If the country cannot raise new debt in the capital markets by then, it must gain access to alternative sources of funds - otherwise a debt restructuring of some sort or an outright default would seem inevitable," Bachmann said.
A History of Securitization
Flashback to 2002 when both the Italian and Greek governments were lauded as pioneers of these state-related securitizations. At that time, both Italy and Greece were able to work around the loopholes in the Eurostat's European system of accounts 1995 (ESA 95). These types of structures were poised to become profitable alternatives for other countries dealing with indebtedness.
Under the Maastricht debt criteria, countries in the European Monetary Unit were required to reach and maintain budget deficit levels of 3% of GDP, and restrict and maintain public debt/GDP ratios to 60%, before joining.
Greece employed a series of securitization programs to fund some of its deficit off-balance sheet
According to figures from Dresdner Kleinwort, the Republic faced a 102.7% gross public debt/GDP ratio in 2002, well above the 60% criteria. Yet, in a relatively short time, the state was able to reduce its indebtedness to a level that complied with the Maastricht criteria.
For Greece, securitization became a tool for promoting the development of the use of the bond markets as well as diversifying the funding sources for the Greek sovereign. At the time, it was enough for Eurostat to decide that the structure counted as off-balance sheet for it to be off balance sheet. There were no rules that made this distinction absolutely clear cut.
Through a series of deals - like the Atlas Securitization S.A., a special purpose entity that issued Ã¢Â‚Â¬2 billion ($2.75 billion) in two floating-rate tranches; Ariadne, a Ã¢Â‚Â¬650 million securitization of future state lottery receivables; and Hellenic Securitization S.A., a Ã¢Â‚Â¬445 million deal backed by future receipts from home loans to state employees - Greece was able to meet the European Union (EU) standards. These deals at the time were sanctioned by the EU.
By 2005, following a shift in how the EU treated these deals - which meant that European governments would no longer be allowed to treat the transactions as off balance sheet debt - Greece had already begun to taper off its strong government debt issuance program.
Fast-forward to 2010, and Eurostat is asking Greece to give an accounting of these structured finance deals, undertaken from 2001 to 2008. The Eurostat now says that these transactions might have allowed the government to conceal billions of euros of new debt from the public and regulators.
The EU now claims that the Greek government failed to disclose information about the currency swaps to a Eurostat team that visited Athens in September 2008. The team went to Greece to monitor the country's debt management.
However, Greece Finance Minister George Papaconstantinou told a meeting of the European Policy Centre think-tank last month that the "kind of derivatives contracts reported by some newspapers were, at the time, legal and Greece was not the only country to use them. They have since been made illegal, and Greece has not used them since."
Getting Out of the Mess
If the review finds that any of the deals did not meet the Eurostat requirements, it could lead to "significant debt revisions" for 2009 statistics because these state-guaranteed loans might default. For Greece not to default on its outstanding debt, the Greek government has to ensure that, in the long run, its revenues are high enough to service its debts and satisfy all other expenditures.
The EU finance ministers have given Greece a March 16 deadline to show that it can make the required spending cuts to bring its deficit down from the EU's highest, 12.7%, to 8.7% this year. They said in a statement that this was essential to remove the risk of jeopardizing the proper functioning of economic and monetary union.
One solution is that Greece could undertake privatizations, but only as a short-term measure given that there is a limited portfolio of assets for this option, said Bachmann. This alternative would at least provide the country with some much-needed space to come up with additional longer-term solutions.
The government could also opt to increase its revenue ratio (ie, the proportion of economic activity turned into tax revenue), although this could be offset by a reduction in economic activity resulting from the increased tax burden.
Greece could also attempt to increase the economy's total production and reduce its current account deficit by reducing the number of Greek holidays, allowing wages to adjust downwards or increasing the retirement age.
"Before Greece joined the eurozone, the state could have increased revenue a fourth way by printing money," Bachmann said. "With Greece being a member of the eurozone, however, it no longer controls its own monetary policy, and printing money would at first appear not to be an available source of revenue."
How it Spells Out for Securitizations
The impact of the Greek sovereign default would mercifully immediately affect only a limited number of Greek ABS and RMBS outstandings.
According to estimates from Unicredit analysts, a total of 44 Greek transactions have been structured with an estimated current outstanding of roughly Ã¢Â‚Â¬41billion ($57 billion).
However, a slowly proceeding Greek liquidity shortfall could trigger several consequences for Greek structured finance exposure. For instance, further sovereign downgrades would lead to negative rating migration in Greek tranches, resulting in downgrades of counterparties (e.g., Greek banks), which would breach counterparty triggers in structured finance deals and in case of a real credit event scenario materializing, several severe negative feedback loops would massively hit Greek securitization exposure.
Should Greece opt for leaving the euro zone, or be ejected from the euro, this would impact euro-denominated Greek bonds if the underlying portfolio is revalued in a non-euro currency, like the former drachma, with a fixed revaluation rate, Unicredit analysts said.
"If Greece leaves the euro zone or even in a worst still theoretical and unthinkable case defaults, massive pricing problems will arise with Spanish, Irish and Portuguese structured finance as investors would flee out from any exposure related to suspicious jurisdictions," Unicredit analysts said. "One could expect a flight to quality triggered by sovereign risk out of securitization exposure related to other 'shaky sovereigns.'"
They said that these together build a major stake in European structured finance. Mark-to-market dips would follow as a consequence because of these factors.
Triple-A Spigot Shuts Off Amid Sovereign Crisis
Although the performance to date of all Greek RMBS deals has been good, the risk of sovereign default has led to several actions by the rating agencies.
Fitch Ratings downgraded the senior classes of 15 Greek RMBS transactions to 'AA+' from 'AAA.' The majority of these notes will remain on Rating Watch Negative (RWN), with Negative Outlooks.
The rating actions reflect Fitch's opinion that Greece's sovereign risk is increasing and might negatively impact the future performance of rated securitization deals.
The macroeconomic and event risks associated with a less remote sovereign default in Greece - as indicated by the downgrade of the sovereign rating to 'BBB+'/'F2'/Negative Outlook in December 2009 - increase the stress that ABS rated above the sovereign are expected to withstand.
These increased levels of risk and stress are not compatible with the degree of stability associated with ratings of 'AAA,' according to Fitch.
Standard & Poor's downgraded all its 'AAA' Greek ABS and RMBS ratings to 'AA', and affirmed all other tranches.
Meanwhile, Moody's Investors Service is currently reviewing its criteria that enable Greek structured finance transactions to achieve 'Aaa' ratings.
The rating agency followed that announcement by placing all except one Greek ABS, RMBS, CLO and covered bond transactions under review for possible downgrade.
The rating agency said the risk of Greece's disorderly exit from the euro zone is negligible.
Needless to say, like most investors in Greek bonds - be it Greek government bonds, Greek corporate bonds, or Greek ABS bonds - we are hoping that concrete external support will be forthcoming for the Hellenic Republic before the situation deteriorates beyond the point of no return," Barclays Capital analysts said.
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