Commentaries

from Rolfe Winkler:

Spanish canary in the European coal mine

The quote of the day comes from Marc Chandler, currency strategist at Brown Brothers Harriman, who has graciously offered to let me reprint a note he sent today.

While Greece gets much of the news, Chandler argues that it's in Spain where the policy dilemma is "most stark."

Today Spain reported that its unemployment rate in Q4 rose to 18.8% from 17.9% in Q3.  The consensus was for a rise toward 18.5%.  The unemployment rate has doubled in the past two years.  As seems to be typical in  Europe, the unemployment [rate] is especially pronounced for young people. In Spain it's 40%...

Cyclical forces and the €8 billion public works program pushed Spain's deficit to around 11.2% of GDP last year according to the EC.  This is almost as large as Greece's.  One key difference between the two in this context is that Spain's debt to GDP is considerably lower than Greece, giving it perhaps greater chance to stabilize the debt/GDP ratios before they become ruinous.

In the face of such sobering news on the labor market today, Spain officials have felt compelled to indicate that they are considering increasing their efforts to cut the budget deficit quicker.  The government is contemplating proposals that will cut another €50 billion or 5% of GDP by 2013.

Rolfe here. Victor Mallet at FT has the news: Spain unveils radical austerity budget.

This illustrates the dilemma policy makers face.  The economy does not warrant an end to fiscal support yet.  The IMF has argued this.  The EC has argued this.  But the dramatic market response to Greece has been a siren call, seemingly forcing policy makers--not just in Spain, but Portugal earlier this week and Poland earlier today too--to mitigate the wrath of the bond vigilantes.

By appeasing the vigilantes, officials risk aggravating the economic downturn, which offsets some of the fiscal austerity and spurs social tensions.   [But] if the vigilantes' concerns are not addressed in a satisfactory fashion, capital will strike, at least partially, and interest rates will rise...also exacerbating the economic downturn.

Many developed economies have borrowed so much, they can borrow no more. While borrowers love to hate their lender, they need him desperately if they've levered up their lifestyle past a point supported by their income.

Governments that rely too much on the bond market for funding should expect the market to turn against them eventually.

Lower Opel costs to help government aid

General Motors’ decision to scrap the sale of Opel rests on the carmaker’s calculation that the hole in its European unit’s finances is not as deep as previously feared.

Governments should welcome the lower demands on taxpayers with open arms. But there is still some horse trading to be done to get everyone on board. 

GM’s chief executive Fritz Henderson is due to present his plans for Opel next week. He has good reason to be bullish.

GM’s previous forecast that Opel needs $3.3 billion to keep going until 2011 appears to have been sharply revised. Some in the industry think the amount required could be nearer 60 percent of that figure — some $2 billion.

Like other carmakers, European scrappage schemes and improved economic conditions have allowed Opel to significantly reduce its inventory. Cars that were sitting on the tarmac have been sold, putting much-needed cash back into the carmakers’ coffers.

Moreover, GM itself is doing better than originally expected in the United States since emerging from bankruptcy in July. This has given it the confidence not only to scrap the sale of Opel to a consortium led by Magna, the Canadian auto parts maker, but also to repay the remaining 900 million euros on a  bridge loan from the German government.

Earlier concerns about GM using U.S. taxpayer funds to prop up its units overseas seem to have eased. Henderson is now confident he can dip into GM’s U.S. pocket to shore up Opel.

Germany will have to change Opel deal after election

It looks increasingly clear that Germany will have to change its deal to aid carmaker Opel once Sunday’s general election is out of the way.

The European Commission has signaled to Berlin that promising 4.5 billion euros in loan guarantees to only one of the two bidders for General Motors’ European arm to preserve all four German production sites and most Opel jobs in Germany may breach EU rules on state aid to industry. EU regulators want to know why Chancellor Angela Merkel and four German states offered the money to back car parts maker Magna’s bid but not for financial investor RHJ International’s, and on what conditions. 

With Britain, Spain and Belgium’s Flanders region — all hosts to Opel production sites – crying foul, the EU executive is under strong political pressure to intervene. British Business Secretary Peter Mandelson has questioned the viability of Magna’s business plan in a letter to the Commission.  Brussels reaffirmed in a statement on Wednesday that Germany could not attach political conditions to the company’s restructuring plan or tie its hands. 

The European Commission will not accept that State aid granted under the Temporary Framework is conditional upon the implementation of a specific business plan, previously discussed and/or negotiated with Member States, which defines the geographic distribution of restructuring measures, without leaving to the beneficiary undertakings the possibility to revise their plans if necessary.

State funding under the Temporary Framework is meant to tackle the financing problems due to the credit crunch, and cannot be used to impose political constraints concerning the location of production activities within the internal market. The beneficiary undertakings must therefore retain full freedom to develop their economic activities in the internal market.

Even the Commission’s German vice-president, Guenter Verheugen, long regarded as the German car industry’s best friend, has told his countrymen that one EU country cannot be allowed to buy a favourable solution for its workers at the expense of another. He has offered the Commission’s help to bring all the Opel host countries together and work out a joint state aid plan for Opel to be monitored by Brussels.

In theory, that means Berlin ought to sign Magna and its Russian partner Sberbank a blank cheque which might lead to a plant in Antwerp or Luton or Zaragoza being kept open instead of an assembly line in Bochum, if the Belgian, British or Spanish site is more efficient. That would be hard for German taxpayers to swallow.

Santander’s debt buy-back not necessarily a flop

Santander’s attempt to buy back 16.5 billion euros of asset-backed debt looks, at first glance like a bit of a flop: in the end investors only sold about 600 million euros of bonds by face value to the bank.

However, the result is not that surprising, for several reasons.

First, 16.5 billion euros was always a long shot. We don’t really know how much of the debt Santander had previously acquired in one-off trades in the secondary market, making it hard to say how much it could have bought back this time.

The tender offer, announced in July, grabbed a lot of headlines, but in fact Spanish, Dutch and other banks – Santander included – have anecdotally been quietly buying back their asset-backed debt ever since the market collapsed at the start of the credit crisis. Moreover, accounting changes introduced in Europe last year will have meant that bank investors who held the bonds won’t have had to mark the debt to market, reducing their need to sell.

Second, probably more relevant, the bonds had rallied in the secondary market after Santander’s announcement to match the levels the bank was offering in the buyback. That, combined with a recent market rally, meant that in many cases the debt was even trading above Santander’s offer price, according to an analyst.

Investors may also have taken Santander’s actions as a show of confidence in the assets backing the debt, and decided to stick it out and hope to get their money back rather than take a loss now. They may be feeling a bit more warm and fuzzy about asset-backed debt given the market’s recent rally and better liquidity as more dealers have started making markets in the debt.

The next move is up to Santander. It could keep quietly buying the debt back in the secondary market, or come out with another tender. Next time, it will have to pay up a bit more to grab investors’ attention.

Calling a bottom in Spain

Is the worst over for Spanish mortgage defaults? That’s one way to interpret Santander’s offer to buy back up to 16.5 billion euros of its outstanding asset-backed debt.

The securities are trading below par – more than 40 percent in some cases before today’s announcement – allowing the bank to reduce debt by buying them back. Cash-rich banks such as HSBC have launched similar buybacks this year to profit from the ABS market dislocation, but it’s the first time a Spanish bank has launched such a large public buyback.

Santander has offered to pay slightly more than market prices, suggesting it thinks there is some money to be made by buying these bonds at beaten-up prices and waiting for the mortgages to pay off.

The buyback could also be a sign Santander believes the freeze in the European securitized debt markets is thawing.

European ABS prices have rallied sharply in recent weeks, in part because traders at investment banks have started bidding for the debt again. Some of the more beaten-up Santander MBS have gained by as much as 15 percentage points since June, according to one investor.

Santander is rumoured to have bought back ABS earlier on in the credit crisis through private one-off trades. Perhaps it wants to get hold of as much as it can now in case spreads keep rallying further.

There may also be some political capital in a large public buyback of this kind. It gives a sign of strength to the market, and shows the bank supporting the secondary market for its bonds. That may win Santander some kudos with investors when it comes to issue MBS in future.

The rain in Spain…

Scare yourself to death with this (HT Alphaville)

Pain in Spain hits cat bonds

Defaults by catastrophe bonds, securities used by insurers to shift the risk of severe losses from natural disasters, have been few and far between.

When deals have run into trouble, it has often been due less hurricanes or earthquakes than some flaw in the way they were structured, such as the four bonds that imploded last year because of their links to Lehman Brothers and dodgy asset-backed debt.

Today Standard & Poor’s downgraded another deal in trouble, Swiss Re’s 252 million euro Crystal Credit transaction. Once again, the problem here is man-made.

This deal is different from most other cat bonds in that it doesn’t reference losses from natural disasters, but is instead tied to the performance of Swiss Re’s credit reinsurance business. Losses on the reinsurance contracts have started to climb as the economy soured. In particular, S&P says, the credit reinsurance business got hit by a “steep increase” in Spanish reinsurance claims.

It’s not the first time these bonds have been downgraded, although things seem to be getting worse. S&P says it’s “most likely” the class C bonds won’t make their principal payments in full at maturity. These were once rated B, and have now fallen to CC. The senior bonds, which were once investment grade, are now B+.

GM dumps Chinese in Opel race, standoff looms

Two things Opel junkies need to know in today’s news.

1) General Motors has dumped Chinese state-owned carmaker BAIC’s long-shot bid to take over GM’s main European arm. That leaves a two-horse race between Canadian-Austrian car parts maker Magna and Belgium-based financial investor RHJ, loosely associated with U.S. private equity firm Ripplewood.

2) The two trustees appointed by the German authorities to a board overseeing Opel in its transition to new ownership are refusing to toe Berlin’s line that Magna’s bid is the only game in town (according to an intriguing Reuters sources story).

This strengthens the prospect of a deadlock between Detroit and Berlin, which in theory would be arbitrated by the five-member Opel Treuhand (trustee) board. The panel comprises two GM appointees, one nominee of the German federal government, one representative of the four German states which have Opel plants on their territory, and a chairman — the president of the American Chambers of Commerce in Germany – who does not have a casting vote.

Chancellor Angela Merkel made crystal clear on Wednesday, before GM and German officials had held their first talks on the final offers, that the German authorities (both her national ”grand coalition” and all four regions) are backing the Magna solution, which she called “sustainable in all respects”.  The Opel workforce and the  co-governing Social Democrats strongly back Magna because it proposes fewer job losses and no plant closures, whereas RHJ would mothball the politically symbolic Eisenach factory in eastern Germany. 

Yet according to Reuters sources, both German trustees are defying their masters (and mistress). The Berlin government’s man is said to favour the offer by RHJ, which would downsize Opel and give GM a chance to buy back control in a few years. The regions’ representative is said to be leaning towards a managed insolvency, under which Opel would go into administration and viable bits would be auctioned off.

If positions do not change, the trustees ought logically to back GM and vote for RHJ. That would leave German authorities with a straight choice between agreeing, however reluctantly, to give state credit guarantees to RHJ, or refusing, at the risk of plunging Opel into insolvency. 

Politics, economics collide over Opel

Political and economic logic are set to collide in the byzantine decision-making over the future of German carmaker Opel, the main European arm of fallen U.S. auto giant General Motors. If politics prevail, as seems likely, the cost to German taxpayers will be higher and the chances of commercial success lower.

The aim of the Berlin government and four federal states, which are sustaining Opel with bridging finance, is to save as many German jobs and production sites as possible. That makes political sense ahead of September’s general election. But the business logic is that only a greatly slimmed-down Opel can survive in an industry with chronic overcapacity. In theory, it is up to GM’s board to choose among the three offers it expected to receive on Monday from Canadian-Austrian car parts maker Magna <MGa.TO>, Belgian financial investor RHJ <RJHI.BR>, and, less plausibly, Chinese state-owned auto maker BAIC. But there are several other powerful players with a say. They include the trustees responsible for the company since GM entered U.S. bankruptcy in June, the German federal and state governments, Opel’s works council and, last but not least, the European Commission, which must approve the restructuring plan as a condition for authorising the state aid.

The German authorities and Opel’s workforce prefer Magna’s bid, which is backed by Russia’s Sberbank <SBER03.MM> and automaker GAZ. The strategy is to seek growth in the dynamic but volatile Russian market. Magna requires the most state aid — 4.5 billion euros — but has pledged to keep all German production sites and cut 10,000 of the 50,000 workforce across Europe, of which just 2,500 would go in Germany. GM Europe also assembles Opels in Belgium, Spain and Poland, and in Britain under the Vauxhall marque.

GM management is thought to prefer RHJ because its offer includes a buy-back clause that could put Detroit back in the driver’s seat after three years in which Opel would be shrunk. RHJ wants less state aid — 3.8 billion euros — and plans a similar number of job cuts. However, the make-up of those cuts would be unpalatable to the Germans: it plans to shrink the plant at Bochum and idle that in Eisenach until 2012.

However smart business this may be, it is lousy politics. Bochum, in the Ruhr industrial rust belt, is still smarting from the offshoring of a Nokia plant to Romania. And Eisenach was the first new car factory to open in ex-communist eastern Germany. Indeed if GM defies Berlin’s wishes, the government has said it would reconsider the offer of state aid to any other bidder.

The key may ultimately lie in Brussels. Germany’s economics minister says the EU competition watchdog will require any buyer to inject more of its own funds as a condition for allowing state aid. That could lead to a more rational business solution, but it could also drive Opel into a dead end by making the deal unattractive to investors seeking a cheap ride.