The T Report: What a FROBbing Headache

Posted by on Jun 12, 2012 in The T-Report | No Comments

You’ve Been FROBbed

We still await details of what the Spanish bailout is. So far the market has decided to take a negative view on how effective it will be. That may turn out to be the correct view, but many of the headlines seemed to ignore what few details we do have.

This is a decent presentation on what FROB has done so far and what it is set up to do.

It isn’t set up to buy assets from banks at over-inflated prices. It is set up to take large, direct equity stakes in banks (or possibly through “CoCos”. If FROB is getting €100 billion of cash that is largely going to be invested as common equity or CoCos at reasonable valuations, that is actually a big deal. If the rest of the money is to absorb losses for banks that are being unwound in an effort to protect bondholders, that too has some value.

We don’t know yet what the FROB will do with its proceeds, but many of yesterday’s headlines seemed to assume the worst and totally ignored the possibility that the FROB will actually do what it says it does. There was some hype that the FROB would be negative for bank credits. If FROB makes equity or CoCo investments that is positive for the credit of those banks.

The discussion of ESM has been equally negative. One story will point out that ESM is not yet ratified and might never be. The next story points out that ESM is senior. We do not yet know where FROB will get the money. For now it would have to be EFSF and assuming ESM is ratified it would then come from there.

What it does to the creditworthiness of Spain remains to be seen. A lot depends on what FROB does with the money. If it squanders it, then it will be negative. If FROB, being guided by the IMF makes good, tough decisions, then the Kingdom of Spain may not be called on its guarantee and the overall situation in Spain could improve. Again, we are short on details, but so far, the market has decided to assume the worst.

The devil will be in the details, but so far the market has decided the details will be hell. If the EU really has had a change of attitude, the details have plenty of potential to surprise to the upside.

One and Done?

This remains the key question. If this Spanish plan is all Europe plans to do, then we will sell off again, regardless of the details. Right now, selling the news, is also betting heavily that Europe is on hold.

We are watching Spanish and Italian bond yields rise across the board. The moves remain big and scary. Without a doubt seeing 10 year yields at 6.62% and 5.98% is concerning. The big question here is will the ECB or EFSF step in and start buying in the secondary market? If the EU is prepared to do more to stop the crisis from deepening, that would be an obvious next step.

Greek elections are also of concern to the markets. That is a risk coming into the weekend and is unlikely to have any resolution until next week. It is likely that a party that demands a new deal will be part of any new government. A month ago, the EU seemed certain to say no to renegotiation. That is far less certain now. If the attempt to use FROB was not a sign of a change in attitude in the EU about how to respond to the crisis, then nothing has changed and a Grexit is possible which would be devastating for all the economies of Europe. It seems far too easy, and cost effective, for the EU to relent and keep Greece happy for now.

We have another day with relatively little economic news, so the markets will largely once again focus on headlines out of Europe. It should make for another choppy day. The longer the EU goes without providing details or announcing any new initiatives, the more likely the sell-off is to accelerate.