The ECB and Greece: The Lender of Last Retort Attitude Must Change

 

The ECB seems to be quite happy to comment on Greece, and most of the comments seem to say that Greece isn’t doing their part. Well, what about the ECB? What have they been doing for Greece? So far, not very much and I think they need to start to play nicely with their holdings. If the ECB just plays nicely, at no cost to the ECB, the situation in Greece would improve quickly and dramatically. The ECB must go from being a lender of last retort to a bona fide contributor to Greece and a true lender of last resort.

The ECB’s Current Holdings:

 

So the ECB currently holds almost €52 billion of Greek fixed rate debt (from Bloomberg data).

€24 billion of that debt comes due in the next 3 years, right when Greece needs all the help it can get to turn around the economy. I think about €10 billion of debt has already been repaid at par, including a whopping €4.6 billion in March. Before going further, just think about the current situation. The markets are on tenterhooks about whether Greece will receive €5.3 billion or not this month, and once again, most of that money is going right back to the ECB. It seems like a shockingly poor way to help Greece through its problems. Demanding payment at par, and forcing Greece to borrow that money so the ECB can book a profit, is just bizarre in my opinion.

The average coupon on the ECB’s holdings is 5.01%. So Greece is paying €2.6 billion in interest, on an annualized basis to the ECB.

If the ECB swapped their bonds for PSI bonds, which currently have a 2% rate of interest, the annual interest expense would drop to just over €1 billion. That is an annual savings of €1.5 billion! That is getting close to 1% of GDP at Greece’s current GDP run rate. What does the ECB care about the interest rate for? They aren’t mark to market. They borrow at whatever rate they set. Why not just switch to the PSI bonds and help Greece save that money?

The PSI bonds would also wipe out all the bond maturity payments Greece needs to make until 2023. They still owe the IMF money, but that is a separate and less odious story.

How much has the ECB booked in profits on the Greek bond positions?

The ECB started their bond purchases in May 2010. The program of buying Greek bonds was definitely over by June 2011 when we had the bailout summit, and the Greek 10 year bond was already trading at 55% of par.

So it is probably conservative to assume that we can look at the ECB portfolio of €60 billion as having being accumulated in December 2010 (some bonds bought before and some after).

That means they held €60 billion of bonds for 18 months. Assuming the 5% coupon on the remaining unmatured bonds, that is €4.5 of accrued (and paid) interest. So the ECB has booked €4.5 billion of income from holding Greek bonds. Even accounting any funding costs for the ECB, it is a big number of pure profit.

Why not just disgorge that money to Greece? Why not return it to Greece. Rather than demanding payment on near term redemptions, just give back the interest that has been earned? That €4.5 billion would be a huge shot in the arm of an economy that is struggling. Maybe that is too kind, but at least that much debt should be forgiven?

But that’s only part of the story. The GGB 6.1% bond maturing in 2015 is a good example. The ECB holds over €3 billion of the bond and it was the on the run 5 year at the time the crisis started in 2010. It is also right about the average maturity of the ECB’s holdings. In May of 2010 the bonds traded in the low 90’s. By June 2011 the bonds were in the low 80’s. It seems reasonable to assume that the average purchase price for this bond was in the high 80’s, let’s call it 87. Some shorter maturity bonds would have had a higher average cost, but some longer dated bonds would have had a lower average cost.

The ECB must have the actual details, but I don’t, so I will work under the assumption that the average price of the €60 billion was 87% of par. That is another €7.8 billion of potential profits that the ECB is sitting on. Some will have been realized already on the bonds that have been paid back. Since those were shorter dated, the reality is that almost none of this has been realized yet.

So unlike the €4.5 billion of interest which has been realized and could simply be returned to Greece, the unrealized gains couldn’t be. But there don’t need to get paid at par. If the ECB just received their “cost” there would be no loss. They would forego profits, but why does the ECB need such massive profits?

Let’s assume that the ECB rolled into new PSI bonds at cost (including the interest they have already received). Then the ECB could roll their remaining €52 billion of debt into only €39.6 billion of PSI debt (4.5 from interest and 7.8 from cost).

The ECB’s Holdings under a PSI conversion plan:

 
What a difference that would make for Greece. No borrowing money to pay back money for the next few years. Annual interest expense on ECB holdings would drop from €2.6 billion to less than €0.8 billion. That is meaningful by any standard.

What would the ECB lose? Nothing. This would just ensure that the ECB broke even on their Greek bond purchases. Is that too much to ask?

Maybe the ECB should “Ask not what Greece can do for you, but what you can do for Greece”?

E-mail: tchir@tfmarketadvisors.com

Twitter: @TFMkts