Wednesday, September 26, 2012

Refinancing versus Fresh Money

Picture a company which has 100 MEUR in debt and a positive cash flow (i. e. the company does not need any new debt). Suppose that the company has just taken a major hit with one of its investments which it had to write off. Cash flow is not affected by that (only a book loss) but the company's net worth has shrunk in half.

The debt is up for refinancing. The banks are all nervous because of the halfing of the net worth. Tedious negotiations take place about the refinancing and they bind the company's resources for about one year. At the end of that year, the banks have finally agreed to a refinancing (no Fresh Money had to be disbursed).

At the end of this exercise, the company (and the banks) has the same 100 MEUR debt as before. What was the great accomplishment? The great accomplishment was that debt which was due is no longer due because it was refinanced. If all companies had to repay their debt when do without being able to refinance it, the world would soon be without companies.

Greece is not quite identical because Greece does need some Fresh Money. However, the bulk of the new financing which Greece needs has been and still is for refinancing.

Wild guesses have been published in recents days about the "hole" which Greece has in its books. It started with 11,2 BEUR and according to DER SPIEGEL, it would be well over 30 BEUR if one extended the austerity measures for a couple of years. 

According to DER SPIEGEL, that hole is due, among others, to the fact that 28 BEUR in Greek bonds held by the ECB fall due within those couple of years. Now who is kidding whom here?

What difference does it make to the ECB whether the Greek bond it holds on its books shows a maturity of 2014 or 2024? Absolutely none! Perhaps the maturity date should have been 2024 in the first place if the bond had been structured well.

The real Fresh Money which Greece needs consists of the following elements: primary deficit and funding/capital for Greek banks. Everything else is nothing but money changing hands, i. e. disbursing money in order to get it back.

The primary deficit is now down to the low single-digit BEUR (and could be a surplus in a year or two). Pardon my language, but this is chicken feed compared to the overall numbers being in play.

The funding/capital requirement of banks is more of an uncontrolled missile because it is very much influenced by the deposit flight. That deposit flight has averaged at least 30 BEUR annually in the last 3 years. Since the Greek banking sector still has about 150 BEUR of deposits, that enormous drain could go on for quite some time. But remember: deposit flight is a completely different animal than a primary deficit: the primary deficit is an expense, i. e. the money is gone when it is spent. Deposit flight is only a shifting of money from country A to country B. What country A loses, country B gains.

The other item affecting the funding/capital requirement of banks is the current account deficit because it withdraws liquidity from the domestic money supply. Greece's current account deficit (before interest expense) is likely to be break-even for 2012, if not even slightly positive. Again, that is not a "big hole".

In sum, the financial problem of Greece is phenomenally overstated by mixing refinancing requirements with Fresh Money needs. If one were to agree on a 2-year moratorium for principal and interest on ALL Greek foreign debt and if one found ways to stop deposit flight, Greece would problably need only a few individual billion Euros as Fresh Money during that time.

And what is a few individual billion Euros these days, anyway?

1 comment:

  1. "And what is a few individual billion Euros these days, anyway?"- That’s an interesting question. Wish I could have this "individual billion Euros" at hand.