It is important to point out that a Euro collapse is not our central scenario – we still believe that the policymakers and the ECB will ultimately make the right decisions as pressure is mounting. But to shed light on the debate we will look at the possible consequences of such a scenario for the corporate credit market. In our analysis we review some of the practical and economical implications but will not go into detail with regards to the legal side of this matter.
The first thing we need to establish is the definition of a Euro breakup. A Euro breakup can happen in several shapes or forms. For our analysis we have defined a Euro Break up as 1) One or more peripheral countries leave the Euro to go to their former local currency with the other countries remaining in the Euro, 2) One or more of the core countries (Germany, Netherlands, etc) leave the Euro with the other countries remaining in the Euro, or 3) The Euro ceases to exist altogether with all countries returning to their former local currencies. There are several effects of a Euro breakup in the shapes identified above The level of the impact for the corporate bond market differs per shape. We highlight some of the major implications.
The efforts of German companies to improve their competitive position could be wiped out overnight, which would have a detrimental effect on the German domestic economy leading to a deep recession with fast rising unemployment.
Hans Stoter
In our opinion, one of the biggest changes after a Euro breakup would be a radical shift in the competitive landscape whereby companies within the core countries will be the biggest losers. The competitiveness of these companies will weaken significantly as the currency of the peripheral countries is most likely going to be much weaker compared to the currency of the core countries. Due to this weaker currency, the cost base of the peripheral companies will improve drastically in comparison with the cost base of companies within the core countries. This will have serious repercussions for export markets. The efforts of German companies to improve their competitive position could be wiped out overnight, which would have a detrimental effect on the German domestic economy leading to a deep recession with fast rising unemployment.
Another immediate implication of a Euro break up would be the unclear situation with regards to the currency denomination of outstanding debt of the companies in countries that change currency. Will this debt still be denominated in Euro’s (in case the Euro continued to exist), or will it be redenominated into the local currency? In the case of this debt remaining to be denominated in Euro, a company from a peripheral country that switches to a local currency will be confronted with a much larger debt burden given the likely weakness of the peripheral currency compared to the Euro. This could mean insolvency for many of these companies. On the other hand, this phenomenon would be a potential windfall for companies in core countries. In case the Euro ceases to exist altogether, we enter into very uncertain territory where Euro denominated debt could either be 100% converted into the local currency or be converted into a basket of local currencies that reflect the composition of the Euro. Bond documentation does not cater for this scenario.
From a corporate funding perspective, the breakup of the Euro will likely lead to weaker credit availability (which is already very tight – see my October column). Banks from core countries leaving the Euro will see a decrease in the value of Euro denominated assets versus the value of its client deposits that by then will be redenominated to the stronger local currency. This could mean a further need to recapitalize.
Hans Stoter
The impact on equity and debt capital markets will be enormous. Obviously there will be huge volatility in the period leading up to and immediately following the Euro breakup. But also after markets have come to terms with the new reality, we may not like what we will see. It will be like going back to the fragmented pre-Euro markets, with local investors buying local currency denominated assets. This would drastically reduce the financial flexibility of corporates, adding to the difficult competitive situation and the bank credit crunch they will likely be facing.
Going through the ramifications of a possible Euro breakup, it is clear that the effects for corporates will be quite devastating, almost beyond the point of imagination. Is there corporate life after a break up? The answer is yes, but not as we know it! Bailing out the periphery may be costly and very difficult to explain to the public, but the alternative could well be worse with a deep recession and record unemployment all over Europe as a result of corporate collapse. We expect that the policymakers will make the right decision and stick with the Euro, and hope that they are able to explain the impact of the alternative to their constituents to get the support needed to make these tough decisions.
