What strategy on Irish bonds and bonds of so-called peripheral countries?

The Irish crisis is finally being dealt with, as the government decided on November 21, to call for external financial aid.
The bailout plan will build on the facilities put in place in the wake of the Greek crisis last spring, hence implying funding from the European Union, the EFSF and the IMF. Furthermore, Sweden and the UK offered to help though bilateral loans, which is fully justified considering the exposure of their respective financial sectors to the Irish risk

Ireland simply came to the conclusion that a small open economy cannot deal, on its own, with insolvency issues of a banking sector several times bigger than its underlying economy. Indeed, assets from the top 6 banks represent 330% of GDP. The collapse of the real estate sector resulted in a sharp contraction in nominal GDP, a deadly combination for an over-leveraged economy.

Finance Minister Lenihan indicated that loans will amount to less than €100bn. The maturity of the loan may be 3 to 5 years with interest in the ball park of Euribor +350/450bps. The 2011 budget (scheduled to be voted on December 7) will aim at a 6bn€ reduction of the public deficit, which could reach 12% of GDP in 2010, or even 32% if the September bank bailout cost is taken into account.

> Next year’s budget is part of a 4-year fiscal consolidation plan targeting savings worth 5bn€ (10bn€ by way of expenditure cuts) to bring the deficit down to 3% by 2014. Progress on fiscal consolidation will be closely monitored by the EU and the IMF, as a condition for the enacted aide. It looks like one third of the plan will be devoted to again recapitalising the banking sector (now largely under government control). Disposals of non-core assets are a priority to downsize the banking sector.

> In the near term, the ECB should maintain its support to Irish banks, heavily dependent on central bank funding (130mds€) and could keep intervening in sovereign debt markets to alleviate tensions. In the longer run, Ireland’s growth model – based on strong Foreign Direct Investment inflows and low corporate tax rates could have to be adjusted.

Coming events

 November 26
General strike in Portugal, just before a line-by-line approval of the 2011 budget due Nov. 30.
 December 2
The ECB will make a decision on its liquidity provisioning strategy, notably 3-month LTRO and bond purchases.
 December 7
Ireland votes on 2011 budget. Social aspect of budget will be examined in December also.
 December 16/17 EU Council Meetings: Draft text for the orderly restructuring mechanism due (critical focus area for international bondholders)
 January 2011
Parliamentary elections

Investment management conclusions

> Ireland

The view of Natixis Asset Management teams has been consistently negative on Ireland since last summer on the grounds of the potential funding difficulties, expected to arise in the banking sector at the expiry of the government guarantee programme. Moreover, Ireland makes up just 2% of the Euro Area sovereign debt market, and liquidity has vanished during the crisis despite ongoing support from the ECB through purchases of Irish (and Portuguese) debt.

However, the bailout plan should support the short end of the curve. For this reason, Natixis Asset Management opts for neutrality on Irish bonds with residual maturity of 1 to 3 years, which offer attractive carry at yields of around 4.80%. As concerns longerdated issues, Natixis Asset Management will review its strategy as details on the bailout plan are unveiled.

> Other « peripheral » countries

Investment management exposures :
 neutral (Spain),
 overweight exposure on Greek debt very short term maturities (less than 1 year)
 underweight exposure to Portugal. Indeed, Portugal is subject to contagion risk, whilst the Spanish government bond market may fare relatively better thanks to domestic banks..