State aid granted in the form of public guarantees is transparent aid when it is calculated according to the methodology of the 2008 Commission notice or a methodology that is notified to and approved by the Commission.
Aid to farmers, small enterprises or revenue-generating projects is often given in the form of state guarantees. This is because what is needed is a loan to pay for the initial investment. The loan is then repaid when the borrower starts receiving revenue from sales of a new product or agricultural output or provision of services. Expenditure is front-loaded while revenue is generated only after considerable time delay. The purpose of the loan is indeed to offset the mismatch between expenditure and revenue.
The problem is not so much the delay between the spending and the earning, but the fact that farmers, small enterprises or projects with long recoupment periods do not have assets to pledge as collateral to the bank that lends them the money. Even infrastructure projects which are tangible assets may not be suitable as collateral because on their own they are useless and cannot be sold to be put to an alternative use. They are valuable in so far as they can generate revenue from the purpose for which they are built. But if the pay-back period is long, then they provide little security to the lender in case of default of the borrower [especially given that lending financial institutions do not normally have experience in running infrastructure projects, nor are they supposed to].
The solution, therefore, is a guarantee on the loan from the bank. Borrowers can normally obtain guarantees from the market on commercial rates. Such rates, however, can be prohibitively expensive. They are expensive not only because of absence of satisfactory collateral, but more likely because it is difficult to calculate default rates for new products or to know how hard farmers work to protect their crops or take care of their animals. The market “fails” because of incomplete or asymmetric information. This is why governments step in and offer state guarantees for free or at low premiums. They aim to correct informational failures. But free or cheap state guarantees are State aid. The amount of aid has to be quantified. Even if the aid is intended to be de minimis, the amount of aid still has to be quantified.
Both the General Block Exemption Regulation [Regulation 651/2014, Article 5(2)(c)(ii)] and the de minimis Regulation [Regulation 1407/2013, Article 4(6)(d)] require that aid in the form of guarantees is “transparent”. Transparency here means that the amount of aid is known at the moment the guarantee is granted. The de minimis Regulation lays down certain criteria according to which guarantees are deemed to be transparent. If Member States deviate from those criteria, they must notify their methodology to the Commission for prior authorisation. The same obligation for prior notification of the methodology is imposed by the GBER.
Recently Greece notified such methodology and it is worth reviewing its main features. The Commission approved in decision SA.45125.
Methodology for calculating the amount of aid in state guarantees
Given the travails of the Greek economy, in this particular case the notified methodology was defined in cooperation between public officials and experts from the banking sector. The methodology was designed to reflect the conditions of guarantees to large corporations and its purpose was to calculate both the market fee of and the aid element in state guarantees to large companies. Such guarantees would be offered to any lender but in particular to European financial organisations which funded projects in Greece, such as the European Investment Bank, the European Bank for Reconstruction and Development or the European Investment Fund
The first step was to calculate a market-conform guarantee fee. The fee mainly depends on two key factors: 1) the probability of default of the borrower and 2) the coverage of the collateral that the borrower may be able to offer.
The probability of default of the borrower is assessed according to the credit risk rating methodology of a Greek rating agent [not revealed in the decision] recognised by the European Securities and Markets Authority and the National Bank of Greece.
The creditworthiness of borrower is graded on a ten-level scale system [A1, A2, … E2]. The corresponding probability of default varies from 0% [A1] to over 25% [E2].
For collaterals, three coverage ratio bands are defined: 1) Uncovered, 2) Coverage up to 30%, and 3) Coverage of 30% and above. This is unusual because although collateral coverage is normally also defined in three bands, the bands vary from 1) coverage up to 30%, 2) coverage from 31% to 60% and 3) coverage above 61%. The coverage ratio is inversely related to Loss-Given-Default [LGD]. A LGD of 70% means coverage of 30%.
Accepted collaterals are in the form of first-ranked liens on real estate and liens on real estate other than first ranked, if there is sufficient discounted net forced-sale value on the collateral. The collateral valuation is the same as the one applied by credit institutions in similar loans.
The collaterals on real estate are valued by authorised surveyors of credit institutions, who also assess the net forced-sale value of the collateral at the time the guarantee is granted.
According to Greek civil procedure, the starting price offered in real estate auctions amounts to 2/3 of the estimated value of the collateral and cannot be lower than its commercial value. Τhe net forced-sale value assessed by the surveyors usually amounts to approximately 2/3 of the estimated commercial value of the collateral and reflects the current situation in the real estate market, taking into account the average auction costs.
The notified methodology to calculate guarantee fees takes into account that, in the vast majority of the loans with a state guarantee, the state, and not the banks, is obliged to seize the collateral and is contractually committed to indemnify the guaranteed bank at the time of default (and not later after the sale of the collateral). During the past few years, banks have asked from the guarantor (the state) to accept this obligation, in order for them to accept to lend to companies.
The combination of the probability of default of each borrower (1-year probability of default) and the value of the collateral, leads to the determination of the commission fee charged by the Greek authorities. The commission fee is then expressed as annual premium.
The commission fees shown in the table below include the following elements: 1) 15 bps to cover the administrative cost, which includes all costs related to control and risk management, as well as the management of securities, and 2) 32 bps for the yearly remuneration of the capital, in line with section 3.4 of the 2008 Commission Notice on Guarantees. According to section 3.4, notional capital amounting to 8% of the guaranteed loans is remunerated at 4%, which implies a return on capital equal to 0.32% of the guaranteed loans.
In other words, the fee is calculated as follows:
Fee in percentage = [% probability of default + 0.15% + 0.32%]
Companies with rating below E1, i.e. E2, are not eligible for state guarantees.
The notified methodology is intended for a self-financing system of state guarantees. For this reason the adequacy of the premiums will be reviewed at least once a year. This means that, for the assessment of the self-financing nature of the scheme, actual losses after recovery will be compared to the received premiums net of the administration and capital costs. Based on the actual loss rate of the methodology, the premiums will be adapted accordingly.
Guarantees that do not include State aid
When the methodology for the calculation of the guarantee fee is used in aid-free guarantee schemes/individual guarantees, the following conditions, which rule out the presence of State aid, are applied:
- Enterprises in financial difficulty are excluded.
- The guarantees are granted for a fixed maximum amount and are limited in time.
- The guarantees do not cover more than 80% of each outstanding loan or other financial obligation.
Guarantees that include State aid
Guarantee schemes/individual guarantees with an aid element are granted only under the following conditions:
- The borrower is not be in financial difficulty.
- It is possible to properly measure the extent of each guarantee when it is granted. This means that guarantees are linked to a specific financial transaction, i.e. they are granted for a fixed maximum amount and are limited in time.
- The guarantee does not cover more than 80% of each outstanding loan.
- The specific characteristics of the guarantee and the loan are taken into account when determining the market premium, from which the aid element is calculated by comparing it with the premium actually paid.
The gross grant equivalent (GGE) of a guarantee is calculated according to the formula:
GGE = D x Z x [F – G]
D = amount of outstanding loan covered by the guarantee.
Z = percentage of outstanding loan D covered by the guarantee.
F = theoretical market premium defined according to the fee grid above.
G = premium actually paid by the beneficiary to the State for admission to the guarantee scheme (in percentage terms).
If a guarantee exceeds 12 months, the NPV of the GGE is derived by using the discount rate set by the Commission.
GGE = Σ[Dt x Z x (Ft – Gt)/(1+i)t]
i = discount rate.
Ft = theoretical yearly market premium of the guarantee for the year t, determined according to the grid above.
Dt = the outstanding debt at year t of the guaranteed loan.
Gt = yearly premium actually paid by the beneficiary for admission to the guarantee scheme at year t.
If the duration of a guarantee exceeds 12 months, but the actual premium is paid by the borrower as a one-off sum at the time the guarantee is granted, then the formula for determining the GGE is:
GGE = Σ[Dt x Z x Ft/(1 + i)t] – Pu
Pu = one-off premium paid at the time the guarantee is granted.
The Commission first checked that the general provisions of the 2008 Notice on Guarantees were complied with. These provisions are:
- The borrower is not in financial difficulty.
- The guarantees must be linked to a specific financial transaction, for a fixed maximum amount and limited in time.
- The guarantees do not cover more than 80% of each outstanding loan or other financial obligation.
- A market-oriented price is paid for the guarantee.
In addition for schemes the following conditions must be satisfied:
- Schemes must be self-financing.
- The premiums charged have to cover the normal risks associated with granting the guarantee, the administrative costs of the scheme and a yearly remuneration of an adequate capital.
On the basis of the above assessment, the Commission concluded that the notified methodology was capable of determining a transparent amount of State aid involved in guarantees.
 The full text of the decision can be accessed at: