Monday 25 July 2011

Greece The morning after

The fact that Europe’s countries are NO longer partners but changed their relationship to CREDITOR-LENDER is the only real “Game Changer”.

  • Now that we have more details of the new bailout we can dissect the numbers further. The so called 21% haircut on the NPV of the rolled over bonds is arbitrary. It only comes if we assume that the risky coupons are discounted by 9% for 30Y or roughly 550bp for the Greek spread. As we show later, it can as high as 40% or as low as zero! Thus the PSI is dubious. 
  • The total size of the new bailout is 109billion.
  • Only 34 billion is hot new money that would go directly into Greece to repay any bond redemptions and plug deficit holes.
  • Another 20billion would go into buying back some Greek bonds from the secondary market. The EU/IIF estimate savings of 12.6billion. This means average price of 62% on a Notional of 32billion. This figure may be optimistic as most long dated GGB are locked in the Hold to Maturity (HTM) book marked at Par. For example between 2019 and 2030 there are 71billion. To find almost half of them at 62% is a tall order.
  • The bonds maturing till 2014 would be subject to “voluntary” rollover. There are 56billion (not including aug11 and mar12). IIF assumes 90% participation in the rollover (is this optimistic or do they know more?).
  • There is a menu of 4 options for the lucky ones that would be rolled over. Three of these have maturity of 30Y and AAA Par guarantee while the last is 15Y with a partial guarantee. The new bonds would have their Par guaranteed by a zero coupon. Hence another 16billion would be given to Greece to buy a 30Y zero coupon bond. This would serve as AAA (EFSF) guarantee for the new bonds.
  • Option 2 in the IIF is a “Committed Financial Facility”. This means that the bond holders would require some sort of strict conditions in order to lend their money to Greece. We do not know any more details but it could be some sort of collateral or other covenants.
  • The plan also assumes that bonds up to 2020 would be rolled over in a similar fashion. This would require another 20billion of a zero coupon guarantee.
  • We infer from the numbers given that the Aug11 (5.9billion) and Mar12 (14.4billion) are NOT to be rolled over but paid in full.
  • Thus so far we have 34+20+16+20. The other 19-20billion would be used to cover any losses in the banks and recapitalise them as needed.
  • These 109 billion would be given to Greece at the preferential rate of 3.5% and in any case no less than the funding of EFSF. So in a way it is linked to the 10Y CMS rate. Are they going to hedge this by receiving the 10Y CMS for 30Y? We do not know but watch this space.
  • The original 110bilion (63billion have been given so far) would also have the rate reduced to 3.5%.
  • The plan also assume a 10Y grace period and repayment in minimum 15 maximum 30Y. This would mean that Greece would have nothing to pay from 2015 to 2025 on 219 billion of loans.
  • On the other hand Greece would have to pay the coupons on the rolled over bonds between 2012 and 2020.

The IIF plan
• Option 1.
  • A 30Y bond with coupon of 4% stepping up to 5%. The principal is guaranteed AAA so we can discount it at the 30Y risk free rate but the coupons are not. IIF assumes a 9% yield for these risky coupons. Our calculation shows that at 9% we get a price close to 79% or an implied haircut on the NPV of 21%. At a 5.3% however we get 100% and at 15% yield the price is 60%. Take your pick.

• Option 2.
  • Same exactly as option 1 but with the “Committed Financial Facility” covenant
• Option 3
  • A 30Y bond with coupon 6% stepping up to 6.8%. The principal is again AAA like option 1. Discounting this structure at with 9% for the risky coupons and 30Y rate for the Par we find price close to Par. The plan is to exchange 100% nominal of old bonds with 80% of the new ones.
• Option 4
  • A 15Y bond with 5.9% coupon. The principal is only 80% guaranteed up to a maximum of 40% or loss of 60% of principal. The plan is to exchange 100% of nominal of old bonds with 80% of the new ones.

Marshall Plan

Greece through the NSRF (National Strategic Reference Framework, Cohesion plan) has for the year 2007-2013 a 20.4billion out of which 4.9billion have been absorbed. The EU would lower the Greek contribution down to 5% from 20% in order for Greece to be able to absorb these funds.
EIB (European Investment Bank) may also fund around 12billion worth of projects.
Thus in total 27 billion could become available for projects in Greece. The hope is that this would spur the Greek economy into growth. According to press reports this money would be given with strict monitoring conditions to avoid the usual spillage.


Memorandum II
  • Needless to say that a new Memorandum of understanding between the Greek government and the EU would have to be negotiated in the next 2 months with perhaps much faster and much harsher conditions.
  • This plan was meant to be a “game changer” for Greece and the European debt crisis. Although there are certain improvements it is still a piece of patchwork. The EFSF is most definitely not a European version of IMF at least for now. It has been given extra powers to pre-emptively raise money and to buy bonds in the secondary market but does not have the research, analysis and weight of IMF. It is still just a shell vehicle for European politicians to implement their short term remedies.

  • The current plan for Greece assuming we believe the scenarios of the IIF and EU does not solve the huge solvency issue of Greece. It deals with the problem as if it is a liquidity issue. Furthermore, it kicks Greece out of the markets for a very-very long time. By pushing the repayments of the loans out from year 10 to 30 effectively back load the debt. This is typically a politicians paradise i.e kick the can down the road. For example, assuming growth of 3% and inflation of 3% and NO new debt, Greece in 10Y time would still have debt 100% of GDP. Thus, it is very likely that this is the start of a series of restructurings and renegotiations.
  • Greece effectively gives up Greek law as the new loans and bonds would be under English law. This is excellent news for the creditors but very bad for Greece. Apart from the loss of sovereignty, the debt now becomes truly external debt and in the likely event that Greece would have to restructure again the consequences would be detrimental.
  • In a way it means that Greece becomes the first fully integrated country in the EU, monetary, fiscal and political. This of course means a great loss of sovereignty. This may not be as bad as it sounds considering the consistent record of the Greek politicians inability to govern the country effectively.
  • One could say that Greece is been put in the freezer for at least the foreseeable future.
Greek Banks
  • For Greek banks it is not ideal either. Instead of getting rid of some of the GGB’s they pile up with 30Y risk. This would fill much of their balance sheet, which could otherwise be used to fire up the economy. Furthermore, it is not clear what the regulatory implications would be for holding such risky long dated assets.
  • Greek banks are paying a high price and their regional aspirations would probably put on hold for a long time.

Has Europe done the magic trick? Is contagion or metastasis of the debt cancer going to stop at Greece?
I am afraid the answer to both questions is not exactly. In a way by taking over completely Greece may serve as a deterrent for other countries (Ireland, or Portugal) or it may push them up to declare default and a huge haircut to avoid being run by the German/Franco alliance from Brussels. This certainly is not exactly a unifying Europe.
The markets were expecting some moves towards fiscal union but instead they got promises for the Stability and Growth Pact (SGP) and macro economic surveillance.

Ultimately, the only solution would be to give more powers to the only elected body of EU, the Euro parliament to raise common taxes and impose perhaps tariffs. They should further pre and post audit national budgets with punitive sanctions.
The so called Eurobond solution would not be acceptable unless there is accountability by democratically elected bodies.
All of these mean that the debt crisis in Europe is far from over. It has been given a brief respite but may come back with increased strength and ferocity.