This post is also mentioned in Greek (citypress Yannis Paleologos)
On the 26th of October the European leaders pushed the head of the IIF to accept a 50% haircut on the nominal of the Greek bonds. This apparently was done in order to punish the banks that invested carelessly into Greek debt and to reduce the Greek debt burden. The noble aim was to reduce the Greek Debt/GDP to around 120% by 2020.
On the 26th of October the European leaders pushed the head of the IIF to accept a 50% haircut on the nominal of the Greek bonds. This apparently was done in order to punish the banks that invested carelessly into Greek debt and to reduce the Greek debt burden. The noble aim was to reduce the Greek Debt/GDP to around 120% by 2020.
They also reiterated their resolve in keeping the
whole PSI exercise on a voluntary basis. In this note we argue that the size of
the haircut may have struck a death blow in the PSI and that now it would be
better if Greece was to make a public offer to buy these bonds back at an
average of 35% (say) rather than mess with the PSI conundrums.
Problems
in implementing PSI
The current PSI version (also known as PSI+) calls for
the voluntary surrender of all Greek bonds maturing up to 2030 (around
205billion) and the exchange of these bonds with new ones with half the
notional. The structure of the new bonds is not known and is the subject,
apparently, of intense negotiations between the different parties. There are
many reports on the possible structures but since nothing is finalised we would
not speculate. The issues that need to be resolved are:
·
Legal
jurisdiction of new bonds (investors demand English law).
·
The coupons of
the new bonds.
·
The maturity of
the new bonds.
·
Partial or Full
Guarantees on principle like Brady bonds.
·
Partial Upfront
cash payment.
·
Ability to
amortise the losses over time.
There are however, many other issues including
technical reasons with bondholders that may cause the complete failure of the
PSI+ or at least very low participation. Lets look at some of them:
1. If you own the bonds outright and on a cash basis then
your decision to participate would depend on where you have marked the bonds
and on how much pressure the government can exert upon you to do the exchange
“voluntarily”.
a. If you still own them at a 100 or at 79 (old PSI
writedown) and you are a European Bank then the pressure may be exerted to
participate. In this case you would suffer the further losses to 50 and perhaps
more if the new Greek Bonds have lower Net Present Value. Most Greek banks and
Greek Pension Funds are in this situation. In fact the directors of the Greek
Pension funds may have a further hurdle to jump, that of felony charges in case
they reduce the assets voluntarily!
b. If on the other hand you have them mark to market at
current prices, the incentives are different. You have already taken the bulk
of the losses and you have them marked at 25-40. The loss is a sunk cost. There
is no upside in participating in the PSI. The reason is simple, if you chose to
stay out your upside is to get repaid at 100 (especially if you own near
maturities 2012-13). If you are wrong and Greece defaults then most probably
you will get a recovery value of around 30-40. But this is roughly where you
have the bonds anyway. So the odds are you are better off staying out of the
PSI+ if you can handle the political pressure. The same logic goes for Hedge
Funds and other buyers who bought the bonds after the big drop and so they have
very little incentive participate.
2. Assume that you own the Greek bonds on an Asset Swap
Basis. Most northern European investors and funds acquired the Greek bonds on
an Asset Swap Basis[1]. Thus
they have the Greek Bonds at 100. If they were forced to participate then they
would suffer losses both on the Bond side (50%) and on the swap side. Since
most of these Assets swaps were done when credit spread levels were around
100-200bp, unwinding the swap would cause further losses! These would be on top
the losses from the new PSI+ bonds (NPV losses). Thus, it may be better for
them to sit it out as the option is almost digital. i.e Participate and suffer
perhaps more than 80% losses or stay out and get repaid 100%.
3. There are many investors who do not wish to touch
Greek risk again either because their institutional rules do not allow to hold
bonds that are not investment grade or because they are not allowed to hold
bonds with maturities of more than 20years (say) or that are not
straightforward boring bonds or simply because they are sick and tired of all
the games being played. Participating in the PSI+ perpetuates the risk and it
is not clear that the new PSI+ bonds would have high credit ratings.
4. If you are a non-EU holder of Greek risk or you are
private investor (not institutional but retail or other) then there is no
reason whatsoever why you should chose to participate. Probably, these holders
are not more than 10% of the total.
5. The big elephant in the room is the free rider ECB.
The central bank owns close to 45-50 billion of Greek bonds and has repeatedly
said that it would not participate in the PSI+. If one can afford to stay out
then it would join the ECB as a joined Free Rider.
6. Many bonds are structured bonds, which have liability
swaps with the Greek state. Retiring these bonds would also mean closing the
swap with the Greek state. This may produce gain or losses for the state. We
simply do not know how much.
All
of the above plus many other technical reasons point to a single answer to the
Greek PSI+. Since the only bondholders
that are going to participate are those that are under the political influence
of the EU government then the solution is very simple:
Abandon the messy PSI+. Buy instead!
Force
the holders under EU influence to “voluntarily”
sell these Greek bonds at 35%. Most of the bondholders under the
political guillotine have already marked them close to that value (50% or
less), so they would avoid further losses and risk management of the new PSI+
bonds. Ask for the ECB to sell its holdings at purchase price (around 75%) or
less. The savings in money, anxiety and endless negotiations are considerable.
Lets run through the numbers.
Assume
70% participation in the buyback offer.
·
After taking into
account the ECB holdings the saving is going to be close to 90billion and it
would reduce the Debt to GDP to around 127% instantly. This is similar saving
with the torturous PSI+.
·
It is a much
better strategy than the prolonged negotiations perpetuating the pain for both
bondholders and the Greeks alike.
·
It also removes
the risk of Greece defaulting or of threatening with law changes by retiring
the purchased bonds.
·
Furthermore, you
do not have to worry about the new legal jurisdiction of the new PSI+ bonds.
Some of the bonds, specifically the international ones have clauses that can
cause the immediate default of Greece (see ITC note on 5th Dec on Greece Could Default)
·
Buying them back
and destroying them or simply changing the moratorium clause by getting the 66
2/3 majority would solve many unnecessary complications.
·
It would free ECB
from the burden of holding Greek risk
·
It would punish
the irresponsible banks by voluntarily forcing them to sell at 35%.
Of
course you may ask where is Greece going to find all the money to buy back
these bonds. Greece would need 73billion to retire 157billion and it would
leave 48billion free riders. This is in fact the very conservative scenario
(70% participation). The money can come from a new deal that is going to
replace the PSI+. The time has come for bold initiatives to resolve the debt
crisis and the PSI, PSI+ were bad solutions that ought to be abandoned and
aborted forever.
[1] In an Asset Swap, the buyer acquires
the bond at a 100 and simultaneously enters a swap whereby it pays the exact
coupon of the bond in return of receiving Euribor plus a spread. The spread
level depends on the credit of the bond and on how far from 100 was the bond
trading when the trade was entered.
