Wednesday 5 October 2011

Restructuring the Restructuring

On the 21st of July European leaders agreed on a second bailout for Greece totalling 109bln. This was on top of the original 110bln agreed between Greece and the famous Troika (EU+IMF+ECB) to be given in instalments assuming Greece complied with the Troika’s demands. Right from the start we expressed reservations as to the ability of the 2nd bailout to deal effectively with the sustainability of the Greek debt. It became increasingly obvious that the 2nd bailout was produced with the health of the banking sector as a driving force and not the reduction of the Greek debt. So it was a matter of time before reality took over.
The news are full of reports, analysts, economists and politicians advocating a much higher haircut of 50% or a “technical revision” of the 2nd bailout. In fact most of the market is concentrating on one aspect of the bailout and that is the PSI (Private Sector Involvement) haircut.
Here we argue that a revision of 2nd bailout need not only involve changing the PSI haircut to 50% but some of the other elements of the bailout.
Main points of the 2nd bailout:
·            34bln of new money.
·            20bln to buy back Greek bonds in the secondary market.
·            20bln to recapitalise the Greek banks.
·            Marshall plan for Greece through NSRF (National Strategic Reference Framework, Cohesion Plan).
·            PSI. Rollover of bonds maturing up to 2020. Implied yield of 9% means effective haircut is 21%.
PSI. A 50% haircut? Is it doable without a full proper Default?

The plan proposed by IIF involves a debt swap whereby bond holders of the old GGB’s exchange their holding with new debt instruments having 30Y (three options) and 15y (one option) maturities. The Greek government would buy a 30Y AAA zero coupon bond in order to make the first three options capital guaranteed. The last option has a partial capital guarantee. Unconfirmed reports suggest that most bondholders opt out for the 1st (30Y Capital guaranteed) option with less enthusiasm for the 4th one. Here lies one of the problems that may need a “technical revision”. When the deal was struck on the 21st of July the 30Y swaprate was close to 3.6% whereas now is at 2.7%. As a result the ZCB would cost a further 11bln for Greece to obtain. This is a significant change that needs to be addressed.
Looking at the first three options in detail if we want to have a 50% NPV haircut with a 9% yield then we need to lower the coupons to less than 1%! Clearly this would not be acceptable to bond holders. Another option apart from coercive default is to remove the 100% capital guarantee at maturity for the first three options in a similar fashion to the 4th option and also lower some of the coupons.
Going further, they may extend the maturities involved to 2030. This would increase the rollover bonds by another 57bln.
Thus, a 50% NPV haircut is hard to achieve with the options as they stand. On the other hand, a combination of lower coupon, lower guarantee and increase the bond participation to maturities up to 2030 might increase the private sector burden but not to 50%.

Other changes

Apart from the PSI, European leaders might decide to increase the funds available for buybacks and also the funds to recapitalise the Banking sector. A buyback of 20-40bln may push up prices from the current levels to close 80%. This is because under the current liquidity (1bln per month is being traded) it represents 20 months of buying!!

Hard Default? Not likely.
All of the above is based in the assumption that Europe wants to avoid a full blown coercive default. There are good reasons to believe that a non-voluntary restructuring is not on the cards at least for now:
·            It is messy, as it would involve several litigations.
·            Europe does not have the time luxury for such a process.
·            Contagion/Metastasis of the problem to rest of Periphery.
·            ECB owns 45bln of GGB that need to be written down causing losses.
·            European banks are not yet ready for further losses.