In the famous children’s movie Dumbo, Timothy the mouse and the cows (EU leaders) are trying to convince Dumbo (Greece) and the audience (Markets) that it has a magic feather and it can fly (survive the fall) despite its weight (debt weight). In the fairy tale, kids want to believe that Dumbo despite his floppy ears (Floppy reforms and economy) does fly. But reality is not a children’s movie. Convincing the markets that this is a sustainable solution and that Greece would be better off after the second bailout is a difficult trick to play.
Our take on the deal:
• The new bailout only mildly addresses the solvency issue of Greece and improves the sustainability marginally.
• There seems to be an embedded 20% haircut on the NPV of the Greek debt but numbers are tricky. This is no significant haircut or NPV loss that would make the Greek debt sustainable. It gives breathing space and pushes the can further down the road. Currently the deficit is running at 10% (even after the austerity measures)!!
• Despite the reduction of the interest burden the fact remains that more than 70% of Greek debt is with non-domestic bondholders. This represents a significant GDP bleeding and current account deficit. For example at 4% (average rate) interest on soon to become 400billion of debt this would be 16billion or 7% of GDP annually or 29% of total tax revenues.
• What would happen if Greece does not comply with the economic reforms. Lagarde’s statement that Greece suffers from “Reform fatigue” is erroneous. Greece mostly implemented tax raids and very few economic reforms to suffer from fatigue. Only last week the 12th tax amnesty (in 20years) was announced perpetuating the moral hazard of non tax payment.
• Estimates of PSI involvement may be optimistic, the NPV loss seems to be 21% and it may come mostly from the Greek banks. This is particularly bad for Greece as it would lock up bank balance sheet for up to 30y instead of creating room for loans to the economy.
• PSI is only limited to Greece in an effort to limit metastasis/contagion to other peripheral countries.
• The Selective Default (SD) rating seems to be unavoidable but the EU would provide credit guarantees in order to satisfy the ECB’s collateral rules and keep the repo operations going.
• One side effect of the deal is the exchange of Greek law with English (mostly) law. This may prove to be the most significant factor in the years to come. Currently, the GGB are under Greek law are being replaced by loans (bilateral) under English loans. At the end of the bailout, Greece would have most of its debt under non-Greek law. Apart from the fact that this is a significant loss of sovereignty any dispute in the future would leave a very bitter taste to the Greeks. This is positive for creditors.
• Contrary to political statements the deal is not a major paradigm shift for the EU. The markets see a closer fiscal union as the only possible surviving strategy for the Euro and instead they got promises of adherence to the fiscal targets agreed.
• The role of the EFSF is changing again and new powers are given which should be positive for the market. The buyback of the EFSF was probably put there to relieve the ECB from its 45billions of GGB’s. Most banks have their GGB’s in the HTM book marked at 100 and will not be willing to sell at a loss.
• The EFSF seems to be introducing collateral rules for the loans. Does this mean that Greece would have to provide collateral for the loans?
• The EU agreed that they don’t like rating agencies when their ratings are against their political will.
• Do not expect Greece to come into the markets any time soon. In fact it is very questionable under these terms if it would try any significant fund raising in the foreseeable few years.
Lets try to dissect the statement of the EU, what it means for Greece, the EU and the markets.
First bailout restructured
The original package of 110billion is being restructured once again.
a. So far out of the 110billion 67billion have been released.
b. The interest rate charged would be reduced from 4.2% to 3.5%
c. The repayment period would be extended from the currently 7.5Y to a minimum of 15 and up to 30Y
d. A grace period of 10y may be involved.
Clearly, the reduction of the interest rate and the grace period together with the maturity extension is a positive development for Greece. As the exact details of the deal are not known and probably have not been agreed it is difficult to estimate the exact amount that Greece saves. The total amount of interest payable under the old deal was roughly 4.2%*7.5Y*110bil=34.65billion (undiscounted). The new assuming that it has a grace period of 10Y starting in 5Y and total maturity 30Y time would be 3.5%*110*15=52.5billion (undiscounted). Depending on whether there is amortization or Bullet repayment there may be savings of 20bil or more, on a Present Value basis. These numbers are tentative and once we have a better idea of the structure we will recalculate them.
New tranche of €109 billion.
The EU promised a new package of 109billion to cover Greece’s shortfall. The new money would be given at the lower rate of 3.5% and the EFSF would be used this time. This new package would be structured along the lines of the previous one. In other words, extended maturities of up to 30Y.
Comprehensive strategy for Growth (point 4 in the communiqué)
The EU would mobilise a task force to target growth and job creation. The EU will use EU funds and possibly European Investment Bank (EIB) to fund what sometimes was called a “Marshall plan”.
Hate to spoil the party but this is one of the reasons that pushed Greece into the mess they are in. In the past 30Y tens of billions of funds (possibly more than 100biln) and subsidies have been given to Greece in order to “integrate” and “converge” with other EU economies. Most of these funds were mismanaged by local politicians or directed with the sole purpose of being re-elected. None of this has changed. This is typical utopian EU.
Private Sector Support
The private’s sector involvement according to the EU would come from:
1. “voluntary” rolling over debt that matures. We don’t know the exact terms of the rollover but a menu approach seems to be favoured.
2. Buy back some bonds from the market.
3. Exchanging or swapping existing bonds with new ones.
The details of how it is going to be done are clouded. IIF has published a document outlining some of the structures involved. These include Par bonds with step up coupon with the principal fully collateralised by zero coupon bonds.
The IIF further calculates that it would represent a 21% reduction of NPV assuming a discounted rate of 9%.
The IIF aims to increase the average maturity of the Greek debt from 6 years to 11.
Given the information above Greece would most probably not be able to avoid a selective default rating. However, this is not a big financial issue. It is only a political issue as EU politicians hate the word default and do not want to see the CDS market functioning properly. In order to satisfy, the ECB, guarantees would be given to the Greek bonds even in the case of Selective default in order for ECB to continue the Repo operations.
Furthermore it is difficult to comprehend why anyone would voluntary rollover or exchange their GGB given the insistence of the EU on a non-default.
EFSF
The EFSF mandate is changing again. Now the can act pre-emptively and not just on call basis. They can help raise money to give to states to recapitalise their banking sector and they can buy in the secondary market bonds.
A significant concession seems to be the “collateral arrangements”. Does this mean that Greece or other member states need to place collateral in order to access some of these loans? Would that be acceptable to the Greek government/people given the recent domestic troubles?
Our take on the deal:
• The new bailout only mildly addresses the solvency issue of Greece and improves the sustainability marginally.
• There seems to be an embedded 20% haircut on the NPV of the Greek debt but numbers are tricky. This is no significant haircut or NPV loss that would make the Greek debt sustainable. It gives breathing space and pushes the can further down the road. Currently the deficit is running at 10% (even after the austerity measures)!!
• Despite the reduction of the interest burden the fact remains that more than 70% of Greek debt is with non-domestic bondholders. This represents a significant GDP bleeding and current account deficit. For example at 4% (average rate) interest on soon to become 400billion of debt this would be 16billion or 7% of GDP annually or 29% of total tax revenues.
• What would happen if Greece does not comply with the economic reforms. Lagarde’s statement that Greece suffers from “Reform fatigue” is erroneous. Greece mostly implemented tax raids and very few economic reforms to suffer from fatigue. Only last week the 12th tax amnesty (in 20years) was announced perpetuating the moral hazard of non tax payment.
• Estimates of PSI involvement may be optimistic, the NPV loss seems to be 21% and it may come mostly from the Greek banks. This is particularly bad for Greece as it would lock up bank balance sheet for up to 30y instead of creating room for loans to the economy.
• PSI is only limited to Greece in an effort to limit metastasis/contagion to other peripheral countries.
• The Selective Default (SD) rating seems to be unavoidable but the EU would provide credit guarantees in order to satisfy the ECB’s collateral rules and keep the repo operations going.
• One side effect of the deal is the exchange of Greek law with English (mostly) law. This may prove to be the most significant factor in the years to come. Currently, the GGB are under Greek law are being replaced by loans (bilateral) under English loans. At the end of the bailout, Greece would have most of its debt under non-Greek law. Apart from the fact that this is a significant loss of sovereignty any dispute in the future would leave a very bitter taste to the Greeks. This is positive for creditors.
• Contrary to political statements the deal is not a major paradigm shift for the EU. The markets see a closer fiscal union as the only possible surviving strategy for the Euro and instead they got promises of adherence to the fiscal targets agreed.
• The role of the EFSF is changing again and new powers are given which should be positive for the market. The buyback of the EFSF was probably put there to relieve the ECB from its 45billions of GGB’s. Most banks have their GGB’s in the HTM book marked at 100 and will not be willing to sell at a loss.
• The EFSF seems to be introducing collateral rules for the loans. Does this mean that Greece would have to provide collateral for the loans?
• The EU agreed that they don’t like rating agencies when their ratings are against their political will.
• Do not expect Greece to come into the markets any time soon. In fact it is very questionable under these terms if it would try any significant fund raising in the foreseeable few years.
Lets try to dissect the statement of the EU, what it means for Greece, the EU and the markets.
First bailout restructured
The original package of 110billion is being restructured once again.
a. So far out of the 110billion 67billion have been released.
b. The interest rate charged would be reduced from 4.2% to 3.5%
c. The repayment period would be extended from the currently 7.5Y to a minimum of 15 and up to 30Y
d. A grace period of 10y may be involved.
Clearly, the reduction of the interest rate and the grace period together with the maturity extension is a positive development for Greece. As the exact details of the deal are not known and probably have not been agreed it is difficult to estimate the exact amount that Greece saves. The total amount of interest payable under the old deal was roughly 4.2%*7.5Y*110bil=34.65billion (undiscounted). The new assuming that it has a grace period of 10Y starting in 5Y and total maturity 30Y time would be 3.5%*110*15=52.5billion (undiscounted). Depending on whether there is amortization or Bullet repayment there may be savings of 20bil or more, on a Present Value basis. These numbers are tentative and once we have a better idea of the structure we will recalculate them.
New tranche of €109 billion.
The EU promised a new package of 109billion to cover Greece’s shortfall. The new money would be given at the lower rate of 3.5% and the EFSF would be used this time. This new package would be structured along the lines of the previous one. In other words, extended maturities of up to 30Y.
Comprehensive strategy for Growth (point 4 in the communiqué)
The EU would mobilise a task force to target growth and job creation. The EU will use EU funds and possibly European Investment Bank (EIB) to fund what sometimes was called a “Marshall plan”.
Hate to spoil the party but this is one of the reasons that pushed Greece into the mess they are in. In the past 30Y tens of billions of funds (possibly more than 100biln) and subsidies have been given to Greece in order to “integrate” and “converge” with other EU economies. Most of these funds were mismanaged by local politicians or directed with the sole purpose of being re-elected. None of this has changed. This is typical utopian EU.
Private Sector Support
The private’s sector involvement according to the EU would come from:
1. “voluntary” rolling over debt that matures. We don’t know the exact terms of the rollover but a menu approach seems to be favoured.
2. Buy back some bonds from the market.
3. Exchanging or swapping existing bonds with new ones.
The details of how it is going to be done are clouded. IIF has published a document outlining some of the structures involved. These include Par bonds with step up coupon with the principal fully collateralised by zero coupon bonds.
The IIF further calculates that it would represent a 21% reduction of NPV assuming a discounted rate of 9%.
The IIF aims to increase the average maturity of the Greek debt from 6 years to 11.
Given the information above Greece would most probably not be able to avoid a selective default rating. However, this is not a big financial issue. It is only a political issue as EU politicians hate the word default and do not want to see the CDS market functioning properly. In order to satisfy, the ECB, guarantees would be given to the Greek bonds even in the case of Selective default in order for ECB to continue the Repo operations.
Furthermore it is difficult to comprehend why anyone would voluntary rollover or exchange their GGB given the insistence of the EU on a non-default.
EFSF
The EFSF mandate is changing again. Now the can act pre-emptively and not just on call basis. They can help raise money to give to states to recapitalise their banking sector and they can buy in the secondary market bonds.
A significant concession seems to be the “collateral arrangements”. Does this mean that Greece or other member states need to place collateral in order to access some of these loans? Would that be acceptable to the Greek government/people given the recent domestic troubles?
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