A few words on the Greek restructuring deal, prospects for Greece and euro zone break up

So we’ve got a deal on the Greek restructuring. Everyone is talking about it. Here’s Reuters from last night:

Greece secured an overwhelming acceptance of a bond swap offer to private creditors and beat its own most optimistic forecasts, a senior official said on Thursday after the deadline expired on a deal needed to avoid a chaotic debt default.

A government official, speaking on condition of anonymity, said take-up on the offer was around 95 percent an hour before the offer closed at 2000 GMT with responses still coming in.

This is the biggest sovereign default in history, bigger than Russia or Argentina, so it’s a very big deal in that sense. Here are the things to pay attention to:

Deal is to swap for a cash payment of 15% of original face. Investors will then be issued new Greek debt worth 31.5% of their old bonds. This will reduce Greece’s debt load of 350 billion euros by about 100 billion euros.

  1. Face value loss is 53% but NPV loss is 74%. The difference is that not only did Greece write down principal but it also extended maturities and lowered interest rates. This makes the net present value of the cash flow even less and accounts for the differential in the face value loss to investors and the actual size of the haircut in NPV terms.
  2. Collective action clause triggered. These bonds were done under Greek law and that means they have a clause which can force holdout bondholders into the deal if certain hurdles are met (50% quorum, 66% deal participation). Greece got close to 95% support for a 206 billion euro bond exchange under this clause. There are 177 billion euros of bonds issued under Greek law (86 percent of all private sector debt held) . But the fact that the CACs were used makes this a non-voluntary deal and so this means it should trigger $3 billion of insurance payouts under credit-default swap contracts. Notice that we’re only talking $3 billion here. Ambrose Evans-Pritchard has a table of who is most exposed.
  3. Bond yields still distressed. We’re talking 16-25% according to reports. These yields are still significantly worse than Portugal even after the bond swap deal. That tells you markets think Greece is not out of the woods.
  4. Primary budget deficit. The reason markets are not enamoured with the resolution here is that Greece still needs a bailout after the deal because it is running a large budget deficit and needs approximately 20 billion euros in financing over the next three years in order to pay its bills. Unless Greece can close this gap, there are going to be problems and/or bailouts to think about down the line.
  5. English law: Apparently the new bonds will be issued under English law, making default and collective action clauses like this much harder. My understanding is that this will give public entities like the ECB a large percentage of face value of outstanding bonds.

Even after this deal, Greece has an enormous debt burden and faces the prospect of continued austerity and depression. I don’t see them getting out of this without re-defaulting and exiting the euro zone. Greece will have a tough time just getting back to 120% government debt to GDP. With yields still sky high, the country will be locked out of the public debt markets for years to come, irrespective of how well they implement their austerity programs and make structural reforms. That mena s more bailouts through 2014. The political will exist to keep Greece on EU life support all that time doesn’t exist, especially if Greece misses targets. A euro zone exit is likely. The question whenever Greece leads in any of these events – bailout, restructuring, exit – is what are the implications for Ireland, Portugal and Spain. You could see Portugal at a minimum leave as well therefore.

After the deal, heads will turn to Spain, Portugal and Ireland. Portugal seems to be the next most important case in Euroland. And the Portuguese and the Irish will want deals down the line too. The Irish will push for senior bank debt losses and the Portuguese will want a sovereign restructuring. I believe they will get it. But I have my eyes focused on Spain because the situation there has the greatest potential for market disruption. The EU faces an important test here because it cannot let Spain violate the rules without some sort of sanction. Yet we seem to be headed to a situation where Spain fails to meet targets. Because Spain is not in an official program they might be able to get away with this without penalty if growth is enough to reduce their deficits in 2013. We will see.

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