PSI. A Gordian Knot Current Issues and a possible solution. 2 nd February 2012 Andreas Koutras, PhD

Transcription

1 PSI. A Gordian Knot Current Issues and a possible solution 2 nd February 2012 Andreas Koutras, PhD andreas@itcmarkets.com

2 Sustainable Solution for Europe and Greece The restructuring of the Greek debt should aim at: 1. Exit Yield. The yield that Greek bonds would be trading after the restructuring. 2. The Exit Rating. The rating of Greek debt after the restructuring. 3. Sustainability of the Greek finances after the restructuring. In its current form the PSI+ does not fulfill these three essential aims Greece would need to borrow again to pay the coupons of the new bonds as it is still runs a primary deficit of 2%. Adding the request that the new bonds to be under English law and the exclusion of the ECB from this process complicates and endangers its success. The official punishment of the Bondholders does not serve the interests of Europe and is not beneficial to Greece. Markets punish more efficiently and faster.

3 PSI. A German Enigma Germany rightly insisted on Private Sector Involvement. However, it asked for volunteers! If Haircut is too little then there is no benefit to Greek debt sustainability. If Haircut too much then the voluntary character is lost. Problem of Holdouts in a voluntary restructuring. CAC? ECB is a largest bondholder and a holdout! Creates Free Riders. EZ insisted on a non-default. This does not help participation. Sustainability is key for participation. Find a way to increase the Participation in the PSI, while keeping the voluntary character in order to avoid a Greek bankruptcy and ECB losses (causing to raise capital and lose credibility).

4 ECB Gordian Knot ECB owns outright around 45bil in SMP. Average purchase price of 80%. Marked at Purchase+Amortization to Par. I.e. around 98 for March12. Equity of 10.8bil+Reserves and retained Earnings of 72bil. Voluntary participation would cause losses of 15-20bil. ECB may need recapitalization from the NCB. i.e. Taxpayers. ECB is not a preferred creditor neither a preferred bondholder. Creating a preferred bondholder would cause havoc in all markets. CAC s are binding for everyone. ECB s exclusion from CAC would be legally challenged. CAC s would trigger CDS. Greece would be placed under Selective Default and cause Greek collateral to be dropped from ECB operations.

5 PSI. Current form 355billion= Loan =10 T-bills =10 IMF=20.1 EZ= bil BONDS 242bil Greek law +18bil Foreign law ECB Holdout 45bil 8-10biln exempt 102 billion Haircut Assuming 100% PSI 102 billion New Bonds Cash payment 15% Cpn 4%, GDP Warrants? 30Y bonds collateralised by Zero coupon. Possibly more NPV haircut 242bil or 110% GDP

6 Alternative PSI option The low market price of the GGB s (20-40%) makes the voluntary sellback a real alternative option within the PSI framework. 1. Take ECB out at cost. 2. Add the option of 30% cash along side the 30Y PSI bond. Taking the ECB out constraints the Free Riding incentives and limits the Hold-outs to only the Foreign law bonds (6.9%) and near term Greek bonds. Pushes participation up. Staying out with Greek law bonds would be very risky. Especially if the new bonds are de-facto senior through extra protection of English law plus other sweeteners. Cash offer helps Exit Yield, Rating and sustainability.

7 PSI. Adding the Cash Option ECB Pay 80% for 45bl 36.0bil 260billion= 95bil in non Bond 355bil or 161% GDP Hold Out Cash 10% of 207bl 20.7bil 80% part. at bil PSI Bond 10% part. at bil Ex. 220bil or 100% GDP 8.0bil 95bil in non Bond 135 billion effective Haircut

8 Advantages for Greece Greece cleans up the majority of its bond stock. Greek debt to GDP drops to less than 120% from day one. Not in As these loans have a 10Y grace period the: Greece s exit rating should be high as the outstanding debt is reduced. Sustainability of Greek finances is improved. Loans have 3.5% coupon. Limits the introduction of English law in new bonds (only official loans). Also minimizes the risk of lengthy and costly litigations. A firm backstop is introduced for 10 years. It would give the necessary time for the much needed economic reforms to work. Most importantly it would reverse the extremely bad investment environment and halt the depression both in the economy and in society.

9 Advantages for Bondholders Most European banks have marked their holdings close to 50% after the EU council decisions. They have already taken the hit. Currently bondholders are asked to take a further NPV loss of possibly 10-15% with the new Greek Bonds making the total loss close to 60-65% They also risk being restructured again if Greece s finance deteriorate further. They extend their credit and interest rate exposure to Greece for 30Y On the other hand with the cash buyback option: Bondholders limit their losses. No risk of being restructured again. Bondholders avoid having to risk manage the new Greek credit risk. Bondholders no longer need to manage the market risk for 30Y. No need for Regulatory charges or other provisions due to the 30Y new Greek bonds.

10 Advantages for Europe The proposal operates within the framework agreed by the EU council. i.e. Voluntary restructuring and avoiding default. No need for a new decision. It punishes the reckless investors harsher as the real haircut is 65-70% (more if agreed). ECB needs no capital raising because of the GGB holdings. The sellback price can be structured so as to limit the losses. The voluntary character allows the possibility of differential pricing. Europe does no need to worry about the financing needs of Greece for 10Y Europe implements a market solution for the debt rather than one dictated. Europe could avoid the costly consequences of a Greek default. If an orderly or a disorderly default occurs, Europe would pay a much higher price to keep the EU united. Europe still has leverage on Greece through the Stability Pact and the funding of the Greek banks. Demand strict conditionality for the funding of the buyback to proceed.

11 Poker time There is a big Poker game being played. Not all hands are good but many could have hidden aces. Greece might bluff with CAC legislation. Legislating does not mean activating. IMF wants to pressure Greece for more reforms and places conditions to Greek Politicians. Europe wants to take moral hazard out.i.e Greek politicians. Limit contagion. Hedge funds threaten legal action. So far, we do not believe that many want a default even if they threaten one.

12 Funding of the Proposal It is clear that Greece does not have the funds for such a buyback. It is also clear however, that it does not have the funds to pay coupons in the new Bonds should the PSI proceed in its current form. Trying to raise it immediately from taxes would exasperate the deep economic recession. The maximum funds needed of around 126billion could be raised in principle by the EFSF using short term bills as payment. Once the bondholders commit to the scheme, the bonds are transferred into a trust or other vehicle and bondholders are repaid as money is raised. Bondholders are also compensated for the waiting time. Greece would most probably be placed on Selective default until an agreement is reached. This is the same status that Greece would be placed if the PSI goes ahead.

13 Dealing with the Hold Outs. Obviously, for the proposal to work a high participation is needed. This is also true for the original PSI option. It would be imprudent to assume 100% participation and the current proposal assumes a 10-15% hold outs. The high participation is achieved by altering the incentives for the hold outs. A major problem of the current PSI proposal is the existence of a large Holdout player, the ECB. Free Riders join the safety of the ECB. By taking the ECB out with a cash offer, bondholders would think twice of being alone after the conclusion of the buyback. Only hard core investors would risk holding out. The cash price of around 30% is very close to where many FI s have marked their holdings making it very appealing and also close to where a the recovery could be should Greece default. This makes the offer very appealing.

14 Collective Action Clauses CAC's were first introduced at around 1870 to facilitate workouts and to stop a malevolent minority blackmailing the will of the majority. Italy and Greece are the only two countries that did not implement the EFC directive in 2003 on introducing CAC's. Bonds have CAC's with different %. For a major change in the terms of a bond, like maturity, Coupon, collateral usually a supermajority is needed of 2/3 or 75%. CAC's need to be invoked in Good Faith. i,e. The needs of the minority have to be taken into account and there should not be a collusion between the issuer and some bondholders to defraud the minority. CAC's usually adversely affect the value of the bond. Especially for lower rating issuers as it introduces moral hazard (Frequent restructurings) Retrofitting CAC is unusual, bordering the illegal. Once accepted anything goes in the EZ bondmarket. Would ECB vote? Would it be a credit event? Yes. Would it be an event of default? For Foreign law bonds, probably. Would rating agencies classify default or Selective Default? Cowboy behavior not consistent with Europe.