Gotta love this straight-shooting piece of research from Alliance Bernstein.
The word “re-profiling” comes straight from “Newspeak“, the communication model employed by the Ministry of Truth in Orwell’s 1984. The one thing that is clear about re-profiling is that it does not include haircuts to the principal of the debt, but alterations to the maturity and potentially also to the coupon of the bonds.
Yes indeed. But even within that nebulous ‘reprofiling’ category there are some distinctions.
For instance, you’ve got a complete re-profiling which would entail extending the maturity of Greek bonds and reducing the coupon — leading to lower Net Present Value (NPV). Then you’ve got a term re-profiling, where maturity is extended but the coupon stays as is, which would also reduce NPV. Finally you could have a soft reprofiling, with maturity extended but the coupon adjusted to offset the impact to NPV. Now we’ve focused on slightly jargon-y NPV effects here, for a reason.
Because Alliance Bernstein’s Dirk Hoffmann-Becking and Norbert Topouzoglou do:
We expect re-profiling (should it take place at all) to be constructed in a way that it does not constitute an impairment. The key to whether or not the re-profiling would constitute an impairment is dependent on whether or not the revised terms reduce the NPV of the bonds.
Accounting buffs will be well-aquainted with the different accounting treatment of held-to-maturity (HTM) banking books and available-for-sale (AFS) trading books. Rather curiously, Alliance Bernstein seems to think that French banks — the focus of this piece — still hold most of their Greek debt as AFS.
So their focus is on avoiding Tier 1 capital losses for French banks. The idea being that although AFS assets are marked-to-market and losses are swiftly taken through equity, they are not recognised in the bottomline profit and loss statement, and therefore Tier 1 capital, unless they’re impaired.
Anyway, here’s the basic idea from the analysts:
So in order to send the current holdings of Greek government bonds over the precipice of the impairment, the question is whether a re-profiling is an event that provides objective evidence that the securities are impaired. A maturity extension without a change in coupon, or a change in coupon that reduces the NPV of the security, is such objective evidence, as it confirms that Greece is not paying its debts and interest in full and in time. Hence in the case of a Complete Re-Profiling and Term Re-Profiling, the banks would have to recognize the full mark-to market impact of the Greek bonds in their P&L and subsequently in Tier 1. However, if “re-profiling” can be done in a way that the NPV of the debt remains unchanged, the reprofiling would not be evidence of an impairment and the banks could maintain the pretense that the Greeks will pay back the debt.
See we told you it was a plainly-spoken note. But can it be done?
Alliance Bernstein reckon yes, and it’s ironically down to that increasingly inverted Greek yield curve, which would traditionally indicate that investors reckon there’s a near-term chance of a default:
Under normal circumstances an extension of maturities whilst maintaining the same NPV would require a material increase in the coupon, reflecting the steepness of the yield curve. However, in the case of Greece, the yield curve is inverse, i.e., shorter term maturities on the 2 and 3 year bonds are higher than the higher maturity bonds (see Exhibit 3). As a consequence, shifting a bond from the 2Y or 3Y to the 5Y maturity may in some cases be possible whilst reducing coupons at the same time, without reducing the NPV (see Exhibit 4, Exhibit 5)
Mesdames et messieurs — modern (Orwellian) accounting.
To avoid Greek restructuring losses – an accounting loophole for banks – FT Alphaville