Pointless Greek bond swap dead — long live pointless Greek bond swap | FT Alphaville

Pointless Greek bond swap dead — long live pointless Greek bond swap

(Reuters) – Losses for private investors on Greek debt in the second financing package for Athens are likely to be between 30 and 50 percent, rather than the earlier agreed 21 percent, euro zone officials said Wednesday…

Four euro zone officials confirmed that a haircut of 30 to 50 percent for private investors was now under consideration, but said no final decisions or agreements have been reached.

“It is still very much in the open and remains to be seen what the initial reaction of private investors will be,” one euro zone official said.

“A voluntary participation is the target, for now at least, and many feel strongly that we must avoid any risk of full default,” the official said.

First — we’d love to know what all the banks who marked Greek holdings down to 21 per cent are going to do now.

One way to look at this is that there is someone out there (perhaps living in this building) who still thinks a 30 per cent cut is actually enough. Bizarrely, because the original 21 per cent debt exchange would have had to price off current high Greek yields, it had already become likely that the effective haircut would be above 21 per cent. Potentially, in fact, closer to 30 per cent. We’re starting from a really soft baseline here.

Plus, this is all very rough. The “30-50 per cent losses” need overall qualification. We guess these losses are losses to overall net present value of debt, in common with the first bond swap. A second Greek bond swap might well mean very little to the actual sustainability of Greece’s debt, if it shifts cash-flows into the future, or spreads them out, without reducing debt to GDP: that’s the health warning that always has to be attached.

For all we know, the terms of the current bond swap may simply be tweaked to get the “new” haircuts, for example by lengthening the maturities of the new bonds or cutting the coupons paid by Greece, while keeping other things (like collateral) much the same.


Tweaking the bond swap

Happily – there was an excellent analysis on Wednesday by Nomura’s Dimitris Drakopoulos on this very subject. Interestingly, Drakopoulos first reverse-engineered the 21 per cent-cut swap to get the kind of haircut that’s being talked about — 40 per cent. Although as he noted, this doesn’t feed through to much debt reduction:

Changes on PSI are mostly focused in terms of longer maturity (40y instead of 30y), lower coupons and potentially some more deeply discounted bonds offered in the exchange (3rd and 4th options are 20% discount bonds this could move to 30%). All in all, these changes could increase the NPV reduction towards 40% instead of 21%. The deal remains voluntary in nature but the risk of larger holdouts increases, increasing the need for more coercion compared to the current PSI…

Example: 40% NPV loss: One Par bond will be offered with 3% coupon and one with 70% discount bond will be offered with 5.4% coupon. Assuming equal participation between the two, total net debt to GDP ratio would drop by 9.2% of GDP initially while annual interest expenditures as percent of GDP compared to current PSI would be 1.2% of GDP lower. In short, this would represent a notably limited change in Greece’s debt profile.

So, Drakopoulos does another swap that cuts bondholder NPV by 60 per cent, based on a single option that writes down the face value of bonds by half. This is a bit more helpful for Greek debt sustainability but as Nomura observe, the two hard limits here are the positions of official creditors and the willingness to coerce private creditors.

As we’ve noted, the ECB didn’t tender its bonds into the first bond swap, despite being the largest single holder of Greek debt. Official lenders in general have avoided having to write down their loans to Greece. All of this keeps Greece’s debt to GDP high because official loans already account for a lot of its overall debt. The chances of a coercive exchange are also simply not looking good given the ECB’s fanatical resistance to the idea. Ironically, both hard limits make the eventual costs of a disorderly Greek default absolutely horrific. The official creditor insistence on being made whole will leave much less recovery for private creditors and will make the 30 to 50 per cent haircuts above seem like a picnic, and a disorderly default would be coercive by definition.

Thus, it’s all about the official creditors, not the private bond swap.

Related link:
A Finnish view on Greek debt losses – FT Alphaville