Thursday’s Greek debt restructuring panic — an enigma inside a riddle, wrapped in a mystery, inside an enigma. And, as BNP Paribas puts it, maybe tied with a Gordion knot to boot.
A Die Welt interview with Wolfgang Schäuble kicked things off. According to the FT, Germany’s finance minister is quoted saying if a study currently under way showed that Greece’s debt levels were unsustainable, “further measures” would have to be taken. When asked what those could be, he ruled out any involuntary restructuring before 2013, warning investors could face losses after then, presumably when the restructuring-focused European Stability Mechamism comes into effect.
And yet the market reacted as if Greece was going to default this summer. It Greek-ed out!
The below from BNP Paribas bank analysts Gregory Venizelos and Rajeev Shah:
The Greek restructuring story is somewhat puzzling, even resembling a Gordian knot. Credit markets traded nervously on Thursday, on concerns that a potential Greek debt restructuring could happen sooner rather than later. These were caused by German Finance Minister Schaeuble’s comments reported by Reuters. “In June we will get a progress report. I’m expecting a detailed analysis on the debt sustainability of Greece, that will be done in consultation with the Commission and the ECB. If this report concludes that there are doubts about the debt sustainability of Greece, something must be done about it.” As well as “until then [2013] a restructuring could only take place on a voluntary basis.”
Did you catch it? Voluntary restructuring before 2013 — involuntary after.
Are the banks — the biggest holders of Greek debt — going to agree to a debt restructuring or exchange (possibly ahead of an expected 2013 involuntary restructing)? BNP Paribas reckons not.
And it’s all because of that pesky CDS issue:
The concept that Greece may be running out of alternatives other than restructuring its debt, to put itself back on a sustainable debt-path, is not alien to the markets. However, such an event is not expected prior to 2013 when the permanent rescue mechanism comes into force (ESF). Further, a voluntary restructuring now would involve holders of Greek debt being willing to tender their bonds. Given that banks comprise a large segment of debt holders and that 80% of banks’ sovereign holdings are in their banking books (read zero capital charges unless provisioned voluntarily), it is hard to contemplate how European banks would currently cope with impairments involved in a sovereign restructuring scenario (potential haircuts of 50% if not greater in the case of Greece). Why would banks choose to crystallise a loss that they have not recognised yet whilst their capital adequacy (for some of them) is still in a fragile state?
The Greek CDS curve does not help towards resolving the Greece restructuring puzzle either. With the 1-3yr part of the curve trading north of 1400bp (drops to 1000bp+ at 5yr) the implied likelihood of an earlier credit event is high (1450bp implies 30% 1y probability at 50% recovery). But if a restructuring was to be voluntary, our CDS specialist expects that CDS would not trigger, thus invalidating such a wide spread (please refer to 7 April Credit Plus for CDS triggers in sovereign restructuring scenarios). Net-net, our more cynical side is inclined to think that the re-surfacing of the Greek story is more of an attempt to soften the Euro rather than a strong hint towards an imminent Greek debt restructuring. The fact, of course, is that Greece appears to be sliding backwards in terms of fiscal consolidation, creating a fertile ground for restructuring concerns to grow.
Related links:
Greek debt hit by restructuring fears - FT
Greek Debt – The Endgame Scenarios - SSRN
Greece and its most grim sovereign-bank loop - FT Alphaville