We did warn that financial markets would have to come to vivid terms with the comparison one day…
This is not a flattering chart for the eurozone:
It’s a two-thirds haircut on Greek debt, in 2012, before the supposed 2013 threshold for a ‘real’ restructuring, and less friendlier to Greece holders too. Importantly, the haircut comes in terms of net present value. A NPV cut could be done via maturity and coupon alterations, not necessarily face value.
It’s a familiar taboo if you’ve followed the travails of Greek banks’ exposure to government bonds within their banking books and the capital risks involved. Nevertheless, a 67 per cent haircut explodes all notions of ‘soft’ versus ‘hard’ restructuring and it’s really worth exploring what this number means.
Above all, there’s the shadow of Argentina’s torturous 2005 debt exchange after its 2001 default.
That is a eurozone reality check.
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Fiscal adjustment <–> haircuts
Why 2012?, you must be asking.
The chart comes via Barclays Capital analysts. BarCap now assume that eurozone officials will wait until Greece is at least on the way to sustainable primary balances after a sovereign restructuring, which is in the first half of 2012. But, with the balance liable to come in at -2.5 per cent this year — it’s implicit here that a 67 per cent haircut must be made on Greek debt in 2012 to push Greece towards sustainability.
Here’s another chart:
Interesting to note that BarCap assume restructuring of Greece’s official debt would be heavy as part of the haircut, with maturities pushed out by 10 years, but far from enough:
Given the implicit debt reduction obtained by the official sector (c. 9% of GDP), bonded debt needs to contribute an additional 83% of GDP. Given that this represents c.120% of GDP by end-2011, it is equivalent to a haircut of 67%…
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Recovery rates, again
Where it gets really interesting however is how BarCap have modelled the recovery rates on post-restructuring Greek debt — again, a subject close to FT Alphaville’s heart.
Modelling all of Greece’s debt as one bond that pays out the average interest rate for Greece (5.15 per cent), and which possesses Greek debt’s average maturity (eight years) BarCap apply the 67 per cent haircut to derive this chart:
OK — time to recycle this recent Moody’s chart of historical rates of recovery in defaulted sovereign bonds:
Note Russia’s and Argentina’s recoveries especially.
FT Alphaville had already been expecting low recovery rates owing to the sheer amount of debt stock that Greece is burdened with. However…
Twenty-five cents in the euro would be a landmark in the history of sovereign debt restructuring. Not only that, it’s really still not being priced either in Greek debt or CDS. In the latter market, recoveries of 40-45 have been more common.
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Greek banks as the caveat to a 2012 haircut
But what about Greek banks’ capital?, you might still be asking.
Because after all, at €29bn, it’s at real risk of being wiped out wherever the haircut is more than 50 per cent — this is partly why there’s been interest in forestalling this cut to 2013, when their exposures would have likely halved, rather than doing it in 2012 and therefore requiring heavy recapitalisation. There’s no easy answer here although under a NPV haircut, we’ve already pointed out that accounting and regulatory capital treatments could limit losses.
In addition, BarCap (like Roubini before) mention the possibility of presenting creditors with a menu of different bonds tailored to capital treatments in an exchange of debt — for example, zero coupon bonds which protect face values, or discount bonds which work vice versa. Add in exotic accouterments like GDP warrants and we’re getting closer to debt being able to be traded away.
And guess what accompanied Argentina’s 2005 exchange?
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But — Greek banks may yet prevent a strong haircut before 2013, leaving the eurozone with some combination of maturity swapping and extra bailout loans.
Of course, BarCap’s haircut is a model that aims to identify the optimal debt reduction for Greece given its expected fiscal path throughout the next four years. It’s still very likely indeed that eurozone states and banks will try to nibble the bullet, rather than bite it.
(Equally, the model is necessarily colourless on some tail risk in Greek debt values, such as the country leaving the euro)
The point is though — if a 67 per cent haircut is needed in 2012, what’s going to be required in 2013?
Related links:
A (hard) Greek restructuring by the numbers – FT Alphaville
What fiscal transfer to Greece do you want? – FT Alphaville
Haircuts: Estimating Investor Losses in Sovereign Debt Restructurings, 1998–2005 – IMF (2005)
Costs of sovereign default – Bank of England (2006)