FT Alphaville has been there, done that on calling a ‘voluntary’ Greek debt maturity extension.
But it’s (at last) overtly on the agenda, and comparisons to Uruguay’s 2003 re-profiling are doing the rounds again. No one remembers the other precedent, oddly enough: Argentina’s 2001 ‘mega-swap’ of key maturities, immediately preceding its default.
Can’t think why.
But we really think these three points bear repeating:
1) It will be default as far the rating agencies are concerned.
We have to point to this chart again:
Agencies downgraded both Uruguay and Argentina to default following the announcement of re-profiling offers — regardless of their voluntary basis. S&P has already warned it could do the same to Greece.
Indeed any exchange that’s designed to avoid a more serious distressed restructuring, and which materially alters the terms of bond payments, comes under selective default.
Of course, you might not care what the rating agencies think, and that’s probably what European politicians will say, too. The thing is — it could matter for the ratings-based mandates of some mainstream investors, who therefore won’t be trading Greece at all after this point (assuming that name risk didn’t leave them to drop the bonds ages ago). Perhaps more likely, a technical default will encourage distressed investors into the fold. It’ll at least affect Greece’s investor base and the time it takes to return to markets.
Mostly though, there’ll be a weird gap between ratings and CDS.
2) It likely won’t be a restructuring credit event triggering CDS.
A ‘voluntary’ exchange of Greek debt has threatened to leave CDS purchasers high and dry for some time. Rather than rehash the long debate here – we decided to look what happened during Argentina’s mega-swap.
At that time, a 1999 set of rules still applied to defining restructuring credit events (ironically, put in place after Russia’s 1998 default) and which the current 2003 Isda definitions later superseded. It’s a key distinction, as this 2005 NY Fed paper relates:
[P]rotection buyers sought payments under credit default swaps as a result of Argentina’s restructuring of its sovereign debt in late 2001 [the maturity swap], which they viewed as voluntary in form but economically coercive. Protection sellers withheld payment, contending that the 1999 Restructuring definition required an exchange of obligations to be mandatory. Argentina later repudiated and failed to pay on its obligations, but by then some protection buyers’ default swaps had terminated at maturity…
There’s even an old legal case that was entirely about the definition of ‘voluntary’ in the 1999 documents, as it applied to the Argentine swap.
By contrast, the 2003 definitions provided that an exchange must be instead ‘binding’ on holders. That’s a tricky distinction, we think. Will Greece’s exchange require a certain portion of bondholders to agree terms and to sign up to ‘exit consents’ allowing old bonds not to be serviced? That’s what Uruguay did. It might be more ‘binding’ than simply asking each bondholder to volunteer bonds but we’re not sure. When the design of the exchange can be manipulated like this, it isn’t looking good for CDS holders.
What is clear is that Argentina CDS had been febrile at the time of the 2001 swap. Lisa Pollack of Markit has helped reconstruct for us how Argentina traded in 2001. While it’s difficult to determine exactly, CDS did eventually trade at expected recoveries, implying expectations of an imminent default. Meanwhile spreads seem to have gone haywire, based on this chart from a mid-2000s IMF paper:
3) It’s highly unclear what the net present value cut will be.
Famously, Uruguay got away with a NPV cut of 20 per cent. It merely lengthened maturities by five years, without touching any coupons or other features of future cashflow that affect NPV. The Argentine swap was much more complicated, taking about 30 to 40 per cent off NPV depending how you calculate it. (There’s an IMF paper here.)
Now — BarCap have already argued that Greece must make a ‘NPV’ haircut of 67 per cent in 2012 if it’s to be a sustainable credit before it becomes too late. (You could well argue whether you really can cut a whole two-thirds off Greece’s debt payments, without hurting any principal whatsoever).
Plus, it’s really not clear how long Greece will have to stay off markets, or to what point in the future it needs to push the 2012 and 2013 bonds in order to avoid a refinancing lump later on (three years? ten years?), or whether coupons will be thrown into the pit too.
After having gone through Groundhog Day just to get officials to admit some form of soft restructuring is on its way, we still simply have no clarity on how much extension is needed.
Nuts.
4) And so, seriously, it’s all about the second haircut.
You can argue — we have: so many times we’ve lost count — that the entire point of a maturity extension is to prepare banks’ accounts and give them enough time to build capital, before a second haircut on par values, that can actually address debt sustainability.
OK, one last bit of Argentine debt history. After the mega-swap, a coup de grace bank run unfolded and quickly pushed the country to default. Depositors knew their banks’ government bond holdings and moved assets accordingly, expecting another, fuller restructuring, as austerity policies also broke down.
Hence you can see why Greek banks in particular are such a hinge for the next steps of the crisis. It’s not just about their capital, but also the use of Greek paper as collateral for ECB funding. Can both those issues be solved during the time bought by a maturity swap?
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Incidentally, if you’re wondering how Uruguay’s sovereign credit has been doing lately: not bad. Might even regain investment grade next year for the first time since the default, according to our FT Tilt colleagues.
Related links:
Hurdles to a Greek restructuring – FT Alphaville
Greece and its most grim sovereign-banking loop – FT Alphaville