And lo — the cherubim descended on the Institute of International Finance’s Greek bond exchange, and sang… well, what were those dulcet tones, exactly? The Ode to Joy – or the Argentine national anthem…
Way too much like the latter, we think.
1. First, Argentine analogies
Before we dive into the term sheet proper…
We can’t possibly hope to cover all the intricacies of the financing offer here, but Argentina is very much on our minds, and it’s worth jumping in at the deep end to see why. You’ve no doubt seen that the offer is split into four options for bondholders, involving a mixture of discount and par bonds with varying bits of collateral attached.
That’s in fact more reminiscent of Argentina’s 2005, post-default bond exchange than the 2001 debt swap it did before default. (And of course similar to just about every Brady bond restructuring ever.) You’ve no doubt also seen that the Greek bond offer results in a net present value cut of 21 per cent. Seems to count from current Greek bond prices, not the original par value — although do get in touch if we’re mistaken — and involves a princely discount rate of 9 per cent.
That’s… way more generous than even those Argentine 2001 swaps, which have been pilloried ever since for leaving Argentina’s stock of debt effectively untouched and no more sustainable than before. (It’s still going to alter bondholder claims enough to be restrictive default once the exchange is under way, said Fitch on Friday.)
See where we’re going? An amazingly complex plan for the first attempt, but not really clear if Greek debt has been made more sustainable. See what you think as we plough through, anyway.
2. The four options — and their collateral
OK, time to dive in to these bond options. The discount/par bond distinction is important, but if anything, we’re most interested in their largely shared collateral arrangements.
a) Par bond 1
Two options involve par bonds — that is, principal untouched, but coupons lowered, and maturities increased, to compensate in order for there to be cash-flow relief for Greece. Here’s how the first one works, according to the IIF:
A Par Bond Exchange into a new 30 year instrument with the principal collateralized by 30 year zero-coupon AAA rated bonds. The zero coupon bonds are purchased using EFSF funds. Greece pays the funding costs to the EFSF. The principal is repaid to the investor using the proceeds of the maturity of the zero-coupon bonds.
Two general things here.
It’s worth noting that the extension to a 30-year bond launches the Greek offer into the stratosphere, in terms of recent precedent. The Argentine 2001 swap extended the country’s weighted average debt maturity by 3.7 years. Uruguay’s 2002 swap did five years.
Second, that collateral. Odd that the EFSF doesn’t issue AAA-rated zero coupon bonds itself. Instead it will buy them from other issuers unknown. (We’d presume another supranational like the European Investment Bank — we’re guessing Bunds would be controversial!)
Now, Greece itself funds the purchasing of the collateral. This is a highly significant point. Nomura’s Nick Firoozye calculated on Friday that around €38bn of collateral will be needed, and thus added to Greek gross debt. There are features in the offer which also reduce gross debt, in the discount bonds we’re about to get on to, and a separate bond buyback. But not by enough. As Firoozye notes:
EUR26.1bn (12% of GDP): 1) a EUR13.5bn debt reduction from exchange = EUR135bn bonds participating*50% of which are discount bonds*20% discount; and 2) a EUR12.6bn reduction in notional from buybacks.
Firoozye says Greece’s net debt is better off, but like we’ve already said, is this private sector involvement, or private sector subsidy?
b) Par bond 2
Next option. Back to the IIF quickly:
A Par Bond offered at par value as a Committed Financing Facility to roll into new 30 year par bond at the time the current claim matures. The principal is collateralized using the same mechanism as for instrument 1.
So, option two is roll-over. The only real difference to the first par bond is that investors won’t tender bonds in an exchange offer in a few weeks’ time, but only as and when current holdings reach their maturity date. Is it worth it for the accounting? Surely under IFRS, banks would already have to assign a markdown to current bonds once they agree to the CFF.
Also, the stepped coupons on both par bonds are the same:
Notably the 4.5 per cent benchmark is just below most estimates of Greece’s average interest rate on its current bonds (around 4.6-5.2 per cent.)
c) Discount bond 1
Taboo-breakers, these. Principal gets written down from face value (by 20 per cent), and is mitigated for investors by a higher coupon:
Same maturity as in the first two options though, of 30 years, plus same collateral. A small question creeping in on participation here. The IIF assumes that each option gets exactly 25 per cent of those holders who take part. Think for a moment just how many of these investors have been holding their Greek bonds to maturity in order to mark them at par. More like three-quarters of ‘em… So, see any participation problems forming?
d) Discount bond 2
The second discount option is curious though! As the IIF explains:
A Discount Bond Exchange offered at 80% of par value for a 15 year instrument. The principal is partially collateralized with 80% of losses being covered up to a maximum of 40% of the notional value of the new instrument. The collateral is provided by funds held in escrow. These funds are borrowed by Greece from the EFSF. The EFSF funding costs are covered by the interest earned on the funds in the escrow account so there is no funding cost to Greece of this collateral. The funds in escrow are returned to the EFSF on maturity, if not used, and the principal on the bond is repaid by Greece.
The coupon paid to the Investor is 5.9%.
It’s amazingly complex, and a bit like the French proposal has been resurrected. Just goes to show the collateral complications at work within this plan.
But we’re missing perhaps the most immediately important bit…
3. IT’S VOLUNTARY!!!
As the IIF note, ‘we are prepared to participate in a voluntary program of debt exchange’ and there are no provisions here to explain what happens to those who don’t volunteer. That’s very different to (for example) the Uruguayan restructuring, where participating holders voted to bind hold-outs, and there were a number of other sticks, such as making old bonds ineligible for pledging at the central bank. No wonder that the ISDA general counsel has already been on the wires warning that the Greek financing offer is unlikely to trigger CDS. (That would possibly disincentivise bondholders to take part in the exchange, perhaps? Think about it.)
Small problem though.
The IIF are assuming a participation rate of a huge 90 per cent. Uruguay achieved that, but that was with those disincentives to refusing the offer. Naturally there are plenty of credit sweeteners involved now to sway investors. But that’s the problem with the Argentine precedent in particular. Too much sweetener and it’s probably going to rot Greece’s debt sustainability.
Isn’t that what this looks like?
Related links:
Banks brace for hits on Greek bonds – FT
Who will roll up, roll up — to the Greek rollover? - FT Alphaville
BarCap’s Hellenic tale of CDS tail risk – FT Alphaville