Photo: Wikimedia Commons
This latest Greek vote/bailout has been particularly hard to come by, in part because everyone is getting clued into the fact that austerity doesn’t actually work. Greece (it seems) is basically insolvent, and cutting spending and raising taxes has only made the economy worse, thus counteracting debt payback.It’s conceivable, though, that there could be a debt restructuring that actually loosened the noose around Athens, giving the economy a chance to survive.
Hopes are now pinned to a debt rollover plan that’s emanated out of French banks.
Deutsche Bank Strategist Mohit Kumar has a good explanation of what the plan is.
Here’s his top-down view:
Recent market commentary has suggested a convergence towards a voluntary roll-over approach where bonds maturing over the next three years horizon would be exchanged for securities with longer maturity.
It is proposed to exchange securities maturing over the next three years into 30Y securities with a 50:30:20 split where 50% gets rolled into a 30Y GGB security, 20% is allocated to a fund invested in AAA securities and 30% is paid as cash. The coupon on the 30Y GGBs is proposed to be a 5.5%
plus an uplift depending on the GDP performance.
Three issues that need to be considered from a bondholders perspective are the NPV impact, accounting treatment of the rolled over securities and liquidity considerations. The transaction appears to be NPV positive on aggregate for bondholders participating in the roll-over process, which acts as an incentive to encourage a large participation rate.
Now there are a couple key points here, the first is that there’s some question about whether such a radical restructuring would count as a default. This matters a) for triggering credit default swaps and b) the ECB can’t take Greek debt as collateral when Greece is in default. Well, word is — according to Reuters — that the ratings agencies are actually OK with the plan. This might be stunning, since really, this is a radical restructuring, but then when you have European politicians regularly blasting the ratings agencies, or even talking about coming up with their own homegrown ones, why rock the boat?
The other issue, as noted above, is that this move could cause major losses for some investors, particularly if you’re holding Greek debt at face value on the grounds that you’re holding it to maturity. As Deutsche Bank notes, this plan should be NPV positive, meaning that on net, it benefits the bondholders who have been marking their Greek debt to market, more than it hurts the bondholders who are holding to maturity.
As for Greece, well…
A successful voluntary roll-over exercise could provide much needed liquidity relief to Greece and would pave the path for a multi-year support package for Greece. The rollover would enable Greece to refinance a portion of the maturing bonds with the EFSF loans at an effective rate of 5.5%. Assuming a participation rate of EUR 30bn, the remaining EUR 63bn of maturing bonds are effectively refinanced at 5.5% (cost of funding obtained via the EU/IMF), which is significantly lower than the prevailing
yield level for Greece. With a lower long term sustainable rate of around 7%, a successful rollover would imply a net NPV relief for Greece of EUR 8bn, on the EUR 63bn of funding obtained via the EU/IMF (assuming a loan term of 7 years).
As we have highlighted before, a voluntary roll-over is a liquidity solution rather than a solvency one. It buys time for Greece to move towards a primary surplus and the stronger countries to ring fence their institutions. Even if a successful voluntary roll-over is engineered, we note the ball would lie in Greece’s court and further aid to Greece would likely be conditional on Greece delivering on the
austerity measures. Thus the base scenario remains one of “extend and pretend” with a successful voluntary rollover pushing the situation further down the road.
Basically, as noted above, it’s a noose-loosener, not a cure-all by any stretch.
The economics of Greece within the euro do not look sound, and the anarchic reaction to today’s vote do not inspire confidence. But for Europe – and perhaps Greece – this looks like the best way forward.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.