A note put out yesterday by JPMorgan (JPM) strategist Stephen Dulake walks through the issue of Greek debt restructuring. It’s something that’s on everyone’s mind this morning, given the violence in European markets.
First, four assumptions:
The principal assumptions underpinning our scenario analysis are essentially
1. There is no forced haircut or impairment of notional per se.
2. Restructuring involves a non-binding debt exchange; for example, creditors
elect to switch into new bonds of equal notional, but longer maturity.
3. Bondholders suffer a loss of present value rather a loss of notional.
4. Greek sovereign CDS does not trigger.
Now, for options:
Greece’s debt maturity profile is significantly front loaded, with 50% of its debt
coming due in the next five years (Figure 1). While the recent commitment from the
EU is likely to see them through 2010, uncertainty over future payments as well as
the need to access the public markets could mean that some form of debt
restructuring will take place over the coming years. Much of the talk in the market
has been about the 30-40% haircut needed to solve its solvency issues. A pre-emptive
move to avoid this and to buy further time could see maturities pushed out through
an exchange offer.
One way that Greece could defer its near term liabilities is through a voluntary
exchange offer. In exchange for the current bonds, investors would receive a new
extended maturity bond with double the maturity. For example, a 2012 bond will pay
the same coupon, but mature in 2014, while a 2015 bond will mature in 2020. If we
assume that this voluntary exchange offer is taken up by 50% of investors and that
only bonds maturing between 2011 and 2020 are affected, Greece could reduce the
present value of its liabilities over the next five years from €142bn to €122bn a 15%
reduction. A 100% uptake would see this fall further to €100bn (Table 2).
Investors in the restructured bonds would lose on average 7pts but their coupons and
notionals would remain intact. If liquidity switched to the new bonds and investors
were comfortable that a more severe default and restructuring had been averted, they
may be willing to accept the exchange. In Figure 2 we show the new maturity profile,
while Figure 3 charts the cumulative debt profile under the current schedule, and a
50% and 100% take up of the exchange.
And the other option:
The second method Greece might choose is to offer a similar exchange, but in this
case it could offer an amortising bond that deferred principal payments for 2 years
and then paid of a portion of the principal annually over the following 10 years.
Assuming a coupon of 4% for this debt, this would provide a similar reduction in
payments over the next five years, with investors taking a 4pt loss on their position.
But here’s the problem. No solution solves the solvency problem. Restructuring only kicks the ball down the road.
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