Euro-Update (28): Evaluating the July 21 Eurogroup Meeting

I guess I should start this blog by at least acknowledging I got it right. The measures taken were right up my alley (check the videos of the press conferences, and the meeting conclusions, as well as the transcript of the Van Rompuy and Barroso press conferences).

But what was decided? What’s the impact?

Meeting results

All in all, between the official and the private sector, the EU hopes this new plan can provide aroung € 147 billion of debt relief to Greece. The EFSF will be allowed to purchase debt in secondary markets; a second bailout package for Greece was agreed lending it €109 billion; the spread in the interest rates on the loans to Greece, as well as to Ireland and Portugal were eliminated and the banks were offered a set of options for them to voluntarily accept default.

Private Sector Bail-in

Although the offical sector measures through the EFSF are all exactly what I expected to happen, the private sector measures, intended to decrease Greek debt by around €38 billion were more comprehensive. I am not implying that they were better than what I wanted. Truthfully I don’t really want anything yet, because I don’t think that they can take it yet. They were more comprehensive, in that they offered a range of options. From FTAlphaville:

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.”

Reactions to the meeting

This being said, not everybody is happy with the EFSF/ESM reforms. The president of the Bundesbank seemed worried about the credibility of the Euro. Similarly, not everyone is happy about the voluntary private sector restructuring. Some, such as Moody’s, are undertain. Buiter wants to increase the size of the EFSF and Krugman wants austerity to stop. Even the markets seem to have lost some of their Friday euphoria. I for one am actually happy. We should be realistic, and realistically speaking, this was the best outcome. As a matter of fact, throwing in a bone to Portugal and Ireland was even surprising.

What’s the actual size of the Debt relief?

Notwithstanding this, any accounting of the debt relief to Greece should only focus, for the time being on the EFSF loans, worth those €109 billion, because private sector participation is Voluntary. I don’t think that without coercion the private sector will just happily take the hit to its balance books that the EU would like them to. So the next crisis may come when the EU realises that a voluntary deal doesn’t do the trick.

I’ll consider this and other issues in my next post where I’ll peak into the future to try to foresee what lays ahead.

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