A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina

Reggie Middleton's picture

In order to assess the impact of sovereign debt restructuring on the
market prices of the sovereign bonds that undergo restructuring (haircut
in the principal amount or maturity extension), we retrieved price data
of the Argentinean bonds that underwent restructuring in 2005. The
sovereign debt restructuring in case of Argentina was a combination of
maturity extension and principal haircut. Argentina defaulted on its
international debt in November 2001 after a failed attempt to
restructure the debt. The markets priced in the risk of a substantial
haircut around this time and the bond prices plummeted sharply. We at
BoomBustBlog are in the habit of taking market prices seriously, and
have factored historical market reactions into our analysis in
calculating prospective price action in distressed and soon to be
Sovereign debt. Before moving on, it is highly recommended
that readers review our haircut analysis for Greece (“With
the Euro Disintegrating, You Can Calculate Your Haircuts Here”
and our more likely to occur restructuring analysis for the same (What is the Most Likely Scenario in the Greek Debt
Fiasco? Restructuring Via Extension of Maturity Dates

The restructuring of the Argentina debt in default was occurred in
2005 when the government offered new bonds in exchange of old
securities. The government gave the option of either accepting A) a par
bond with no haircut in the principal amount but substantially lower
coupon and longer maturity or accept B) a discount bond with a haircut
in principal amount to the extent of 66.3% but relatively better coupon
rate and shorter maturity than in case of Par bond. If the bondholder
accepted A), for each unit of bond, one unit of Par bond will be
allotted. If the bondholder accepted B), for each unit of bond, 0.33
unit of Discount Bond will be allotted. The loss to the creditor, which
is decline in the NPV of the cash flows, was nearly the same in both
cases as the lower principal amount in Option B was offset by better
coupon rate and shorter maturity. The price of the par bond in the
market and the price of the discount bond multiplied by the exchange
ratio (real price to the bond holder) were largely the same when they
were listed in the market in 2005.

The IMF estimated the average haircut (decline in the net present
value of the bond) was on an average 75% and the market priced in most
of this haircut before the actual restructuring in Feb 2005. The prices
of the bond in default declined nearly 65% between Feb 2001 and Feb

One should keep these figures in mind,
for in the blog post “How Greece Killed Its
Own Banks!
I ran through a much, much more
optimistic scenario that wiped out ALL of the equity of the big Greek
banks. Remember, the Greek government stuffed these banks to the gills
with Greek bonds in order to created the perception of a market for
them. As excerpeted…

Well, the answer is…. Insolvency! The
gorging on quickly to be devalued debt was the absolutely last thing
the Greek banks needed as they were suffering from a classic run on the
bank due to deposits being pulled out at a record pace. So assuming
the aforementioned drain on liquidity from a bank run (mitigated in
part or in full by support from the ECB), imagine what happens when a
very significant portion of your bond portfolio performs as follows
(please note that these numbers were drawn before the bond market route
of the 27th)…


The same hypothetical leveraged
positions expressed as a percentage gain or loss…


When I first started writing this
post this morning, the only other bond markets getting hit were
Portugal’s. After the aforementioned downgraded, I would assume we can
expect significantly more activity. As you can, those holding these
bonds on a leveraged basis (basically any bank that holds the bonds)
has gotten literally toasted. We have discovered several entities that
are flushed with sovereign debt and I am turning significantly more
bearish against them. Subscribers, please reference the following:

To date, my work both free and
particularly the subscription work, has shown significant returns. I am
quite confident that the thesis behind the Pan-European Sovereign Debt Crisis research is still quite
valid and has a very long run ahead of it.  Let’s look at one of the
main Greek bank shorts that we went bearish on in January:

nbg since research

Now, referencing the bond price charts below as well as the
spreadsheet data containing sovereign debt restructuring in Argentina,
we get…

Price of the bond that went under restructuring and was exchanged for
the Par bond in 2005


Price of the bond that went under restructuring and was exchanged for
the Discount bond


With this quick historical primer still fresh in our heads, let’s
revisit our Greek, Spanish, and Italian banking analyses (the
green sidebar to the right), many of which are trying to push the 400%
mark in terms of returns if one purchased OTM options at the time of the
research release. It may be worthwhile to review the Sovereign debt exposure of Insurers and Reinsurers
as well.

We may very well get a bear market rally or two that may pop prices,
but from a fundamental perspective, I do not see how significantly more
pain is not to come out of this debt fiasco. The only question is who’s
next. We feel we have answered that question is sufficient detail
through our Sovereign Contagion Model. Thus far, it has
been right on the money for 5 months straight!