Guest Post: The Countdown To Sovereign Debt Write-offs Has Started

Tyler Durden's picture

From Peter Tchir of TF Market Advisors

The Countdown to Sovereign Debt Write-offs Has Started

Don’t be fooled by the IMF’s announcement that Greece will get a new round of money.  This bailout is merely to give a couple of months for the parties to seriously negotiate what haircuts and debt extensions investors need to take in Greece, and Ireland and Portugal.  Virtually all the comments made by the parties involved fit in with the view that we are now in a phase where people are negotiating how much they will write off and what else they will do.  Almost none of the comments indicate that anyone is really trying to put together a plan that is going kick the can down the road for a long time.  I am fading this rally as only the most optimistic investor can believe that this problem doesn’t lead to real default/restructuring with haircuts in the next couple of months.

Why do banks waive covenants?

It looks like Greece has failed to meet the criteria the IMF had set out to provide more money, yet the IMF seems intent on releasing the next tranche.  Banks typically waive covenants and release more money only when they truly believe the borrower will turn around, or when they extract enough value from the borrower that they feel safe making the new loan, or when they aren’t prepared to deal forcing the borrower into default. 

Does anyone really believe that Greece is going to get turned around?  I don’t.  In fact I am highly confident that Greece will still not meet the criteria the IMF has set out when it is time for the next tranche.  That will be the deadline for the default/restructuring.  The IMF can waive the covenants this time because shortly they get to review the progress again and can fail them at that time.

The IMF, which allegedly has some collateral for the loans it is making, be receiving even more collateral on this latest tranche?  Could they have perfected their security interests making their own loans extremely safe?  That is a real possibility.  If this next tranche only includes IMF money, or lending that is collateralized very specifically it would be another clear sign that the game has changed and the lenders are protecting their new loans at expense of existing bondholders.

Are the IMF, or the EU, or the ECB, or the banks prepared to deal with a default or real restructuring right now?  The answer clearly seems to be no, but it is also clear that over the past month, the EU in particular has realized restructuring, possibly with losses needs to occur.  Talk about the ‘Vienna accord’ and ‘voluntary private restructuring’ has become louder.  That will take time.  How do you easily pressure a bank into taking a loss, particularly while were still hopeful for a painless solution just a few weeks ago.  These ‘voluntary’ decisions won’t be so voluntary, but it will take time for the governments to convince their banks en masse to reach an agreement.

Waiving the covenants and providing the next tranche of IMF money, particularly if fully secured, is completely consistent with the idea that we have entered a relatively short period of negotiations leading to real restructuring.

Germany is laying the groundwork for real write-offs.

Germany was the first EU member to suggest private sector haircuts.  It has seemed more open to private sector losses than any other
government.  Not only has the German Finance Minister been outspoken on his desire to include the private sector in any package, but the Bundesbank issued a statement that it is confident that the Euro can withstand Greek default.  That was the first time in this crisis that a statement has come out trying to prepare the markets for a potential default.  As statement start to come out stating that the banking system is strong enough to withstand a default, you know someone is seriously considering a default.  I believe that this statement, which has been largely ignored, is a tell.  It is the first step in the process of trying to soften the market.

Against this, the ECB continues to lash out that restructuring/default is not an option.  At least that is how it seems on the surface.  A little below the surface and it seems like they are starting to take some steps to soften their stance.  First, and most importantly, Draghi seems to be the main spokesman.  Trichet seems to be quiet on the subject now.  Many people (at least me) blame Trichet for making the situation worse through the ECB’s wanton purchase of Greek (and Irish and Portuguese) bonds in the open market.  By bringing Draghi to the front line are they starting to distance themselves from ECB policy under Trichet?  Are they setting him up as a scapegoat?  It is plausible to me.  Then even looking more closely at what Draghi says also indicates a potential softening.  He says “The cost of a real default…”   What does he mean by real?  Is that to make it easier to wiggle out down the road and say whatever happens wasn’t a “real” default?

Germany seems to be moving further into private losses and preparing the markets for how contained those losses will be and the ECB is softening a bit and making it easier to blame its original stance on Trichet if they change their mind.

What about contagion risk?

There is real risk of contagion.  That is another reason that the EU/IMF/ECB need to buy a few more months because not only do they have to restructure Ireland and Portugal.  When the next plan is announced it will be comprehensive and Greece, Ireland, and Portugal will be included.  I had been surprised how quiet Ireland has been.  Other than being mentioned in general terms as part of a contagion argument, relatively few new specifics were being talked about.  Suddenly this week, here they are.  Allied Irish sub debt had a credit Event.  Noonan is speaking about haircuts for senior Allied Irish bondholders.  He is commenting on Greece.  It is not a coincidence in my mind that suddenly he is speaking out, as he is likely involved in this next phase of negotiations.  In fact, it seems that the number of finance ministers and ECB officials who are hitting the airwaves is expanding.  I assume if that many people feel the need to comment, something serious is going on behind the scenes.

Contagion risk is there, but it is being addressed so Greece, Ireland and Portugal can be sorted out at once, and the banks that would be in biggest trouble can get help if they need it.

The Government Changes in Greece Point to Default

You could argue that the changes to the Greek parliament are an attempt to get approval to jam another round of austerity on its people.  That could be, but I think it is more likely that Prime Minister Papandreou does not want to be labeled as the man who put Greece in default or who crushed the Euro, so he is trying to escape that role, or drag others into a group to share the blame.  He is clearly politically savvy, he was an MD at Goldman, and prime minister.  If I was him I would be trying to do things so that my name doesn’t go down in history as the person who broke the Euro.

Banks Can’t Handle the Defaults

I really think most banks can handle the defaults.  The most likely outcome, in my opinion, is there is some amount of permanent debt reduction and any remaining debt has its maturity extended for a long time.  The banks that aren’t mark to market would have to take a loss on any permanent reduction in principal but there is no reason they have to take a loss on any debt that they extend the maturity.  So if a bank took 100 million of 2 year bonds, and exchanged them for 80 million of 10 year bonds, they would take a write off of 20 million.  That seems manageable for most banks (and the governments can directly support any bank that can’t handle it).  From a stock price perspective, no one is buying the stocks of banks with big exposure to Greece, Ireland, and Portugal, on the basis that they don’t have impairments in the portfolio.  Given where debt is currently trading, and how much of the write off is permanent, and the trading price of new bonds, bank stocks may rally.  I occasionally read articles about banks trading below book value as being cheap.  I usually stop there because I believe smart investors try to figure out the value of the banks holdings are not easily fooled by non mark to market accounting.  If I am correct, the banks will have some big losses, their share prices may not react much, and the various EU countries can bailout their own banks directly if they choose to.


A subject that will get its own write-up,  but from the data available from the DTCC, concerns about CDS on sovereigns seems overblown, even if there is a Credit Event.  Of all the subjects written about, the only that seems to get the least accurate treatment is the potential impact of CDS on the outcome.  The problem is a debt problem.  The bulk of all losses will result from poor lending and bond buying decisions.  CDS will spread some gains and losses around, but will not in itself have a meaningful impact on the market.  Trying to compare AIG is wrong as AIG had almost nothing to do with single name CDS and had ridiculously loose collateral terms even by the 2007 standards, let alone today. Lehman, with massive amounts of debt saw its CDS settle with little confusion, and the market dealt pretty well with the loss of Lehman as counterparty on so many CDS trades.  There were more surprising losses from things as simple as repo agreements than from its role as CDS market maker. 

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
FreeNewEnergy's picture

Haircunts, bitchaz!

falak pema's picture

Germany is driving the "hair cut " train. If ECB decides to accept this stance, the train will move down this more realistic road. The ECB will supervise contagion risk. The apparent backing of the FED to this German plan now makes the plan the realistic route to go. 

Kudos to RM for having told us this at ZH....Let's see how this plays out. The linch-pin for avoiding EU meltdown is Spain...

monopoly's picture

Looks like stagflation to me. The worst of both possible worlds. Until inflation kicks in and roars like the Harley Palin was on. Embarrassing.

monopoly's picture

This is like a very slow death. Scary.

Quintus's picture
In other words, the losses suffered by the banks as a result of this proposed debt write-down will be made good by their respective Central Banks handing them more free money.  This is just re-organising the deckchairs on the Titanic.  Instead of, lets say, Greece owing Deutsche Bank €1bn, the Greek debt will be written off and replaced by the ECB handing Deutsche Bank €1bn to compensate them.  How does this help lower overall indebtedness?  It's just Global debt monetisation, basically.  Hyperinflation bitchez.
TheGoodDoctor's picture

QEIII for the European banks again?

monopoly's picture

If I were long stocks here, any stocks, good ones too, I would be very nervous now.


fonestar's picture

If I were long stocks I would be drooling on myself watching CNBC.  Not reading posts on ZH!

bankonzhongguo's picture

Well, I'm hearing some Greek lawyers and parliamentarians are seeking to subpoena GS, Paulson, and Blankfein with the intent to jail these guys on the former $25 billion.

Who would of thought the Greeks would do the job of the Irish?

Again, none of this will be heard on CNBC.

Surround the IMF on Greek territory and just suspend debt payments until someone goes to jail.  Meanwhile, expect to not borrow again - except from China.

TruthInSunshine's picture

Mr. Margin is giddy with anticipation. There are still many good assets to seize to offset so much leveraged ugliness.

Mr. Margin loves downhill skiing.

Mediocritas's picture

As was posted up on ZH earlier, the required eurodollar reserves to deal with marking Greece to market are already in the system thanks to QE2.

This train is ready to roll. All aboard!

TruthInSunshine's picture

Oh, Maximus, you should see the Coliseum!

We will tour, soon; first Greece, then on to Ireland, Portugal, Spain & Italy.

And only Zeus knows where to from there, yet again!

For our journey is just about to begin, Maximus!

Let us raise our chalices, and toast to the splendor of the mess Bernankopolous has made of global economies and finance, where we will freely pillage and plunder!

For by this time next year, we will be Kings, eating and drinking from gold vessels!

hambone's picture

Speaking of "write offs" - seems nows a good time to write off all those who bought any Pandora or LinkedIn ever making a profit on that one...the trashing is on!

hedgeless_horseman's picture

Don't forget GM!  On its way to ultimate support at $0 AGAIN!!!

hambone's picture

IPO crashapolooza!!!  The spectator event of the summer!

Armando Javier Finkeltein of the Boise Finkelsteins's picture

Pandora's box has been opened and she has an ugly box

treasurefish's picture

The question posed by the author if the IMF is prepared to do it's own restructuring sounds odd to me. (Later edit: I may have misread it, but I'll keep the questions open). I guess everyone has their masters. What exactly does it mean for the IMF to default?  SDRs become worthless?  Is that when we all go back to the gold standard?

carbonmutant's picture

Greeks need to start breaking some glass if they want the money...

gwar5's picture

The PIIGS are dead! Long live the PIIGS!


TruthInSunshine's picture

I still haven't found a truly catchy acronym that captures the full essence.




What about China & Japan? How am I going to work those in?

treasurefish's picture

(J)esus (C)hrist! (U) PIIGS (S)UK!


- Essence captured? Check.

- Catchy? Check.

I hereby coin.  Feel free to add France wherever you deem fit.

TruthInSunshine's picture


I forgot about France, too!



Which is worse - bankers or terrorists's picture

The ECB will have to be bailed out itself if Greece delivers a haircut.

When means the NY Fed bails out the ECB.


1inchRacker's picture

Zero Hedge, thanks for great articles such as these.

I live in France, and if I didn't have access to analysis such as this to counterbalance the BS we're fed in mainstream...they take a story, skim off 5% to look at, twist that to fit this or that slant and what you're left with is nothing short of downright lies. Thank you once again.

spanish inquisition's picture

The options are defauting like Iceland and rebuilding in 5 years or becoming a slave for the next 20. Will it work?

“Iceland should be humble and avoid advising other countries, especially when it comes to banking,” Sigfusson said. “What happened was an emergency situation which couldn’t be avoided.”

What it means is "Fuck yeah, do it!..(I just can't say so, otherwise they will invade our ass.)"

slewie the pi-rat's picture

i will take a number...

...ok, USA goes 9th. 

just wait till our turn?

gorillaonyourback's picture

1 quadrillion of derivatives, dat gonna sting

Mad Cow's picture

As it goes *poof* into computer bit heaven.

P-K4's picture

Good comprehensive article, well written.

"So if a bank took 100 million of 2 year bonds, and exchanged them for 80 million of 10 year bonds, they would take a write off of 20 million"  poses two questions: wouldn't the CDS costs be different for 10 year bonds ... and who expects Greece to remain in the EU ten years from now let alone two years from now?

I can see many of the restructured bonds making their way into American pension plans courtesy of Frank-Dodd (i.e. providing cover). It'll be called the "Build Europe" bond with interest rates subsidized by the IMF.

TheProphet's picture

Well, even if they could get CDS protection on the bonds, the ECB will not allow them to use the bonds as collateral.


Commander Cody's picture

If Greece default is not such a big deal, then why is it such a big deal?

XitSam's picture

Q: Why are all these negotiations done behind closed doors?

A: If the serfs knew what was going on, the hangings would begin tomorrow.

taraxias's picture

Oh sure, everything is contained, just print some more CB money, hand it to the banks and everything will be okay.

What a crock of shit !!!!!

It's derivatives baby, derivatives, trillions and trillions of them. Deal with that......

Jack Sheet's picture

Interesting perspective and worth posting but most of it appears to be speculation. Where are the author's sources ? Greek Deep Throat ? DSK's attorneys? Treeshay's secertary?

oogs66's picture

sadly most things are just available on public sites and through some knowledge of credit, but the media has no interest in giving full details on what people said, except for ZH.  check some old zh and ransqwak headlines and you will see most of it. the rest is that some people did do credit for a living.  some posts here on nuclear power were amazing and correct, but were from different sources, because that was their area of expertise.  its why an open site like ZH blows away traditional news sources


swissinv's picture

fully agree - you speak out of my soul... a residual risk is still inherent though

YHC-FTSE's picture

Papandreou was a director at Goldman? It's not listed on his CV. That, I didn't know and it makes so much sense now why GS was instrumental in hiding Greek debts from budget overseers then charged hundreds of millions of euros for the work. He's also got 27 Billion dollars worth of CDS with IJ Partners to look forward to (If he isn't hung for treason), when he leaves office. 

Slipmeanother's picture

The USA and Wall St need to understand this: Europe continues to be the worlds leading economic and trade grouping having both the largest savings and political stability, It is the economic and trade group with the most multilateral experience. In addition thanks to the Euro the EU has the only real credible alternative reserve currency. The recent support and bi-lateral meetings with the BRICS countries has seen dollar to Euro diversification by the BRICS--headed by China. Without the Euro the BRICS would be condemned to suffer Washingstons unipolar world. So de-facto its the Euro which breached the Dollar wall, a breach that now the BRICS are enlarging using their wealth to stimulate the Euro as an alternative to the Dollar. No amount of BS spin from Wall St or the City of London can change the facts. Forget about the BS, the Euro is here to stay and the crisis has strengthened the EU institutions far quicker than would have been possible without it---watch and learn

Noah Vail's picture

Is that all? Anything else you'd care to add to your prepared and oft repeated remarks?

Buck Johnson's picture

We truly don't know how much debt they are in trouble with.

Wolf in the Wilds's picture

With respect to CDS,  I think the DTCC data is incomplete.  The key is CDS done before the Big Bang event in 2009.  BIS data indicated that there were Eur41b exposure to Greece sitting in the US.  And the bulk of the exposure is indirect (ie through credit derivatives).  I believe that these exposures were created pre-crisis through credit CDO products that were placed to US investors during 2005-2007.  These generally have a maturity of 5-7years making them mature during the next 2-3years.  This will pose a problem for a voluntary extension of maturity.  The banks who sold these CDOs will be holding bonds against it.  If these bonds are extended, then the risk attached to the bonds will no longer be hedged as the derivatives expire.  Eur41b is not a small sum.  It represent 16% of the debt outside Greece.  Without this participation, I cannot see how a voluntary debt exchange can work.


Tjemme's picture

Great article!
(*) I agree that the term 'private sector participation' has probably enabled a political discussion of default. And ECB insistence that a default is unacceptable has probably created the time to properly prepare for a default.
(*) But I am not fully persuaded by the other comments:
- The IMF insisted on a guaranteed one-year financing. This suggests that they may not participate if European governments only want a few months delay. But, yes, IMF is unlikely to be spoilsport.
- I think the main problem for the ECB is that they don't want to have defaulted securities as collateral. Restructuring into higher-grade debt needs to accompany a default.
- Most banks can handle defaults? Perhaps most European banks can handle a default of the Greek government, but regulatory exclusion of sovereign exposure from concentration risk leaves the Greek banks vulnerable. Indeed, their capital flight suggests that they need a parachute sooner. To avoid a Lehman, banks need to demonstrably handle defaults of Greek banks as well. Perhaps a 'stress test', just for Greece?
- Contagion risk handled by a bigger plan? I am not sure politicians are ready for this. I personally think contagion risk (at least as described by the ECB) is primarily a (hopefully manageable) investor issue. If Europe can't even avoid a small Greek default, investors realise Portugal and Ireland also need to stand on their own feet. Yes, rating agencies are known to be slow, but if Greece can, at this time, still cause downgrades of French banks, it is clear that we need as much preparation time / clarity as possible.
- Greek politics. one interpretation of 'tough conditions' is that Greece urgently needs to make some major changes. This requires maximal pressure and Greek political support.
- CDS. Some people suggest that only CDS only has a notional of EUR 5bn. I agree with Wolf that this exposure may well be bigger (

JohnsonSmith's picture

I found your article very nicely compiled with good content. Thanks for sharing the updates regarding Greece debt. Instant cash