From Peter Tchir of TF Market Advisors
Greek Debt Rollover - Who Is Getting Rolled Over?
Over the weekend the French announced the outlines of a rollover plan to “help” Greece. This morning the German banks seem to be on board with the plan. According to the headlines, this should be good news for Greece. But is it? Working through the details as best possible shows it strengthens the positions of the banks and weakens the IMF/EU/ECB (“Troika”) and is expensive for Greece. The consequences of the rollover plan are that:
- The Troika has to provide more money up-front without being able to enforce austerity compliance
- The Troika is more likely to continue to fund Greece longer than it would otherwise because of the additional up-front payment and the moral suasion the banks will use to encourage further use of public funds
- Greek interest payments will go up, and with the GDP kicker, will be almost 2.5 times what they are currently scheduled to be and are in line with existing Greek long bond yields
The analysis clearly demonstrates that the Troika is put into more risk sooner, and with less control than it would be without the rollover. Greece will be paying a higher coupon over the next 3 years by offering the SPV rates in line with its existing long bonds. The banks get immediate risk relief from a combination of cashing out 20% of their short dated Greek bonds and structuring the SPV to ensure maximum recovery. The banks have also made a proposal that ensures they will be receiving a good rate of interest in spite of the relatively low headline coupon mentioned. It is no wonder why the banks are falling all over themselves to agree to the plan. It sounds like they are being kind, but they are much better off with the plan by shifting near term risk to the Troika and longer term rate risk to Greece.
The Rollover Plan
The details of the plan are still being worked out, but here is my current understanding:
The plan is meant to affect debt with maturities ranging from 2011 to 2014. From Bloomberg, under the tickers GGB and GREECE, I found a total of €270 billion. Of that, €108 billion matures prior to 2015. Without the rollover, Greece would have €38 billion coming due in the next year that would have to be funded by the Troika since it is apparent the capital markets will not be open to new Greek bonds in that time frame.
For simplicity, and since the headlines are showing more countries are joining the rollover bandwagon, and insurance companies are also mentioned, I will refer to them as “Participants”. The Participants are supposed to retain 30% of their existing exposure to bonds in this maturity range. So far there is no indication that it has to be pro-rata, across their holdings, so I think it is safe to assume that Participants will roll their longer dated maturities and keep as much short term paper as possible, since that is most likely to be funded by current Troika commitments.
So now let’s assume the full €108 billion subject to the rollover is in the hands of institutions that decide to participate. There may be some bonds in reality that are not owned by Participants, but since insurance companies are joining with banks, and more countries are participating, the simplification seems reasonable. Figuring out the breakdown of what 30% of debt will be retained is a bit tricky, but I don’t think it is wrong to assume that Participants will retain as much short dated paper as possible. Let’s assume Participants keep €25 billion maturing within 1 year and €7.5 billion maturing during the 2nd year. That would be the 30% that Participants retain. So far, under this scenario the Troika will only have to redeem €25 billion in the next 12 months, an improvement from the €38 billion currently expected.
Greece will only receive 71% of the money that is rolled over. Under the scenario laid out, the Participants would be rolling over €76 billion of debt. Greece would pay the Participants this money so that the rating agencies and CDS contracts do not trigger (whether that is a necessary step or not, I’m not sure, but it is the mechanism the rollover would use). The Participants would then put that €76 billion into a Special Purpose Vehicle (“SPV”). The SPV would then use about €21.5 billion to purchase some highly rated securities to guarantee the principle. The remaining €54 billion would be lent to Greece for 30 years. Since it seems safe to assume Greece doesn’t have an extra €21.5 billion lying around, this difference will have to be funded by additional loans from the Troika. The rollover, no matter what the maturity breakdown of the retained portion is, causes an immediate shortfall for Greece of €21.5 billion.
In order for the rollover to work, the Troika needs to lend an extra €21.5 billion to Greece now. So much for continued progress on austerity measures for Greece. The rollover forces the hand of the Troika to provide an extra €21.5 billion immediately. Forcing the hand of the Troika to provide money now without Greece demonstrating ongoing success in its austerity program benefits the Participants at the expense of the Troika (aka, taxpayers). Assuming the Troika makes the loan to Greece to enable the rollover, the Troika will now be lending €46.5 billion to Greece over the next 12 months instead of the €38 billion. A little worse, but the key to focus on is the large up -front payment now to enable the rollover to work. It is a direct transfer of risk from Participants to the Troika and undermines the ability of the Troika to play hardball with Greece in regards to forcing a balanced budget.
In spite of the perception that extending to 30 years means the Participants are taking on more, risk, this rollover drops the risk significantly over the near term. If Greece defaults ahead of the rollover, the €108 billion in this bucket would trade to a recovery value. Assuming that recovery was 40%, the Participants would lose €65 billion. If Greece defaulted the day after the rollover, the Participants would only lose €52 billion because the Troika would have paid them out. Since it would be hard to imagine a scenario so cynical, it is safe to assume the Troika will lend money for awhile longer so that Greece doesn’t default immediately after the rollover. But who owns the bonds that are getting repaid? The Participants, because that is the part of their portfolio that they wouldn’t rollover! So virtually every Euro lent by the Troika after the rollover will be used to pay back the Participants even more money. The rollover forces the Troika to pay out €21.5 billion now, so they are less likely to turn off the spigot any time soon. The Participants will play the ‘see how we helped out card’ and encourage the Troika to do their part, particularly so soon after the ‘sacrifice’ of making the rollover.
If the Troika pays out for another year, under the scenario I laid out, the Participants would only have €7.5 billion of regular bonds left, and €76 billion of SPV notes. Without the rollover, at the end of the year the Participants would have owned €70 billion of Greek bonds, so a default with 40% recovery would have cost the Participants €52 billion. Please keep in mind, that the rollover ploy makes it more likely that the Troika continues to lend longer than it might otherwise because of the up-front payment to initiate the rollover and the “moral suasion” coming from the Participants. With the rollover executed, Participants would lose €4.5 billion on the remaining bonds they hold. Although the SPV has a notional of €76 billion, Greece received only €54 billion. In theory the Participants should only receive 40% recovery on that amount, but since the Participants structured the SPV let’s assume they structured it in such a way that in event of a Greek default, their claim is for the full notional. They would then recover €30 billion from the SPV note, for a loss of €24 billion, giving the Participants a total loss of only €28.5 billion. So after a year, Participants would only lose €28.5 billion on a default with 40% recovery, compared to a loss of €52 billion without the rollover. That doesn’t seem like a risk increasing trade. My analysis does ignore interest payments collected over the year, which would have been marginally more in the non rollover world, but nowhere near enough to offset the savings in event of default.
It is true that by the end of 2014, the Participants would have more exposure to Greece than they would have had if they did not rollover. But, in this market, the dramatic reduction in near term exposure seems well worth that trade off, and interest on the SPV notes also helps to reduce the residual exposure at the end of 2014.
Speaking of interest, from a Bloomberg story, a coupon of 5.5% was mentioned on the SPV Notes. I haven’t seen any other specific numbers, though something just over 5% seems to be the rumor. Since I’m working under the assumption that the rollover is designed to be good for the Participants, let’s look at this coupon more closely. The headline of 5.5% for 30 year Greek debt seems low. It looks like the Participants may actually be helping out on current interest, that Participants are actually trying hard to make interest rates lower for Greece. The first question is whether the coupon is paid just on the Greek portion or the entire notional. It would be common practice for the coupon to apply to the full notional. That begs the question of where the money is coming from to pay the coupon. The Participants paid €76 billion for the notes, but €21.5 billion went to buy a zero coupon instrument to protect the principle at maturity. So by definition that component is not generating the income. So the entire 5.5% coupon must be coming from Greece. Since Greece only received €54 billion, Greece must be paying a coupon of 7.70% on the money it borrowed to enable the SPV to pay a 5.5% coupon. 7.7% coupon for Greece seems less “cheap”. Then there is noise about additional coupons of up to 2.5% based on the GDP of Greece. An additional 2.5%, again paid only by the Greek portion, is 3.5% to Greece, so a total potential coupon of 11.2% from the Greek perspective. Suddenly it isn’t so cheap. An annual coupon of 11.2% for Greece in good times and 7.7% without the GDP kicker is not extremely low, nor a gift, in my opinion.
Maybe 7.7% or even 11.2% seem attractive relative to where bonds are trading in the secondary market. With Greek 2 year bonds yielding 27% according to Bloomberg maybe it is. On the other hand, the Greek long bond yields 11.45%, so compared to potential rate of 11.2% it doesn’t seem like the Participants are making too much of a sacrifice. In addition, the average coupon on bonds maturing prior to 2015 is only 4.57%. That is the coupon Greece is paying and the Participants are receiving. It does not matter where bonds are trading in the secondary market, the average coupon on debt in the 2011 to 2014 maturity is only 4.57%. So as part of the SPV, Greece will be paying an interest rate of somewhere between 7.7% and 11.2% which is higher than the 4.57% Greece is currently paying on debt subject to rollover, and is almost as high as the 11.45% the existing Greek long bonds are yielding. Once again, I find it hard to figure out where the big benefit is for Greece.