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Greek Debt Likely Unsustainable Even With Haircuts, Barclays Complete Q&A On PSI

Greek Debt Likely Unsustainable Even With Haircuts, Barclays Complete Q&A On PSI

17.January.2012, 15:32


Greek Debt Likely Unsustainable Even With Haircuts, Barclays Complete Q&A On PSI

Tyler Durden's picture

As we discussed earlier, the bigger news of the day (as opposed to the ratings actions which are well-discounted) is the new reality that PSI talks are going nowhere. The lack of incentives for an increasingly 'hedged' community of GGB holders as the banks reduce exposure and shoot themselves in the foot leaves a glaring hole in the dis-union that is the EMU. Barclays Capital is out with a very complete Q&A on 'everything you wanted to know about Greek PSI Talks and implications but were afraid to ask' and while they remain more positive on the probability of a successful outcome than us, one thing we agree on is that even with 100% participation Greek debt is not likely to be sustainable in the absence of substantial fiscal and structural adjustment in the years ahead.

Greek PSI - Questions And Answers

1) Will the PSI go ahead?

It seems at this stage that policymakers are quite determined to proceed with the PSI and finalise it as soon as possible. If Greece aims to stay in the eurozone without hard default, PSI is crucial as a funding resource (ie, via extension of maturities), as well as to improve debt sustainability. There is still some small probability that the whole PSI negotiations can fall apart and Greece can hard default on its debt. However, in this scenario, the risk of Greece leaving the eurozone would be much higher unless rest of eurozone decided to fund Greece for so many years to come. Given the vulnerable state of the eurozone at this stage, policymakers cannot afford to let such a scenario happen, in our view. Therefore, the most likely baseline scenario, in our opinion, is that PSI will go ahead in some form. [ZH - we are not so sure!!]

2) Can the PSI be delayed?

PSI has already been delayed many times since summer 2011, and there is not another three months to delay it. Greece was able to stretch its finances up until now to avoid a hard default. With the €8bn sixth tranche release from the EU/IMF first programme, Greece has enough funds to continue until the March redemptions (€14.4bn redemption on 20 March 2012). However, without the PSI and further EU resources, there is not any room for the March redemption to be paid. As such, March Greek redemption is implicitly the hard deadline for Greece.

3) What is the likely timeline?

The latest timeline reported by Reuters news reports is as follows. The technical details of the PSI deal are likely to be released over the next week or so. The Troika and Greece would then agree to the second Greek bailout package by the end of January (which is when the next EU summit is held). With all these in place, investors are then invited to the actual PSI process in early February, which is aimed to be finalised by before the end of February.

4) What are the broad targets for the PSI?

The October EU summit set two broad targets for the PSI: 50% notional haircut on €206bn eligible debt targeted for the PSI and 120% debt/GDP by 2020. Alongside these, the PSI was also deemed to be in voluntary in nature.


On the whole, the headlines coming from policymakers still by and large show that they are willing to stick with these broad targets. While the PSI is deemed to be voluntary, the Troika wants €100bn of debt relief from the PSI, which would imply almost 100% participation. This and the voluntary nature of the PSI are in conflict, though, because it is very difficult to get a universal participation in a voluntary PSI (especially recently – some sovereign wealth funds are reported to have said that if the ECB is excluded from the PSI, they will consider themselves “official sector” as well and not participate). However, Greece and the Troika seem much more determined on achieving universal participation and, as a result, are considering retroactive CACs into existing bonds under Greek law.

5) What are the likely technical details for the new bonds from the exchange?

The new bonds are likely to have a maturity of about 30yrs with coupons of about 4-5% and a 50% notional haircut. Investors would receive 35% notional of new bonds and 15% upfront cash (or a similar NPV worth AAA collateral). Depending on the maturity of the old bonds, the exchange bond might have different splits between notional and cash (but still a 50% notional discount) and a different maturity (a bit longer or shorter than 30y).


Let us also clarify the misunderstanding from the media regarding the haircut and NPV losses. The notional haircut is 50% in the PSI if Greece and Troika stick to the October EU summit target. However, the NPV loss will also depend on the final coupon and maturity, as well as the discount rate used to find the present value of the cash flows. For instance, a new 30y bond with 35% of notional, 15% upfront cash payment and a 5% coupon will result in about 65% NPV loss with a 9% discount rate, but a 70% NPV loss with a 12% discount rate. Moreover, while there was a dispute on this about a month ago, it seems most likely now that the new bonds from the PSI will be under English law.

6) Does the PSI in its current form make the Greek debt sustainable?

The October Troika debt sustainability report highlights that the current PSI with nearly universal participation gets debt/GDP close to 120% by 2020. First, this number is still on the high side to conclude that Greek debt is sustainable. Second, the underlying macroeconomic assumptions by the October Troika report in terms of GDP growth and primary balance post-2015 are still optimistic (c.3.8% average nominal growth and average 4% primary balance). If these macroeconomic assumptions are reduced to a more realistic 2.5-3%, then the debt sustainability picture would look much worse.As seen in Figure 1, a 50% national haircut with 50% participation does not get Greece close to 120% debt/GDP by 2020, as envisaged even with the relatively optimistic macro economic assumptions of the Troika. Only if 100% participation is achieved would close to a 120% debt/GDP target be reached. For this reason, the Troika does not want to sacrifice universal participation and is determined to do whatever is necessary to maintain it. When worse macroeconomic assumptions are used, the notional haircut needed for a reasonably sustainable debt path is about 80%.


Therefore, if Greece and the Troika go ahead with October summit broad parameters for the PSI, even with 100% participation Greek debt is not likely to be sustainable in the absence of substantial fiscal and structural adjustment by Greece in the years ahead.

7) How likely is it that CACs will be introduced to the existing Greek government bonds? If they are, will they be used and what do these mean for CDS triggers?

Given the determination of policymakers to achieve universal participation, CACs are very likely to be introduced to the existing bonds, in our opinion. The question remains whether they will be used at the end of the formal PSI process or not. The mere act of introducing CACs does not trigger the CDS, but if the CACs are used subsequently, that action will likely trigger the CDS. While we think that CACs are very likely to be introduced, policymakers would likely prefer not to use them to avoid CDS trigger if they can. In other words, if the mere existence of CACs brings a very high participation such as 95% from the voluntary PSI, then we do not think the holdouts will be forced by CACs. However, if the participation is less, say about 70-80%, policymakers would not hesitate to use the CACs due to the fact that debt sustainability is in even greater jeopardy without 100% participation.

8) Will the ECB participate?

With the probability of CACs being introduced to the existing bonds under Greek law, the expectation that the ECB might participate with its GGB holdings under the SMP has increased as well. However, even if CACs are introduced, it should still be technically possible to exclude the ECB.


During this week’s ECB press conference, President Draghi said the ECB is not in the private sector and therefore is not on table for negotiations with Greece regarding the details of the deal. However, he did not have as hard stance as Mr Trichet, and the press conference was somewhat vague regarding what the ECB might end up doing in the end. Therefore, we  do not think some form of ECB participation can be ruled out at this stage.

9) What kind of difference does it make if the ECB did participate?

If the ECB participates in the PSI under the same terms as private investors, it would have certain implications for Greece as well as the markets. First, it would increase the probability of a higher take-up by other investors. Second, the debt sustainability of Greece would improve somewhat more because the PSI eligible paper size would increase from €206bn to about €250bn. The schedule for release of funds from the EU/IMF to Greece under the second programme would not have to be as frontloaded given that the ECB would likely to be holding mostly front-end Greek paper.


In terms of market implications, ECB participation is likely to give the market some important messages. First, it makes the December changes in the ESM draft regarding private sector participation more credible. In other words, Greece is unique and the only PSI for eurozone, but even if there might be more PSI in the future, there is at least some part of official sector that took a loss, which makes the issue of subordination of existing holders less concerning. Second, ECB participation also gives the message to the market that the ECB is determined and willing to be bold to help resolve the eurozone crisis.

10) Does it really matter if the CDS is triggered?

The GGB market is already pricing in pretty much the worst case scenario as bonds post-2014 maturities are trading flat at the 20-25 price level. The contagion effect of the CDS trigger on other asset classes is most likely to be muted as well, or at least not as negative as the market has been expecting. According to DTCC, net protection outstanding is pretty small as well at €3.3bn. More important, a CDS trigger is pretty well publicised now. Indeed, if the ECB decides to participate in the end as well, the market effect, as we discussed above, can be positive even if CDS is triggered. If the PSI negotiations fall apart and a hard default occurs, then the contagion and the implications for the market can be substantial.

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