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In "With the Euro Disintegrating, You Can Calculate Your Haircuts Here", I explicitly illustrated the likely loss to principal of sovereign debt investors who would be forced to take haircuts "for the cause". While we fully stand behind the calculations and the logic, chances are several sovereigns may attempt to undergo sleight of hand in order to placate investors as best they can. We suspect we will soon be hearing of significant restructuring plans in the Eurozone, starting with Greece. The piece below expands on these thoughts and offers subscribers live spreadsheets that illustrate the potential repercussions. It is recommended that these scenarios be taken into consideration in light of the info offered in the post "Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!" and compared to the haircut analysis as well. All paying subscribers are welcome to review our analytical overview of Greece's public finances (Greece Public Finances Projections) as well as the full Pan European Sovereign Debt Crisis analysis which is freely available to everyone.
Greek Restructuring Scenarios
There are several precedents of sovereign debt restructuring through maturity extension without taking an explicit haircut on the principal amount, and many analysts are predicting something of a similar order for Greece. This form of restructuring is usually followed as a preemptive step in order to avoid a country from technically defaulting on its debt obligation due to lack of funds available from the market. It primarily aims to ease the liquidity pressures by deferring the immediate funding requirements to later periods and by spreading the debt obligations over a longer period of time. It also helps in moderating the increase in interest expenditure due to refinancing if the rates are expected to remain high in the near-to medium term but decline over the long term.
However, the two major negative limitations of this form of restructuring if applied to Greek sovereign debt restructuring are –
Thus, even though the amount of funds required each year to refinance the maturing debt will be reduced by extending maturities, the solvency and sustainability issues surrounding Greece’s public finances, which were the primary reasons for it’s being ostracized from the market in the first place, will remain unanswered.
In order to assess the effectiveness of this form of restructuring for Greek sovereign debt, we have built three scenarios in which the maturities of the Greek debt is extended. These scenarios weren’t designed to be exact predictions of the future but to represent what may happen under a variety of highly likely scenarios (a pessimistic, base and optimistic case, so to say):
In all the three scenarios, we computed the total funding requirements and compared the same with funding requirements prior to restructuring. It is observed that restructuring will help in easing the immediate pressure of procuring funds to meet the huge funding requirements lined up in the next 5 years. However, it will also lead to substantial loss to creditors in the form of erosion of present value of cash flows. (Discount rate was the benchmark yields of Greek government bonds for similar maturity period).
We have also built in the impact of EU/IMF assistance to demonstrate the impact on funding requirements over the period 2010-2025. We assume that IMF/EU will disburse the entire assistance of EUR 110 billion by 2013. The IMF loans will have to be repaid after 3 years from the disbursement date and the payment will be distributed over the next two years. The EU loans will have to be repaid after 3 years from the disbursement date and the payment will be distributed over the next five years. It is observed that IMF – EU assistance will be just a short term relief and Greece will face the pressure when it will be forced to turn to the market to not only fund its maturing debt but also repay EU-IMF loans.
Conclusion – It is seen that the restructuring by maturity extension will marginally moderate liquidity concerns. But the primary and the more fundamental concerns about the high level of debt and the related refinancing and interest rate risks, the huge interest burden, the poor primary balance will be left unresolved by this form of restructuring. The revenues are weak and expenditures are high resulting in huge primary deficit and the government need to first fill this huge gap before it earns a primary surplus to cover the interest expense and reduce debt levels.
The government debt currently stands at 124.5% of GDP and is expected to balloon to 156.1% of GDP owing to lack of funds from primary balance to cover the interest expenditure which continues to add to the government debt levels. The three scenarios built for maturity extension show that maturity extension will not substantially help this issue to contain the ballooning government debt. Under restructuring 1, 2 and 3, the government debt is expected to stand at 154.4%, 123.7% and 147.0% of GDP at the end of 2025.
Disclaimer
Reggie Middleton, LLC's Boom Bust Blog analysis and conclusions in this presentation are based on publicly available information. Reggie Middleton, LLC recognizes that there may be confidential information in the possession of the Companies discussed in the presentation that could lead these Companies to disagree with Reggie Middleton LLC's conclusions. The analyses provided may include certain statements, estimates and projections prepared with respect to, among other things, the historical and anticipated operating performance of the Companies. Such statements, estimates, and projections reflect various assumptions by Reggie Middleton, LLC concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. No representations express or implied, are made as to the accuracy or completeness of such statements, estimates or projections or with respect to any other materials herein. The content herein is not, and should not be considered, investment advice of any form or fashion. Users of this content agree to hold harmless and indemnify BoomBustBlog, Reggie Middleton, LLC and its agents, contractors, members, employees and associates against any action that may occur out of the use of this material.
Actual results may vary materially from the estimates and projected results contained herein. Reggie Middleton, LLC and its affiliates may own investments that are bullish or bearish on the subject entity in this material. These investments may include credit-default swaps, equity put or call options, warrants and short sales of common stock. Reggie Middleton, LLC is in the business of trading - buying and selling - public and private securities. It is possible that there will be developments in the future that cause Reggie Middleton, LLC to change its position regarding the Companies and possibly increase, reduce, dispose of, or change the form of its investment in the Companies.
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Reggie Middleton is an entrepreneurial investor who guides a small team of independent analysts, engineers & developers to usher in the era of peer-to-peer capital markets.
1-212-300-5600
reggie@veritaseum.com