Government Debt reestructuring Lessons: Ahead of Greece worst scenario

Escrito el 27 abril 2010 por Antonio Rivela Rodríguez en Uncategorized

Many “golden” rules have been broken since 2008.

Rules like “TIER 1 bank issued” will never default… oops!

A bulge bracket american bank like Lehman can not end up bankrupt… oops!

or “AAA rating” never defaults… oops! I did it again!… You know the song?

… and many others.

One scary “golden rule” is the one that denies that Government bonds can default…. We have the same memory spam that Dory´s Nemo gold fish …

The following is a summary of a very interesting UBS credit research piece on a potential Greek debt reestructuring.

What I like about the article is the amazing coverage of past government reestructuring situations where IMF was involved like Pakistan, Moldova, Ukraine, Argentina, Russia, etc.

History can explain the future indeed…

A look at sovereign debt restructuring

The meltdown in bond markets today would appear to clearly point to increased pricing of default risk in
Greece. Given the growing clamour in the markets about the possibility of an IMF-led debt restructuring,
we examine the historical precedents and go on to explain why we do not expect restructuring in the
near term in Greece.
What do we know about past sovereign debt restructurings where the IMF has been involved?
The first point to make is that there is no ‘typical’ restructuring scenario or policy template followed by
the IMF. Recovery rates (as judged by looking at the change in net present value of the restructured
debt) in past sovereign restructurings have varied greatly depending on the circumstances and existing
debt levels of each country, as we explain below.

Secondly, and contrary to the concerns of some investors, it is not within the IMF’s mandate to demand
that debt restructuring takes place.

We can broadly classify previous sovereign debt restructurings into two types:
(i) Pre-emptive: restructurings often took place in a negotiated manner ahead of a more disorderly
default. Recent examples of this include Ukraine (1998-2000), Pakistan (November 1999), Moldova
(June 2002) and Uruguay (May 2003).
(ii) Post-default: restructurings have tended to occur following missed coupon or principal repayments,
sometimes ahead of IMF involvement in the country. Examples include Ecuador (October 1999), Russia
(May 1999, August 2000) and Moldova (April 2004). IMF studies show that these cases have tended to
see a larger reduction in the sovereign’s debt, though on average they have also resulted in larger
subsequent contractions in GDP.
What typically happens during a sovereign debt restructuring?
(i) Extension of maturity and/or limited reduction in coupon payments: This has been the more
common form of restructuring for the “pre-emptive” cases discussed above. Here coupon payments are
temporarily reduced, with the balance being paid at a future date. This often takes place via a debt
exchange, where an existing bond is exchanged for a new bond of longer maturity (examples include
Moldova’s June 2002 exchange offer and Uruguay’s May 2003 debt exchange) .

Debt reduction, as calculated by the net present value of the restructured cash flows, has tended to be
relatively small: 2 to 10% in the case of six case studies looked at by the IMF1 between 2000 and 2005
(using a fixed 10% discount rate to enable direct comparison).
(ii) Principal reduction: This form of restructuring has been more prevalent among the “post-default”
cases discussed above. Considered a more serious and extreme step, this form of restructuring involves
permanent haircuts on bonds. In many such cases, a distinction has been made between domestic and
non-domestic creditors, with the former receiving preferential terms. Typically there has been no
‘template’ for haircut sizes – examples of principal reductions include Ecuador in 2000 (NPV reduction
of 25% in external debt to private creditors, no reduction for domestic holders), Russia in 2000 (NPV
reduction of 44%) and Argentina (NPV reduction of 75% in the global debt exchange of 2005).

Historically this form of reduction has been associated with deeper economic contractions in the
sovereigns concerned, according to the IMF.

It should be pointed out that all of the above types of restructuring are considered credit events for CDS
purposes, as is the formal subordination of existing debt. Typically, an ISDA committee must determine
that a restructuring credit event has taken place in response to an investor request.

What has the IMF’s role usually been?

The policy response has varied broadly in response to the idiosyncratic nature of the states involved and
the orientation of the IMF at the time and as such, there is no typical policy template to refer to. As our
EM colleagues have pointed out, more recent IMF Stand-By Arrangements in EU states such as
Hungary and Latvia have tended to take a softer and more ‘hands off’ approach than earlier
interventions. We note again, however, that the circumstances of those countries were very different to
those of Greece today – fiscal deficits were not as high, and balance of payments support was a key
factor in the IMF response.

The IMF would normally be expected to carry out a debt sustainability analysis as a first step. Next
steps typically include targets for various metrics such the fiscal deficit, external debt position, central
bank reserves etc. As we previously pointed out, it is not within the IMF’s remit to direct a sovereign to
restructure its debt, though in the extreme case of restructuring, the IMF has frequently been involved in
facilitating discussions between debtor nations and their creditors to ensure an orderly restructuring
(often as part of the IMF’s so-called ‘Lending into Arrears’ policy).

What could happen in the case of Greece?

The above discussions presuppose no involvement from the EU side, and here is where we see the
essential difference for the Greek case. The key point to make is that the European policymakers wish
this to be seen as an EU-led initiative, and as such it is unlikely in our view that the IMF will be given
free reign in setting the policy agenda. In any event, the IMF funds for Greece are likely to come
disproportionately from EU countries2 (see Fixed Income Strategy Daily, 25th March 2010) and with
1 “Cross-Country Experience with Restructuring of Sovereign Debt and Restoring Debt Sustainability”, 29th August 2006, International Monetary Fund.
2 Though Eurozone countries ex-Greece constitute around 27% of IMF’s overall total of quotas, loans made in any single IMF intervention are not
necessarily made by members on a pro rata basis. Instead, they are dependent on many factors – among others: political interests (often involving
geographical proximity) of members towards the beneficiary state, when a country became a creditor. In our view, it is likely that Eurozone countries
will contribute a proportionately greater amount to the IMF portion of the loans.

In the case of Greece, the most likely initial scenario is that the EU and IMF will insist that Greece
implements the measures already outlined in the Stability Programme update submitted by the Greek
government to the European Commission in January. Some additional austerity measures are possible.
The €45bn in EU/IMF funds will be disbursed in tranches following review of performance targets, in
keeping with normal IMF practice.

We think that the adoption of the above measures will take place in the first instance and these measures
will be allowed to run their course. As previously outlined, we see some relief rally in Greek spreads
occurring when the first tranche of loans has been disbursed. This should preclude recourse to the more
drastic option of immediate debt restructuring by Greece, which has not been the historical precedent in
the IMF’s involvement in other countries.

In our view, the EU countries will be very anxious to avoid a debt restructuring, not least due to the
European banking system exposure to Greece (see our US credit strategists’ report ‘UBS US Credit
Compass’, 5th February 2010) and fears of contagion to other peripherals. In addition, as we discussed
on Tuesday, the commitment to EMU as a cornerstone of the “ever closer union among the peoples of
Europe” referred to in every European Treaty should not be underestimated, despite recent election
rhetoric in Germany and elsewhere (though it should be noted that the senior coalition partner in
Germany expressed the party view that Greek default must be prevented as such a default would break
up Euro area). These considerations are likely to see sufficient funds being made available to meet
Greece’s near term liquidity needs.

However, as UBS economists have written, debt sustainability remains a major concern and a default in
the medium-term is possible, but certainly not our central case scenario (UBS European Economic
Focus, 8th April 2010). In the hypothetical case that restructuring were to occur, historical precedent
suggests that the “pre-emptive” restructuring model referred to above is the most likely outcome. As we
pointed out, such cases have typically involved extension of maturity and debt exchanges rather than the
more extreme case of principal reduction.

Question of seniority of debt

Investor concerns have also centred on the issue of seniority of EU and IMF loans versus current Greek
bonds. It is worth pointing out that formal subordination of a country’s debt is a credit event. This hasn’t
happened in previous IMF interventions in Hungary, Latvia etc. More typically, as lender of last resort,
the IMF loan is de facto senior as the sovereign will be more inclined to restructure its other debt first,
ahead of not paying back the IMF, though the IMF loan is not de jure senior. On the EU loans, the
Dutch Finance Minister has already stated that the EU loans will not have seniority over existing Greek
Short term outlook

As it stands, we expect a request for activation of the Greek aid package to follow in the coming days.
Greek government sources were quoted on Reuters today as stating that a bridging loan mechanism was
being discussed, which suggest that the parties in Athens are looking at ways of getting Greece over the
19th May redemption hurdle while the parliamentary approval for Eurozone bilateral loans is underway
in Germany, Slovenia and elsewhere.

Antonio Rivela dixit


riccardo 9 mayo 2010 - 15:18

I don’t know if this is true but I could not verify this story from another news source.

Israel buys 13 Greek islands..


blue monkey 11 mayo 2010 - 02:11

Greece and Spain won’t pay back. This was a calculated Risk, and a Lesson for the Banking System. The only thing Germans can do is:
REPOSSESS 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
U.S.A must REPOSSESS 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.
Greece’s problem is too much debt. Greece has a budget deficit of 12.7% of GDP – meaning that the country is spending 12.7% more than the value of one year’s economic output.
Greece is no different to a serial credit card borrower who can’t pay back his loans. But just like a serial credit card borrower, as long as Greece keeps relying on borrowed money to fund itself, the problem won’t go away. It will just get worse.
Don’t worry; the ECB, the Fed or both will print the money.
And all of us will share the pain, with our hard-earned money.
Bad is never good until worse happens.

college financial planning 1 septiembre 2011 - 16:43

Great points. I am now not sure where you are getting your info, but great topic. I needs to spend some time learning more or understanding more. Thanks for fantastic info I was searching for this information for my mission.

rabaty 31 agosto 2013 - 15:40

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