Posted on: 12/Apr/2011
If it does so, Greece will become the first Western European country to restructure debt in 60 years. The longer Greece waits, the more of its obligations will be held by official creditors and the less room for manoeuvre it will have.
It has become increasingly clear that it is now a question of when, not if, Greece will restructure its USD350bn of government debt - and the sooner it does it, the better.
Delays in taking the plunge will only make an eventual restructuring much more problematic for Greece, because the longer it uses the 110 billion euros of rescue money provided principally by the European Union and the International Monetary Fund to repay maturing bonds and interest payments, the more it will eventually transfer its debt to those official creditors.
"Greece's debt stack is unsustainable. That will bite in two years. By then up to two-thirds of the debt may have migrated from bondholders to the EU and IMF," said one sovereign restructuring expert.
"Then, if you try to restructure those preferred creditors, you will have a very stark choice. It would be better to do something now than concede effective control of the process to those creditors in the official sector."
In other words, if the current situation continues, Greece's fellow EU members, who are providing the bulk of the bail-out, and the IMF will ultimately call the shots on any future restructuring of the country's debt structure – and therefore its access to the market.
If the country wants to retain any pretence of sovereignty, it must try to reach agreement with creditors sooner rather than later. Greece has already bought itself a little time, extending the length of the bailout loan from three years to seven and reducing the interest rate on the bulk of this by 100 basis points.
"Officials and politicians can keep saying that a restructuring is not on the table, but in the end the market will dictate what happens. Either the entire debt will end up with the EU and IMF or the debt will be restructured. The market is telling you that," said another restructuring adviser.
Yields to maturity on ten-year Greek government bonds dropped to 7.5% immediately after Greece negotiated the bail-out last May, but have remained above 10% since last November and are now just below 13%. Yields on shorter-term paper are even higher. Demand has dropped for paper maturing after 2013 and Greek CDS currently stands at 999 basis points, which infers a 58% probability of default.
Mohamed El-Erian, chief executive of bond investor Pimco, believes that last week's bailout application by Portugal brings a Greek debt restructuring closer.
"Instead of a falling domino that threatens to topple countries higher up the credit-quality ladder, the latest aid request will likely speed up the debt restructuring of the three countries in Europe's intensive-care unit," he wrote in a Bloomberg column.
Balanced against those imperatives is the fact that those calling the shots in Europe - essentially the leaders of Germany and France - have been keen to delay the moment of truth for as long as possible, to protect their banks from the damage that would be caused by a Greek restructuring.
It is also the case that not all of Greece's debt needs to be repaid in one fell swoop. And, since most of its debt is longer-maturity fixed-income paper charging a reasonable rate, Greece can continue to pay the interest required. A forced event of default is therefore unlikely in the short term.
Greece faces some looming bond maturities: notably 6.59bn euros on May 18 and 6.82bn euros on August 20. At the moment such repayments are not a problem, thanks to the bail-out package. A 8.56bn euros bond was repaid in March without difficulty.
But there is another difficulty caused by using money from the IMF and EU to repay maturing bonds: it effectively subordinates all other debt.
"The more of such super-senior EU and IMF debt there is, the more regular debt traded in the bond markets starts to look like mezzanine finance," said Max Ziff, managing director at Houlihan Lokey.
"The EFSF will be replaced in 2013. What happens then? As currently promulgated, new EU debt post-2013 will be super-senior. This uncertainty has undoubtedly been a contributory factor to the rapidly widening spreads of Irish, Greek and Portuguese bonds."
While a restructuring of Greek debt will be an extremely delicate exercise, the country has some factors in its favour. Around 90% of its debt is in fixed-rate bonds denominated in euros and governed by Greek law.
The government could introduce legislation to impose collective action clauses. This would make it easier to bind dissident creditors who hold out on proposals to change the terms of instruments.
The precise shape of a restructuring remains to be seen, but restructuring specialists have long been convinced that a "voluntary" exchange offer is most likely. "In my view, if there is any action it will take the form of a 'soft restructuring', such as an exchange offer that will keep the principal the same but maturities lengthened with a very low sub-market interest rate," said Ziff.
One solution would be to extend the maturities of outstanding debt without cutting the principal value of the paper, or the coupons. This was the course taken by some Latin American countries after Argentina defaulted a decade ago.
"Uruguay 'reprofiled' its foreign bond stock in 2003 by stretching it for five years. No haircut to the principal was given," said the restructuring expert. Uruguay, whose debt was investment-grade, managed to raise money in the capital markets within a month of the re-profiling.
"If I were a betting man, that option might be chosen in this instance," the expert added. "Greece could then use the remaining monies from the 110bn euro bail-out for opportunistic buybacks to nibble away at the overall debt stack."
It may be possible to make such a voluntary exchange offer stick, provided the effective haircut is given through extending maturities or reducing coupons rather than touching the principal, particularly with collective action clauses to bind the agreement of the majority of creditors on the dissenting minority.
"From the perspective of the bank creditors, it may be the ECB that holds the ace in the pack as it could state simply that it will only accept the new (exchanged) bonds for repo purposes, which would force the banks to accept any such exchange offer," said Ziff.
Creditors would still have options. "Bondholders may say they will not exchange their bonds or accept new terms unless the IMF and EU conditions are met, as they are in the end going to be investing money on the future prospects of the country," said one sovereign restructuring lawyer.
The EU and IMF are both monitoring the Greek economy on a quarterly basis to check that the required conditions of the bail-out are met before discharging more money. This will also effectively ensure that the country remains investor-friendly.
Lazard is advising the Greek government.
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