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Greek buzz cut

31 October 2011 By Neil Unmack

How severe a haircut will Greece’s creditors suffer? One might think that was agreed at last week’s euro summit: the face value of their bond holdings will be halved. But the coupon the new bonds will pay has yet to be hammered out. If the euro zone plays hardball, the real economic losses could be nearer 60 percent, according to a Breakingviews calculator.

The provisional agreement between the euro zone and the Institute of International Finance, which negotiates on behalf of banks, envisages creditors swapping old bonds for new ones with half their face value. The euro zone will contribute 30 billion euros to the deal as a sweetener to protect the new bonds’ principal. It also looks like the new bonds will have a maturity of 30 years.

The sweetener means the principal and the coupons on the new bonds need to be discounted at different rates, given that the former is protected but the latter are not. A low rate, say 3.8 percent, equivalent to the cost of funds for the euro zone bailout fund, the European Financial Stability Facility, seems appropriate for the principal. A higher rate is needed for the coupons, say 9 percent, roughly what the country’s bonds yielded when it was bailed out in 2010.

The key variable is the coupon. If the bonds paid 6 percent, as was suggested in the Greek press last week, they would be worth 94 percent of their new face value. After factoring in the upfront halving of face value, the total loss for bondholders would be 53 percent. But if the coupon matched the average cost on Greece’s existing debt, about 5 percent, the value of the new bonds would be just 84 percent and the overall loss 58 percent.

Banks might try to negotiate other sweeteners to minimise the pain – for example, promises to increase the coupons if Greece grows more rapidly in future. But their creativity will be constrained by the fact that Athens is projected to have debt of 120 percent of GDP in 2020 even after the debt restructuring.


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