Tag Archives: Debt restructuring

“Sovereign Bond Prices, Haircuts, and Maturity,” NBER, 2017

NBER Working Paper 23864, September 2017, with Tamon Asonuma and Romain Ranciere. PDF. (Local copy.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” CEPR, 2017

CEPR Discussion Paper 12252, August 2017, with Tamon Asonuma and Romain Ranciere. PDF. (ungated IMF WP.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” IMF, 2017

IMF Working Paper 17/119, May 2017, with Tamon Asonuma and Romain Ranciere. PDF.

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

Monte dei Paschi Bail-X

The Economist reports about plans for Monte dei Paschi’s future:

… retail investors in the bank’s junior bonds, many of them ordinary customers. European state-aid rules say that they should lose their money along with shareholders. Technically, they will. In fact, to preserve their savings and avoid a political outcry, they will be deemed to have been “mis-sold” the bonds: they will receive shares which will in turn be swapped for new, safer bonds.

Italy has to come up with a restructuring plan, likely to involve job losses and branch closures, for the commission’s approval. (The ECB must also certify the bank’s solvency.) Bosses’ pay will be capped at ten times the staff average. And Monte dei Paschi must sell its sofferenze, the worst category of non-performing exposures, which in March amounted to 24% of all its loans. A state guarantee will cover senior tranches of these securitised debts. Atlante 2, a fund backed by Italian financial institutions, and others are negotiating with the bank over more junior slices.

Government Debt with State Contingent Coupons

On VoxEU, Myrvin Anthony, Narcissa Balta, Tom Best, Sanaa Nadeem, and Eriko Togo discuss the history of government debt with state contingent coupons and offer some lessons.

  • In the mid-19th century, the Confederate states issued cotton-linked bonds
  • In the late 1970s, Mexico issued oil-linked bonds
  • In the 2000s, Turkey issued revenue-indexed bonds
  • Since 2014, Uruguay issues nominal wage-issued bonds
  • Some other examples (figure taken from the column):
  • Obviously, confidence in data quality and thus, quality of institutions is important for the success of such issues.

State contingent securities also have been used in debt restructurings:

The first use of state contingent bonds in debt restructurings occurred in the Brady deals from 1989-97, which allowed commercial banks’ claims on debtor countries to be exchanged for tradable instruments, allowing the banks to clean up their balance sheets. Many of these instruments included ‘value recovery rights’, which envisaged additional debt payments in circumstances where the debtor country’s economic or terms of trade conditions improved substantially … Oil exporters generally linked the payments to oil prices, while other countries linked either to GDP or measures of the terms of trade. Many of the Brady instruments subsequently made significant ongoing upside payments (e.g. Bosnia and Venezuela), while in some cases sovereigns chose to repurchase the instruments as it became clear that upside payments would be triggered (e.g. Mexico, and Bulgaria in the mid-2000s).

More recently, ‘upside’ GDP-warrants have featured as part of the package of bonds issued to creditors in each of the three major restructurings of the past decade: Argentina (2005 and 2010), Greece (2012), and Ukraine (2015). In the case of Grenada (2015), the restructuring deal included instruments with both upside and downside features (Table 2).

Inflation linked bonds have been successful:

Inflation-linked bonds have a long history, dating back to a 1780 issuance by the State of Massachusetts … More recently, they emerged in Latin America in the 1950s and 1960s, in an environment of very high domestic inflation, and the UK became the first advanced economy to issue inflation-linked bonds in 1981. … the global stock of government inflation-linked bonds had grown to around USD 3 trillion by 2015 … Despite this recent growth, inflation-linked debt still accounts for a relatively small share of sovereign debt portfolios in most countries …

Related VoxEU column on policy implications.

Puerto Rico’s Debt Restructuring

On Econofact, Daniel Bergstresser provides background information on Puerto Rico’s debt crisis. From his text:

  • Unlike U.S. municipalities, a U.S. territory cannot resort to Chapter 9 of the Bankruptcy act.
  • The island’s economy benefited from corporate tax exemptions (until 2006) and from tax exemptions on interest paid by municipal bonds issued by Puerto Rico and its agencies (“triple tax exemption”).
  • Total bond indebtedness (face value) amounts to over $70 billion, about 70 percent of the island’s GDP. The island owes an additional $50 billion in unfunded pension obligations to its state employees and retirees. Different government-sponsored entities issued the debt, apparently representing different claims on the Commonwealth’s revenue streams.
  • Puerto Rican issuers were downgraded from investment grade status in 2014. In March 2015, governor Padilla announced that the island’s debt was unpayable.
  • Resolution has been delayed by disagreement about the borrowers’ capacity to repay.
  • Puerto Rico defaulted on its general obligation debt in June of 2016 and President Obama signed the “Puerto Rico Oversight, Management, and Economic Stability Act” (PROMESA) law. This created an oversight board with the authority to oversee the island’s budget and facilitate restructuring talks. The law also created a bankruptcy-like “Title III” mechanism. The oversight board placed a moratorium on debt collection by the island’s creditors until May 1, 2017. On May 3 the island entered the debt restructuring process. Chief Justice John Roberts has assigned the case to U.S. District Judge Laura Taylor Swain, and the first hearing in that case is scheduled to occur on May 17.

Puerto Rico and its Control Board

In the FT, Eric Platt offers an update on the debt situation in Puerto Rico:

  • The U.S. territory carries a USD 70 billion debt burden.
  • It has defaulted multiple times over the past year, “including on bonds backed with a constitutional guarantee.”
  • It did not have access to a court-backed restructuring process until Congress recently passed and President Obama signed the Puerto Rico Oversight, Management and Economic Stability Act (Promesa).
  • A seven-person control board controls the island’s finances and will oversee negotiations with creditors.
  • Puerto Rico has two weeks to submit a turnaround plan to the board.

“The IMF and the Crises in Greece, Ireland, and Portugal”

The Independent Evaluation Office of the International Monetary Fund released a critical report on IMF supported policies in Greece, Ireland and Portugal. It questions the legitimacy of certain decisions. The executive summary states that

[t]he IMF’s pre-crisis surveillance mostly identified the right issues but did not foresee the magnitude of the risks … missed the build-up of banking system risks … shared the widely-held “Europe is different” mindset … Following the onset of the crisis, however, IMF surveillance successfully identified many unaddressed vulnerabilities, pushed for aggressive bank stress testing and recapitalization, and called for the formation of a banking union. …

In May 2010, the IMF Executive Board approved a decision to provide exceptional access financing to Greece without seeking preemptive debt restructuring, even though its sovereign debt was not deemed sustainable with a high probability. The risk of contagion was an important consideration … The IMF’s policy on exceptional access to Fund resources, which mandates early Board involvement, was followed only in a perfunctory manner. The 2002 framework for exceptional access was modified to allow exceptional access financing to go forward, but the modification process departed from the IMF’s usual deliberative process whereby decisions of such import receive careful review. Early and active Board involvement might or might not have led to a different decision, but it would have enhanced the legitimacy of any decision. …

The IMF, having considered the possibility of lending to a euro area member as unlikely, had never articulated how best it could design a program with a euro area country … where there was more than one conditional lender, the troika arrangement … proved to be an efficient mechanism … but the IMF lost its characteristic agility as a crisis manager. … the troika arrangement potentially subjected IMF staff’s technical judgments to political pressure …

The IMF-supported programs in Greece and Portugal incorporated overly optimistic growth projections. … Lessons from past crises were not always applied, for example when the IMF underestimated the likely negative response of private creditors to a high-risk program. …

The IMF’s handling of the euro area crisis raised issues of accountability and transparency, which helped create the perception that the IMF treated Europe differently. … Some documents on sensitive issues were prepared outside the regular, established channels; the IEO faced a lack of clarity in its terms of reference on what it could or could not evaluate; and there was no clear protocol on the modality of interactions between the IEO and IMF staff. The IMF did not complete internal reviews involving euro area programs on time, as mandated, which led to missed opportunities to draw timely lessons.

It lists the following recommendations:

… should develop procedures to minimize the room for political intervention in the IMF’s technical analysis. … should strengthen the existing processes to ensure that agreed policies are followed and that they are not changed without careful deliberation. … should clarify how guidelines on program design apply to currency union members. … should establish a policy on cooperation with regional financing arrangements. … should reaffirm their commitment to accountability and transparency and the role of independent evaluation …

In her response, the IMF’s Managing Director emphasizes that the IMF-supported programs did work in the cases of Ireland and Portugal (and in Cyprus) while Greece was a special case. She supports the report’s last four recommendations but disagrees with the premise of the first.

Puerto Rico may Restructure its Debt

In the FT, Eric Platt reports that US Congress has passed emergency legislation allowing Puerto Rico to restructure its debt.

Unlike US cities and municipalities, Puerto Rico and other territories do not have access to protections under the US bankruptcy code.

The legislation gives the island and its debt-issuing entities that right, so long as they have made “good-faith” efforts to negotiate with creditors and have received sign-off from the control board.

With the deal, Puerto Rico will be able to continue funding basic services and avoid crippling lawsuits.

Greek Debt: Now and Then

In the FT, Mehreen Khan offers a “Greek debt dilemma cheat sheet.”

  • Face value: EUR 321 billion, thereof EUR 248 billion owed to official creditors.
  • Official creditors: Eurozone countries (Greek loan facility), eurozone rescue funds (EFSF and ESM), IMF, ECB.
  • Maturity profile:
    1
  • IMF proposal for restructuring:
    2

Argentina to Resolve Litigation and Return to International Capital Markets

In the FT, Daniel Politi and Pan Kwan Yuk report about an agreement between Argentina and four holdouts, yet to be implemented by Congress.

A few weeks ago, New York judge Griesa had indicated that he would lift the injunction preventing Argentina from servicing its restructured debt. This improved Argentina’s bargaining power. According to The Economist, Griesa had written: “President Macri’s election changed everything. … The Republic has shown a good-faith willingness to negotiate.”

Argentina’s Debt Negotiations

In the FT, Chris Giles, Gillian Tett, Elaine Moore and Benedict Mander report about the negotiations between Argentina and the country’s creditors that are about to start, now that the new government has taken office.

Argentina’s finance minister has announced that the country intends to honor the face value of outstanding debt but wishes to negotiate interest payments.

As a sign of support from the international community, Jack Lew, Treasury secretary, announced that the US had ended its formal opposition to the World Bank and other multilateral development banks’ lending to Argentina.

Observers expect that the IMF will soon be involved to provide technical assistance.

In an FT blog, Charles Blitzer argues that successful negotiations should start with a non-disclosure agreement. He links to the Institute of International Finance‘s Principles for Stable Capital Flows and Fair Debt Restructuring.

Credit Default Swaps

In a set of slides from Deutsche Bank Research (from 2011), Kevin Körner discusses credit default swaps and the sovereign default probabilities implied by these swaps.

The CDS spread amounts to the insurance premium a protection buyer pays to the protection seller; it is quoted in basis points per year of the underlying security’s notional amount; and it is paid quarterly. In the event of a default on the underlying security, the protection seller effectively must pay one minus the recovery rate on the security (the protection seller pays the notional amount and receives the security).

Example: A CDS spread of 339 bp for five-year Italian debt means that default insurance for a notional amount of EUR 1 m costs EUR 33,900 per annum; this premium is paid quarterly (i.e. EUR 8,475 per quarter).

“In equilibrium,” the present discounted value of premium payments (up to the maturity of the underlying security) corresponds with the present discounted compensation payments by the protection seller (up to maturity).

Current data.

Ukraine Restructures Its Debt

In the FT, Elaine Moore and Neil Buckley report that Ukraine secured a restructuring deal with its creditors. The deal includes a 20% haircut on some bonds as well as new GDP-linked securities. The FT writes:

The IMF alluded to the uncertainty in early August when it reiterated that although it expected Ukraine’s debt operation to be completed, it was willing to support the country even if debt discussions failed and a moratorium was imposed. However, the repercussions of Ukraine defaulting on its debt would have been severe. Ukrainian bonds, issued under English law, contain cross-default clauses that mean missed payments on one can trigger default on all, allowing bondholders to demand repayment, drag a country into lengthy legal battles and exacerbating existing economic problems. … If Ukraine succeeds in a debt restructuring it could plausibly return to international debt markets within a yea r… Market prices for Ukrainian bonds have recovered in recent weeks as hopes rose that the country would avoid default …

Eurozone Finance Ministers Approve Third Greek Bailout

In the FT, Duncan Robinson and Christian Oliver report about Eurozone finance ministers’ approval of the third bailout for Greece, amounting to 86 billion Euros.

Contrary to Germany’s recent demands, the approval came in spite of the fact that the IMF has not committed to participate in the new program. In fact, the IMF has committed not to participate unless Greece’s debt burden is further reduced. Finance ministers effectively promised such further cuts in the future.

The deal falls short of what the German government had hoped to secure (see also this previous blog post).

 

The Brussels Agreement of 13 July 2015

Graeme Wearden in The Guardian summarizes the results of the Euro summit that ended with no Grexit:

An agreement has finally been reached in Brussels after almost 17 hours of talks, Europe’s longest-ever summit. A deal on the new bailout for Greece has still to be thrashed out, however. Here are the key points:

Greek assets transfer

Up to €50bn (£35bn) worth of Greek assets will be transferred to a new fund, which will contribute to the recapitalisation of Greek banks. The fund will be based in Athens, not Luxembourg as the Germans had originally demanded.

The location of the fund was a key sticking point in the marathon overnight talks. Transferring the assets out of Greece would have meant “liquidity asphyxiation”, said the Greek prime minister, Alexis Tsipras.

Bridging finance

Talks will begin immediately on bridging finance to avert the collapse of Greece’s banking system and help cover its debt repayments this summer. Greece must repay more than €7bn to the ECB in July and August, before any bailout cash can be handed over.

Debt restructuring

Greece has been promised discussions on restructuring its debts. The German chancellor, Angela Merkel, said the Eurogroup was ready to consider extending the maturity on Greek loans. There is now no need for a Plan B, she added.

New legislation

The Greek parliament must approve the deal before the German bundestag votes. It must also start passing legislation straight away to implement the agreed measures.

Creditors have insisted on immediate action on:

  1. Streamlining VAT
  2. Broadening the tax base
  3. Making further reforms to the pension system
  4. Adopt a code of civil procedure
  5. Safeguarding of legal independence for Greece ELSTAT — the statistic office
  6. Full implementation of automatic spending cuts
  7. Meet bank recovery and resolution directive

Radical reforms

Tsipras pledged to implement radical reforms to ensure that the Greek oligarchy finally makes a fair contribution. The agreement thrashed out overnight would allow Greece to “stand on our feet again”.

Implementation of reforms would be tough, the Greek prime minister said, but: “We fought hard abroad, we must now fight at home against vested interests.”

He added: “The measures are recessionary, but we hope that putting Grexit to bed means inward investment can begin to flow, negating them.”

Updates and additional links

More from the GuardianAn assessment by an analyst.

The official Euro summit statement.

Accounting, Greek Debt, and Realism (Part Three)

In a Vox blog post, Julian Schumacher and Beatrice Weder di Mauro offer meaningful Greek government debt statistics. They quote an ESM estimate according to which the 2012 restructuring of Greek debt owed to official lenders amounted to a 50% haircut (see this previous blog post). And they argue that the net present value of Greek government debt relative to GDP amounted to 93% (presumably in 2013 or 2014), in line with other estimates (see this previous blog post).

How Greece Benefitted from European Debt Relief

The 2014 Annual Report of the ESM contains a box on “How Greece Benefitted from European Debt Relief” (p. 29). The concluding paragraph states:

The measures correspond to substantial economic debt relief … Considering these maturity extensions and interest rate deferrals over the entire debt servicing profile from a net present value (NPV) perspective shows a reduction in the overall debt burden and reveals implicit savings. … Stretching out principal repayment schedules over such an extended period of time, along with interest payment deferral, imply that these payments account for substantially less in NPV terms when assessed from the Greek side taking into account the financial market perspective.

No explanation is given as to why the NPV perspective should only reveal “implicit” savings. Whether a Euro must be paid in ten years or in twenty does make a difference, and a rather substantial one at the relevant interest rates. A footnote attached to the last sentence of the above quote is rather obscure as well. It says:

It should be noted that this does not entail any financial loss or write-down from an EFSF perspective. The EFSF is fully repaid; Greece has to cover any financing costs related to the agreed interest rate deferral in line with the amendment of the Master Financial Assistance Facility Agreement.

See the earlier post on how to correctly account for sovereign debt.

Olivier Blanchard Defends IMF Policy in Greece

In a Vox blog post, Olivier Blanchard addresses four critiques against the IMF’s engagement in Greece. He argues that

  • the 2010 program did help Greece; without it, Greece would have undergone much harsher “austerity;”
  • the financing given to Greece did not only benefit foreign banks; the 2012 PSI amounted to debt relief on the order of 10’000 Euro per capita;
  • “[m]any … reforms were either not implemented, or not implemented on a sufficient scale … [m]ultipliers were larger than initially assumed … [b]ut fiscal consolidation explains only a fraction of the output decline”;
  • conditionality also reflects political constraints on the part of the lender countries.

Olivier sees the Fund on the sidelines, in particular after Greece’s default against the IMF:

The role of the Fund in this context is not to recommend a particular decision, but to indicate the tradeoff between less fiscal adjustment and fewer structural reforms on the one hand, and the need for more financing and debt relief on the other.

IMF Research and Greece

Ashoka Mody argues in an Econbrowser blog post that recent IMF research should guide a Greek deal. According to Mody this research shows that debt overhang is very costly; “austerity” can be self defeating; and structural reforms generate uncertain payoffs. He therefore recommends

  • large scale debt relief, resulting in a debt quota of 50%,
  • a scale down of the banking system, and
  • a primary surplus quota of 0.5% over the coming years.

Olivier Blanchard, IMF chief economist, disagrees.

International Bankruptcy Law back on the Agenda?

Elaine Moore writes in the FT that the idea of an international bankruptcy law gains traction, after IMF suggestions in the early 2000s for a “Sovereign Debt Restructuring Mechanism” failed to receive sufficient support. In September, 124 UN General Assembly members supported the proposal to develop a legal framework for restructuring sovereign debt.

This proposal complements the agreement among market participants, international organisations and regulators (against the backdrop of Argentina’s latest default) to change bond clauses with the intention to facilitate renegotiation through binding majority decisions.

IMF Policy Vis-a-vis Greece

Christoph Eisenring reports in the NZZ about a critical internal assessment of the IMF’s recent policy vis-a-vis Greece. The relaxation of the “medium term solvency” requirement for IMF lending in a situation of acute contagion risk should be reconsidered; contagion should be addressed with different instruments; debt should be restructured earlier than happened in the Greek case; and bail-ins should be favoured.