Greece has defaulted: The French plan, the ECB and rating agencies

This is the best analysis I have read so far on Greece’s salvation, since Greece has de facto defaulted, however European (and other) official are disguising it. Since I do not see the point of reinventing the wheel, I post this analysis in-extenso without any comment.

Making Sense of the French Rollover Plan

Confusion continues to reign supreme over what the French rollover plan does for the various entities.  The details and mechanics are a bit sketchy, but I have attached the proposal that I found, and will use that as a basis for the analysis.  As I go through the details, and incorporate the latest rating agency comments, the conclusion remains the same – this is a good deal for the Participants, a mediocre deal for the Troika, and punitive to Greece.

What a real rollover would look like

The French proposal is slightly complex at best and convoluted at worst.  Before digging into the specifics, let’s look at what a true rollover would look like.  If Participants agreed with Greece to extend the maturity AND reduce the coupon AND do it immediately, that would be a clear example of a rollover that benefitted Greece. 

There are 3 key elements to a real rollover.  The first is that they would agree to the rollover now.  That would take away uncertainty.  The maturity extension is the rollover, and the longer it is delayed, the better for Greece.  The coupon on the new debt should be lower than the coupon Greece is currently paying.  If all 3 of these criteria are met, and the new bonds are pari passu with the existing bonds, then I think everyone would agree that Greece benefits, the Troika would benefit, and the Participants would have made a sacrifice.  The French proposal, as we will see, potentially does not satisfy any of the 3 aspects listed – it is not immediate, the coupon will be higher than existing debt, and the maturity extension is linked to taking some debt out of the market, so it’s not as clearly a benefit as the headlines make it seem.

The Rollovers Should Not Trigger a CDS Credit Event

In any case, let’s assume Participants actually did the proper rollover.  That should NOT trigger CDS.  The ISDA credit derivative definitions for a Restructuring Credit Event have to meet 2 tests.  The first part of the test is straightforward and is met if bonds are extended, or the coupon is reduced, for example.  This condition would be met.  The second condition is effectively that it is involuntary.  If the actions of some bondholders can force other bondholders into an agreement then this condition would be met and there would be a CDS Credit Event.  In the case of Greek bonds, that looks unlikely.  I have only looked at the offering circulars from a couple of bonds, but there does not appear to by anything that could force a bondholder to change the terms of the debt.  There is no reason, that on a €1 billion issue, €950 million could be exchanged and €50 million could remain outstanding.  If that is the case, then there would be no CDS Credit Event under this true rollover.

The Rating Agencies can be largely ignored

Of all the rating agencies, S&P, so far, has come out with the most comprehensive definition of what they would do.  The first thing S&P said it would do is lower the Greek Issuer Rating to “SD”.  First, I have to admit, that in all the years that I have followed the credit markets, I cannot remember seeing an “SD” rating before.  I am almost certain that no regulator and no Participants have any rules based on the “SD” rating. So while Greece is rated SD, the regulators and Participants should have a lot of leeway on how to treat the debt, and since it would be performing, I don’t see why the status quo would be changed.  S&P goes on to say that a D rating would be applied to bonds that are maturing and are subject to the plan.  When will they do that?  If they do it now, they will be rating bonds that are paying interest and will pay par at maturity as D.  The rating agencies, which have enough problems with rating obligations too highly, will now be saying something is in default, when it is paying.  I suspect that regulators and Participants would ignore the D rating and rely on the fact that the bonds are performing and are expected to be paid back at par.  The rating agencies could apply the D rating right at the time of maturity, but that doesn’t have any impact on the Participants, because they would receive par on those obligations and no longer hold them.  So any downgrade of existing obligations to “D” based on the proposal is unlikely to impact the Participants or regulators at all.  The downgrade will only serve to keep track of defaults for the rating agencies’ annual default history studies. 

The key question will be what are the new bonds rated.  S&P makes it seem as though the new bonds would have the current rating of the old bonds (“CCC”).  So, again, status quo would be retained.

A real restructuring would help Greece, help the Troika, and cost the Participants some money, and would avoid a Credit Event and demonstrate that the rating agency characterizations of default have no meaningful accounting or funding impact for the Participants.

The French Rollover Plan in Detail

The Rollover Does Not Alter the Existing Maturity Schedule

According to the proposal I have attached, the following sentence seems to be the operative one regarding timing:
During the period from July 2011 until June 2014 (the “Period”), following each redemption of Existing GGB’s, each Participant undertakes to participate in one of the following options
So, it looks like Participants agree to the plan now, but rollovers do not occur until each individual bond matures.  The immediate impact on the debt maturity schedule for Greece is negligible.  The Participants only share in the bailout if the Troika continues to provide Greece with funding.  Retaining the original maturity schedule is useful for the Participants.  If there is a default by Greece, the Participants will still hold their existing short dated bonds which can get higher recoveries in sovereign debt restructurings.

Since the Participants do not provide a maturity extension up front, the key to Greece paying its debts is the continued willingness of the Troika to release tranches of promised bailout money.  By waiting until each bond is repaid, the rollover plan addresses a couple of key issues.  The rating agencies can rate the debt whatever they want, but if the bonds are paid in full at maturity the Participants will not have to take a write-down, so they preserve non mark to market accounting.  That is important for some of the Participants.  By waiting until the debt is repaid at maturity, it reduces the risk of some other credit claiming “fraudulent conveyance” or arguing about “off market price” transactions.  Waiting until the bonds mature and are redeemed at par by Greece before “purchasing” the new bonds is better from an accounting standpoint for the Participants than agreeing now to extend the maturities when the bonds are trading below par.

Funds from a maturing bond are rolled into 3 assets

When a bond is redeemed at par, the Participant really receives 3 assets.  The language is confusing, the use of the SPV obfuscates the actual investment, but it is actually fairly transparent to see through the headlines. 

For every €100 million of maturing debt a Participant holds, they will be able to retain €30 million to do with as they please.  Of the remaining €70 million, they purchase 2 assets, a AAA rated 30 year, zero coupon bond, and a 30 year Greek amortizing bond.  Yes, the plan calls for them to purchase 1 asset, an SPV, but it is a simple SPV and is worth breaking the SPV into its two components. 

The Participant will buy €70 million of an SPV.  The SPV will be “principal protected” by a AAA rated asset and provide a coupon of between 5.5% and 8.0% depending on the GDP growth of Greece.  But let’s look through the SPV and see what the Participant really gets.

€20 million is spent to buy the AAA zero coupon bond.  The zero coupon bond should cost about 30% of face ¹ and the actual proposal uses a price of 28.5%.  So the investor owns a AAA rated, zero coupon bond, that they spent €20 million to buy and has a face value of €70 million.  This asset might be used to get a principal only AAA rating on the SPV Note.  It might help with regulatory capital even, if the Participants can use a principal only rating, but in any case it should be viewed as a separate asset.

So the remaining €50 million actually goes to Greece.  Of the €100 million of debt the Participant owned, €30 million is repaid in cash, €20 million they agree to use to buy a 30 year zero and €50 million goes to Greece.  Since Greece clearly needs all the money it can get, the only logical place for Greece to receive the €50 million the Participants are keeping is from another loan from the Troika.  Whatever entity (possibly some iteration of EFSF) sold the zero coupon bond to the SPV is likely to provide financing to Greece.  It only makes sense since they will have €30 million of proceeds that needs to be invested somewhere.  The remaining €20 million must come from the promised tranches of Troika bailout funds.
What does the loan to Greece look like?

It is possible to back out the details of the €50 million loan to Greece.  The Participants expect to receive €70 million at maturity from the SPV, so that the asset they paid par for can be redeemed at par.  Therefore it is logical to conclude that the SPV is not relying on any money from Greece for principle redemption at maturity.  The SPV is supposed to pay a minimum of 5.5% coupon on the €70 million face amount of the SPV note.  That is €3.85 million per annum.  That has to be coming from the Greek loan – the SPV only has 2 assets, the Greek loan, and the zero coupon bond.  The SPV (and Participants) are relying on Greece to pay €3.85 million per year for 30 years.  This is just like a mortgage.  In fact it is a 30 year mortgage, with initial amount of €50 million with annual payments of €3.85 million.  That is equivalent to a 6.55% mortgage rate.  Since none of the GGB bonds maturity in the next 18 months, has a coupon higher than 5.25%, the Participants aren’t helping Greece on their annual interest payments.  If Greece is going to see a reduction in average coupon, it would have to be coming from the loans from the Troika.  So far, those loans still seem to be coming around 5%, so there is no current interest expense benefit for Greece.

This mortgage loan to Greece is very creative by the Participants.  It helps explain why there are no details of the loan terms in the proposal.  It is a bit difficult to work out, but a 30 year, 6.55% mortgage is the only possible way to explain the cash flows.  Not only is the interest rate above current coupon rates, so Greece will be paying more, the duration of the mortgage is far less than 30 years.  The Participants would have you believe that they have lent Greece money for 30 years.  The reality is the loan has a much shorter duration and will be half paid off in the 20th year.  The terms, as you dig deeper, once again seem to be better for the Participants than for Greece.

I almost forgot something.  The 0 to 2.5% additional interest the SPV will be paying based on the GDP of Greece for any given year.  That would be an additional payment of up to €1.75 million each year.  That payment has to be coming from the Greek loan asset the SPV holds, since it cannot be coming from the zero coupon bond, by definition.  If that happened in the first year of the SPV it would represent a payment by Greece of 3.5% of the amount borrowed.  Since the loan is a mortgage and principle is being paid down, the potential additional payment by Greece as a % of interest is astronomical near the end of the loan.  If Greece only owes half the original principle by the end of year 21, that same payment would be 7% from the perspective of Greece, on top of the 6.55% they are already paying.

This coupon “kicker” linked to GDP that is paid on the full notional of the SPV is problematic for Greece since they are paying a “kicker” on a notional that is 40% more than they received.  The problem becomes onerous because that kicker is linked to a fixed amount, yet the money Greece borrowed from the SPV is being repaid annually like any other mortgage.  It is only safe to assume that the annual principle payments have to be funded elsewhere, so Greece will owe interest on those borrowings too.

The Participants are not lending to Greece for 30 years, the duration is much shorter, and the coupon payments start out potentially high, and become usurious in the later years.

The structure is designed in a such a way to make it look like the Participants are being helpful – 30 years at a low coupon, but separating the SPV into its zero coupon component and the loan to Greece clearly demonstrate that the terms being offered to Greece are far worse than the headlines that the Participants are selling to the public.

I would be surprised if Greece agrees to the loan terms as included in the French proposal and wonder if they have even been consulted?

Source:

Zero Hedge: Guest Post - Making Sense of the French Rollover Plan

http://www.zerohedge.com/article/guest-post-making-sense-french-rollover-plan

Fédération Bancaire Française: Long-term investor initiative for Greece

http://www.ifre.com/Journals/17/Files/2011/6/29/FBFProposa0.pdf

Greece, eurozone and the euro: the body is really getting rotten

1. The EU wobbling around the Greek ongoing crisis 

Since early May, a succession of events and a flurry of declarations coming from all corners of Europe, often antagonistic, have again put the eurozone to the forefront of the news (Greece's fable continues to unravel). Greece is moving closer to political chaos and the impotency of European leaders is not discontinued.

The rift between the ECB and European politicians as well as politicians between themselves is widening: the ECB and the European Commission stand against a debt maturity lengthening whilst Schaeuble, the German Finance Minister supports it and Lagarde, the French Finance Minister and to be Director General of the IMF opposes it, since it would be considered as a credit event i.e. a default; rating agencies are adopting the same view. Then what is a credit event is also subject to interpretation and arm twisting (watch how much US banks would loose if they had to pay on CDS they wrote on Greece to European banks and insurance companies – no doubt rating agencies would be under a lot of pressure).

The latest trick to share the burden of the flawed eurozone construction and 2010 Greek rescue is to propose private creditors to “voluntarily” agree to purchase new Greek bonds when existing ones mature (no talk about the interest rate) for approximately EUR 30 billion over the next three years. Trichet however stressed that the ECB has no intention to rollover its own holding of Greek debt: true the ECB is not in the private sector! However, I am convinced that the ECB would buy new Greek debt from banks in the secondary market so, no change – an inflated ECB balance sheet and banks reducing their exposure to PIGS.

Rating agencies indicated that anything that would look like a forced conversion would trigger a default. Trichet is on the same line when he declared in Frankfurt on June 9: “We exclude all elements which are not voluntary.” There are already reports that French banks would be ready to rollover their Greek bonds: phone calls have gone at light speed between French Government officials and Heads of banks…

Fitch added that a Greek debt swap offering investors terms “worse” than those of the existing securities would constitute a coercive or distressed exchange, and be considered a default. Another criterion for assigning a default rating is that the exchange “is, or appears to be, necessary to avoid insolvency and/or illiquidity”. But for arm twisting, rating agencies would declare that Greece has defaulted on its debt obligations.

As Bloomberg reports: “Sustained ECB resistance could leave politicians facing the prospect of asking their taxpayers to finance a Greek budget shortfall that may amount to 90 billion euros ($130 billion) through 2014.”

I have no doubt that one party will bend, none wanting to contemplate the consequences of the absence of some form of agreement, how bad it is, and overall not bear the responsibility of a failure.

2. A new rescue package

After over a year of stubborn refusal, talks are now about letting the private sector share

the burden of Greece’s insolvency (only lying or utterly incompetent politicians could say it was a mere liquidity crisis).

Under pressure from his fellow European pairs, Papandreou agreed to EUR 78 billion additional austerity measures and asset sales until 2015 (EUR 6.4 billion spending cuts in 2011 and another EUR 22 billion in 2012-2015, plus EUR 50 billion privatizations), yet to be passed before the Greek parliament, in order to persuade the IMF to release its share of the EUR 12 billion tranche (EUR 3.3 billion) originally due later in June and now early July.

The size of a new bailout for Greece has increased week after week. Late May, we were around EUR 45 billion, then EUR 90 billion and now some talk about EUR 120 billion, including asset sales by the Greek Government (and if they achieve EUR 25 billion until 2015 - 50% of what is planned - it would be a real achievement). Aproximately 42% would be lent by eurozone countries and the IMF, 29% would come from both Greece’s asset sales and rollovers by creditors.

However, extending maturities by seven years, as suggested by Martin Schaeuble, is only kicking the can down the road, which European politicians have been very good at (right, teens do that too). It would give banks more time to get rid of their PIGS debt to the ECB, completing the full transfer of risk from the private sector to the ECB.

This would add to the already EUR 75 billion purchased by the ECB (EU 40 billion of Greek debt according to Barclays Capital) under its Securities Market Program which ends up financing Governments, event if the contrary is stated.

As outlined by Markets & Beyond over a year ago, the politically motivated EUR 110 billion rescue package had no chance to succeed not addressing the roots of the problem: over-indebtedness and lack of competitiveness. There was no way that Greece could return to the bond market in 2012 as planned in the rescue package (EUR 27 billion to be raised in 2012).

Without a dramatic increase in revenues (read GDP), the current potion instilled by the IMF and the EU is a death kiss.

3. Take a sit back and relax: the reality of hard facts

A second rescue plan will fail as did the first one. EU politicians are only interested in gaining time praying that growth and inflation will do the job for them.

The austerity program of Greece is plunging the country into a prolonged decay, unemployment having reached a record 16.2% in March, up from 15.9% in February and GDP at current prices down 0.5% in March QoQ (-5.1% YoY) which weight on public finances. Preliminary data in May show the Central Government budget deficit widened in the first five months of the year to EUR 10.3 billion (+14% compared to the same period in 2010 and +35% if one does take into account massaging of the Public Investment numbers for approximately EUR 2 billion).

For the period 2011-2015, on rather optimistic assumptions, Markets & Beyond calculations give EUR 105 billion of cumulated additional deficits plus EUR 108 billion of maturing long term debt (and short term financing could also come into question– Greece has not been able to finance itself at 52 weeks since May 2010, only 13 and 26 weeks). And this does not take into account the Financial Support Mechanism loans from Europe and the IMF...

According to banquet Pictet, Greece’s nominal GDP would need to grow by 21% annually for the next 10 years at 12% financing (we are around 18% right now) to get back to the Maastricht criteria of 60% Debt/GDP: we are living on Mars! If one was using 4% GDP growth and 4% cost of financing, with EUR50 billion asset sales and 2% primary budget surplus, it would take Greece 45 years to reach 60% Debt/GDP ratio!!

Tightening fiscal policies and increasing tax collection are necessary but will be far from enough to solve Greece’s debt trap; asset sales will reduce the financing gap but we are talking about stock, not cash flows. Top line must dramatically improve, i.e. GDP growth and exports. This will not be possible before a prolonged period of time without getting a kick in the arm.

My view (let’s dream):

• Restructure debt with a 50-70% haircut to reduce debt to manageable levels
• Run the fiscal policy independently from Greece, in effect putting the country under tutelage, to avoid getting back to square one 5-10 years down the road
• Improve competitiveness to foster GDP growth (and exit the euro?)

This would have a spillover effect on other eurozone countries and US banks that wrote CDS to European one, therefore:

• Debt to equity swap and/or straight nationalization for banks that could not sustain book losses or raise equity with the private sector (estimated by Markets & beyond anywhere between EUR 300-450 billion) – there are 6000+ credit institutions in Europe ensuring a wide mutualization of risk

A Greek default would represent 1-2% of European banks capital base, A PIGS default would add 10-12%, this would be serious business, still manageable if well planned ahead of events which the eurozone has failed to do so far

• Recapitalize the ECB that would be (is) insolvent
• European banks would reduce their losses by triggering CDS payments, further pooling the risk with US banks

Where eurozone politicians are leading us:

• Short term
• a voluntary (sic!) purchase of new debt by banks when old ones mature
• Gain a bit of time (6 months to 1 year)
• Longer term term
• A default, which CMA currently rates at over 75% probability, with a 50-70% haircut minimum
• A quasi permanent fiscal transfer from the eurozone (read Germany) to Greece (and then the rest of PIGS)

In any case, down the road, Greece will default.

So far European leaders have been impotent and preferred to muddle through instead of grasping the problem, blinded by the European construction (destruction in fact) dogma: adding debt to debt will not resolve over-indebtedness. The longer it takes, the more painful it will be.

Source:

Les Echos: Fitch Outlines Rating Approach to a Sovereign Debt Exchange

http://blogs.lesechos.fr/IMG/pdf/FI_SOV_Sovereign_Debt_Exchange_20110606.pdf

Bloomberg: numerous articles

http://www.bloomberg.com/news/worldwide/

Reuters: EURO GOVT-Peripheral debt under pressure, overshadows ECB

http://www.reuters.com/article/2011/06/09/markets-bonds-euro-idUSLDE7581X420110609

CMA: Market Data – Sovereign Risk Monitor

http://www.cmavision.com/market-data/

Pictet & Cie: Protection prudente des portefeuilles en temps de crise

Greece’s fable continues to unravel

It could have been the scenario of a TV series, but it will not last over as many years as to Dallas or The Experts did.

The past two weeks have been rather rich with events:

3^rd May: Portugal agrees to a 3 yr EUR 78 billion funding from the IMF and Europe.

6^th May: An article published in Der Spiegel magazine says Greece may leave the eurozone.

Unscheduled meeting in Luxembourg of several eurozone Finance Ministers (France, Germany, Greece, Italy and Spain in addition to the President of the Eurogroup, Jean-Claude Juncker, the ECB President, Jean-Claude Trichet, and the European commissioner for economic and monetary affairs Olli Rehn).

8^th May: rumors emerge of an additional loan to Greece anywhere between EUR 25 to 45 billion

9^th May: S&P downgrades Greece from BB- to B with negative watch joining the highly speculative bandwagon; now we are halfway from investment grade and default. Moody’s puts Greece under credit watch with potentially a multi- notch downgrade.

10^th May: IMF and EU experts arrive to Greece to discuss the budget execution progress and I guess a maturity extension of the EUR110 billion rescue package together with an interest rate reduction plus any additional “adjustments” i.e. new loans.

15^th May: meeting in Berlin between Angela Merkel and Dominique Strauss-Khan (pulled by the Police In New York out of an Air France flight because of an accusation of sexual assault!).

As a side question, I would really be interested in knowing who in Germany did leak the information to Der Spiegel (since the source seems to be German, even if I wonder this is not playing in the Greek’s hands to extract more palatable terms by threatening to leave the Euro): budget hawks to pressure the Chancellor Angela Merkel not to give away anything? Germany to weight on Greece and other EU countries to come to their terms? Any other?

I having no way to know where the truth lies, and can only use conjectures, I therefore prefer to focus on hard facts, as validated by Eurostat:

• 2010 Government deficit/GDP: 10.5% (just as a reminder: 8.1% were targeted when the rescue package was agreed last year, 7.6% in 2011 and 6.5% in 2012)
• 2010 debt/GDP: 142.8% (worse than my May 2010 forecast of 132%, yet rather deemed to be on the doom side at the time)
• 2010/2009 debt: + EUR 29.9 billion
• 2010 debt maturing: EUR 40.5 billion

In addition:

• Debt issuance in the market: only 13 and 26 weeks T bills were issued since mid April 2010, rapidly shortening debt maturity.
• Nearly EUR 10 billion are due in May, including a 6.2 billion 10 years bond maturing on May 18. Greece could try to refinance it with 13 and/or 26 weeks bill, but this would spur the. If they do not receive the EU and IMF EUR 15 billion installment due at the end of May (who knows, maybe the IFM will leave politics aside -I do not expect anything form the dogmatic European side), they can close the door and leave the key to anybody who wants it.
• Interest payments represent more than 6% of GDP, and these rates are heavily subsidized by the EU taxpayers via the EUR 110 billion bailout at 4% (market rate are north of 10%).
• Greece is running a deficit in the turn of EUR 500 million/month over the budget.
• All economic and social indicators are worse this year than the previous.

The latest release of the budget execution shows that the gap between the planned (EUR 6.9 billion) and the actual deficit (EUR 7.2 billion) is increasing month after month. And this does not include the figures for the Public Investment Budget which were grossly manipulated in February, artificially reducing the deficit by EUR 1.6 billion and allowing Greece to show a budget in line with plans until March.

As I was forecasting last year, the austerity program is exerting its toll on the economic activity which in turn is translating into lower tax revenues despites efforts to fight tax fraud. There is no reason why this should change, any additional austerity measure will weight on GDP in the absence of an export boom that will not occur.

According to my calculation (at least the optimistic one), in 2011 the deficit and the debt will respectively reach 11.3% (EUR 25 billion) and 158% of GDP (EUR 354 billion), using the actual (optimistic) official growth forecasts. This is no more sustainable than in 2010, to the contrary.

Then only trump card Greece holds (and only to some extent) is a successful privatization plan (that may be completed too late anyway) which could amount up to EUR 50 billion (I do not believe one minute that the final number will be near half of it). Nice number, but it does not address the root of the Greek problem: its lack of competiveness and structurally negative trade & services balance. And the lack of competitiveness is not only a question of labor cost, it is also and mainly having goods and services that other want to buy: the DM, like the Swiss franc, always revalued versus the Club Med currencies and Germany has had positive trade balances for decennials. The strong euro did not deter Germany to remain the world largest exporter. And on this count, I do not see what Greece can do… On a more fundamental basis, this leads to wonder how countries (generally small ones because lacking of critical mass) without a specific competitive advantage will be able to remain independent in a world which is increasingly opened and interconnected. In this context, a new rescue package would be a waste of money and time (the UK wisely indicated that they would not participate).

The numbers are rather striking: according to the OECD, since 1993 Germany has cumulative trade surplus of USD 2,075 billion (70% of the eurozone total!) whilst Greece had a deficit of USD 373 billion.

The train is in motion, the wall is getting closer by the day whilst the EU pointsmen are asking the taxpayer to lengthen the rail tack faster instead of stopping the train before the disaster occurs and the eurozone ends up in a wreck. The EU is in denial as usual whilst there is absolutely no way Greece can abide, even lousely, by the original bailout terms (for example to private capital markets in 2012): there is no way Greece can increase its tax receipts by +/- 35% (on official numbers, 50% according to my calculations) to get a flat budget. In order to get a budget surplus to pay down debt in a reasonable way (say 10% a year), Greece needs to more than double its tax receipts – so, forget it.

A default is certain (whatever you call it: debt restructuring or rescheduling, interest deferral or reduction, etc.): let’s investors (banks and money market/bond funds) pay for their mistakes and if this leads to some bank not being well-capitalized enough (I would not buy shares of Dexia! – nor any European bank for the matter), let shareholders be wipped-out and bondholders take their losses, not the taxpayer: this is called capitalism.

Quid about the ECB balance sheet, which must hold +/- EUR 50 billion of Greek debt (not talking about Portugal, Ireland and Spain)…?

And, one last word, watch France.

Source:

Der Spiegel (international edition): Greece Considers Exit from Euro Zone

http://www.spiegel.de/international/europe/0,1518,761201,00.html

Moody’s: Moody's places Greece's ratings on review for possible downgrade

http://www.moodys.com/viewresearchdoc.aspx?lang=en&cy=global&docid=PR_218672

Hellenic Republic - Ministry of Finance: Budget Execution Bulletins

http://www.minfin.gr/content-api/f/binaryChannel/minfin/datastore/f1/75/38/f1753817b1599ffefcabffb9c5e1e68ade5532ec/application/pdf/Prel_Bulletin_4_ENG_10-05-2011_no2-6.pdf

Eurostat: Statistics

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/themes

OECD: Statistics from A to Z

http://www.oecd.org/document/39/0,3746,en_2649_201185_46462759_1_1_1_1,00.html

Associated Press: IMF chief accused of sexual assault at NYC hotel

http://hosted.ap.org/dynamic/stories/I/IMF_HEAD_ASSAULT?SITE=CAVIC&SECTION=HOME&TEMPLATE=DEFAULT

Banks’ exposure to PIGS countries

© Markets & Beyond

Every quarter, the BIS publishes with a 6 months lag, banks exposure country by country. I drew a table to compare the evolution from June to September 2010; banks in main creditor’s countries continued to cut (sell to the ECB) their exposure in the tune of well over EUR 100 billion, and there is no reason that this trend has abated since:

However, banks in Germany, France and the UK remain deeply vulnerable with commitments of over EUR 1 trillion:

Source:

Bank for International Settlements: Consolidated foreign claims of reporting banks

http://www.bis.org/publ/qtrpdf/r_qa1103.pdf#page=72

Greece: State Budget Execution Jan-March 2011 - Not looking good

As my readers know, I closely follow Greece’s budget execution. The situation is not improving:

• Revenues continue to lag forecasts and the fiscal position is deteriorating: -9.8% during Jan-Feb 2011, -11.0% during Q1 2011.
• Expenditures seem to have reached a point where it is very difficult to significantly cut further.
• The PIB item was actively “managed” in February (see my previous comment on 29^th March) but this could not be repeated.
• GDP is expected to contract for the third year in a row and there is no way that unemployment will not also deteriorate to ~15%.
• Debt as a % of GDP will continue to increase at least until 2014 according to my calculations.

5 yr CDS spreads are at record levels at 1221 b.p. on Friday according to CMA, the world riskiest sovereign by a long margin, i.e. a 63% of default risk. Markrit has 1090 b.p. CDS insurance cost, a 117 b.p. increase over the week and +51 b.p. Friday alone.

Spreads with Germany’s 10 yr bond yield have also passed the 10% mark!

I have long been advocating a restructuring/default/rescheduling of the Greek debt, since the current bailout is only postponing the inevitable, and the CDS market is clearly showing the way…

Bondholder will take a haircut, which is perfectly normal since investors should pay for their mistakes, not the taxpayer. This is the only way to finally clean banks’ balance sheets and let go under the ones that are undercapitalized.

The EUR has been unscratched since early January due to major events in other parts of the world, but I do not believe this is going to last for very long, at least the CDS markets believes so. The more so if the FED takes a less dovish stance at its next meeting April 26-27, which I expect.

Source:

Markets & Beyond: Portugal, Greece and the EURO crisis- What the news are?

http://marketsandbeyond.blogspot.com/2011/03/portugal-greece-and-euro-crisis-what.html) and this cannot be repeated

The French mint issues a limited series of gold and silver coins: a rip-off!

The French mint (“Monnaie de Paris”) is issuing 10,000 gold EUR 1,000 face value (weight 20 g or 0.71 oz @ 999.99/1000 title) and 50,000 silver EUR 100 face value (weight 50 g or 1.76 oz @ 900/1000 title). They will be delivered from mid-June to end July and a 30% deposit is required to reserve them.

Do not rush!

First, Gold coins were already sold out within 48 hours with people queuing in the street at “ Monnaie de Paris” Thursday and Friday. Tuesday, I was told by officials there that silver coins were also sold out.

Second, it is a rip off!!

1) Investors get a 1:3 leverage for +/- 3 months having to deposit only 30% of the face value until delivery

2) The interesting feature is that the coins have legal tender and it is therefore possible to exchange them at face value at any bank in France (and probably throughout the eurozone but I could not find confirmation of this). This means that if the metal value of coins was to fall below the face value of coins, investors would still get the face value. This puts a floor on gold and silver prices: it is the same as having a free undated long put on gold and silver prices.

Let’s take an example.

If gold prices continue to go up, then the value of coin will go up accordingly. If gold prices were to fall to EUR 500/oz giving a gold value for gold coins of EUR 323, your coin would still be worth EUR 1,000.

BUT

There is more than one catch however: as usual no free lunch!

1) According to the data indicated on “Monnaie de Paris” web site, the oz used is an ounce and not a troy ounce; this means 28.35 g/oz is used instead of the 31.104 g/oz for the quotation of precious metals, a ratio of 0.912 (see calculation below).

2) At the time of writing, the value of precious metal for each coin is well below the face value:

Gold @ $1,460/oz x 0.912 x 1.44 EUR/USD x 0,71 oz= EUR 656.51, over 50% premium!

Silver @ $40.6/oz x 0.912 x 1.44 EUR/USD x 1.76 oz = EUR 45.26, over 120% premium!!!

I doubt the collectable value (if any) warrants such premia. As usual the poor guy in the street has been ripped off.

And paying a put option at such premia looks very rich to me.

3) If the price of precious metals were collapsing, I also doubt that French authorities would not renege on the possibility to exchange the coins at their face value.

One last thing, the price includes 19.6% VAT; if you are a non-EU resident you are normally entitled to the reimbursement of VAT (and you pay whatever tax, if any, in your country of residence); here, forget it: you pay the full price.

Why on earth any rational investor would buy these coins when much cheaper alternatives are available; the history of love French have with gold is so long that they were trapped once again by the Ministry of Finance... (this does not mean that there will not be a mini-bubble in the short term – Oops! A bubble created by a Ministry of Finance, anything new?).

Source:

Monnaie de Paris: La Boutique

http://boutique.monnaiedeparis.fr/is-bin/INTERSHOP.enfinity/WFS/Monnaie-Front-Site/fr_FR/-/EUR/ViewStandardCatalog-Browse?CatalogCategoryID=6PqsE6zmTcYAAAEuIykkXE22

Portugal, Greece and the EURO crisis: What the news are?

1. Portugal

© Markets & Beyond

Despite repeated attacks against the euro, it has rather well survived so far, mainly thanks to the ECB buying PIGS sovereign debt in the open market, the bailout of Greece and Ireland and an agreement reached at the EU Summit in Brussels on March 11 that unveiled a plan to expand the EU bailout fund (the ESM) to EUR 700 billion on a permanent basis, up from the EUR 440 billion EFSF mechanism currently in place that only has an effective EUR 250 billion lending capacity.

However, EU politicians are delaying until June the announcement of details on how it will finance the interim EFSF mechanism that must address sovereign debt issues in the period from now until the ESM goes into effect in mid-2013. This is happening at a time where Portugal Government had to resign.

Portugal has long been the next in line since the crisis publicly emerged in 2010: Last week Prime Minister Jose Socrates had to quit following his defeat before the parliament over a third round of austerity measures did not trigger a wave of euro selling beyond a short lived small dip. From what I read, Portugal can match EUR 4.5 billion of debt becoming due in April; things might be more difficult for the EUR 4.9 billion due in June at a time when the next election should take take place. As a consequence, rating agencies downgraded Portugal and CDS increased. A bailout of Portugal would require ~ EUR 70 billion.

June looks like a key month, if markets wait until then, which I doubt. However, always watch interest rate differentials (real or anticipated) with the USD which are currently supportive of the euro.

PIGS economies are at best anemic and I do not see how long they can sustain high unemployment, high interest rates and negative growth without bond investors having to pay their share of any debt rescheduling (in essence debt rescheduling is what is happening with Greece right now: interest rates lowered by EU Finance Ministers and debt maturity lengthened; this is a bailout that will be paid for by European taxpayers).

2. Greece

It is always interesting to look at number beyond the large prints shouted at the media by politicians.

“According to the data available for the State Budget execution for the two months January – February 2011, on a fiscal basis, the State Budget deficit is Euro 55 million lower than the target set in the 2011 Budget for the first two months of the year. The two first months 2011 State Budget deficit amounts at Euro 1,024 million compared to a Euro 1,076 million target.
The 2011 State Budget deficit has grown – as expected – by 8.5% compared to the 2010 deficit during the same period, as a result of the non repetition of some measures as well as the higher than projected GDP decline during the last quarter of 2010, which has been recently revised for the whole year by ELSTAT.” [emphasis mine]

Down the press release, the explanation is given for this good performance despite a worse than expected economic situation and decreasing tax receipts.

“Public Investment Budget (P.I.B.) revenues increased by 354.5% and P.I.B. expenditures declined by 67.9%”

After all, nothing really abnormal, good management; well, look at the table below:

One will notice that this good performance comes from the PIB deficit that turned to be positive: since I started to look at the Greek Budget (2009), this item has always been negative but for one month in 2009 and 2010 -for figures rather meaningless- and suddenly it becomes hugely positive when headline numbers are awful (revenues substantially down at - 9.1% and expenditures up at +3.3%) and well below what was planned. If one compares the actual number to the target, we are totally out of line: + 604 x for PIB revenues and -70% for expenditures!! They either got their math wrong or it smells manipulation; the PIB item is quite easy to manipulate (just postpone investments and cash in revenues ahead).

Let see whether this rather long quite period for the euro will last much longer (probably a bit since markets still anticipate a rate hike in the eurozone).

Source:

Greek Ministry of Finance: State Budget Execution

http://www.minfin.gr/content-api/f/binaryChannel/minfin/datastore/fc/a6/88/fca688dfad038ce88efd687c303b6968f2c0251b/application/pdf/Preliminary_Bulletin_02_2011_Eng.pdf

Markit: CDS market summary

http://www.markit.com/cds/cds-page.html

Saxo Bank:  The EU and the siren song of the expected outcome

                        CDS 5 yr cost and PIIGS 2 yr yields

Bloomberg: Portuguese Bonds Slide as Prime Minister Quits on Budget, Fitch Downgrades

http://www.bloomberg.com/news/2011-03-24/bunds-rise-on-safety-demand-as-portugal-s-prime-minister-quits-over-cuts.html

Uranium: follow-up

© Markets & Beyond

Uranium shares were hammered Monday and Tuesday following the nuclear crisis in Japan and its consequences in the world for the nuclear electricity generation as a whole.

This is chilling people (therefore politicians in the West) and, as for the Three Mills Island and Tchernobyl accidents, the anti-nuclear lobby is becoming more voiceful and media start to listen.

• In India, the Minister (whoever he his) in charge of the nuclear industry said that the design of nuclear plants will need to be reviewed (Areva is building 2 there).

• In France, ecologist are calling for a referendum within the next 2 years and undoubtedly they will use this for the local elections next week et the following

• Gemany’s Merkel called for a 3 months moratorium on expanding the life of old nuclear plants.

Let’s pause and reflect. Beyond the weak links (Germany, Switzerland, probably some other Northern European countries and the Obama’s Administration), the leading nuclear countries reaffirmed their commitment to the nuclear industry (France, fast growing economies) – have they any sensible choice anyway. I even do not see Japan renouncing to the nuclear electricity. After all the Fukushima nuclear power station sustained the earth quake perfectly; it is the tsunami’s wave’s height that was higher than the plant was designed for and caused damages to the cooling system. In addition, from what I read (intox or reality?), the Fukushima reactors are from an old GE design (1960s…) much less robust than recent designs. As reported by the NYT:

“But the type of containment vessel and pressure suppression system used in the failing reactors at Japan's Fukushima Daiichi plant is physically less robust, and it has long been thought to be more susceptible to failure in an emergency than competing designs.”

The question I am asking myself is: what could replace nuclear energy in the 20 coming years to meet demand? I do not see any but (1) increasing the consumption of fossil fuel (coal and natural gas in particular - green energies will only represent a fraction a requirements), (2) a technological breakthrough or (3) a substantial reduction in demand. 

Today, (1) is the most likely alternative if the nuclear industry growth was to be phased down, which I do not expect but if the Japanese problems turn out to be a nuclear disaster; even so, I doubt China and other fast growing economies will stop their programs beyond rhetoric toward the population to alleviate their fears. In the West, it may be different in some countries, but I do not see the main nuclear ones to shift away from this source of energy (France not being the least).
If one believes my "optimistic" (realistic) view of the nuclear industry, the coming days may provide great opportunities to buy good uranium mining companies as well as others involved in the nuclear chain.

In any case, contracts are long term by nature and due to the time horizon from the start of building a plant to its completion, the collapse of uranium share prices (up to 50% in 48h for most junior and intermediate miners), including Cameco (-24% at its lowest Tuesday compared to Friday’s closing), the leading one, is unjustified in my opinion when compared to fundamentals.

Disclosure: This was written to my Partners at P&C on Monday and updated/completed Wednesday at Australia’s closing.

Source:

The New York Times: Experts Had Long Criticized Potential Weakness in Design of Stricken Reactor

http://www.nytimes.com/2011/03/16/world/asia/16contain.html?hp

Chart of the Day: Family Home Price/Gold

An interesting chart showing US median family home price in gold: today it takes 120ounces of gold to buy the median single-family home vs. 601 ounces in 2001, 80% down from the peak and near it previous trough in 1980. Markets tend to overshoot however and I expect this ratio to significantly decrease. We probably are in for a 35-40 years cycle before it rebounds.

Source:

Chart of the Day: Median Single-Family Home Price / Gold

http://www.chartoftheday.com/20110311.htm?T

The Seven Immutable Laws of Investing

A down to earth paper on investing from James Montier of GMO, full of common sense, far away from all the mathematical/statistical models that failed so badly during the financial crisis.

GMO is a top notch value investor.

Source:

Grantham, Mayo, Van Otterloo & Co (GMO): The Seven Immuable Laws of Investing – James Montier, March 2011

http://www.gmo.com/