The Gathering Storm

Buchheit & Gulati

My favorite rail company:Hell Rail

Hell Rail - Fun Facts

$3.8 million a day in losses (2010)

$13 billion in debt (5% of GDP)

$ 1 billion loss in 2008 (revenues of $253 million)

3 different strikes since first half of 2013 itself

Cheaper to send everyone by taxi (2 passengers to a

taxi)

Given finances, how do these companies Survive?

Govt gives it money (by borrowing from foreign banks)

But what happens when Greece’s Debt/GDP balloons? Co. borrows (with guarantee) – Does not count to Debt/GDP

But this game ends with Greek goes bankrupt

No one wants a guarantee from a bankrupt sovereign?

1995

-199

9

2000

-200

4

2005

-200

9

2010

-pre

sent

0

5

10

15

20

25

30

35

40

45

50

Number of Greek Bonds with Sovereign Guarantees 1995-2012 (n=73)

We got Worried – Three Reasons

1. Greek debt, other than Official Sector lending, was supposed to be disappearing. Instead, it was just migrating into a different animal

2. No one knew how to restructure these instruments, if there ever needed to be another restructuring.

3. We suspect that our data is the tip of the iceberg (maybe no more than 5-10% of the total number of guaranteed debt instruments)

Response from our Official Sector Friends

No need to worry - read this from the Debt Managers (July 2011):

The Committee considered making . . . CACs mandatory for . . .[guaranteed] debt [but] . . . concluded not to . . . because . . . they represent only a very small portion of the total euro area governmental indebtedness. 

Plus, 90% of euro area sovereign debt is under local law – just change the law (ala Greece 2012)

<192

0

1920

-192

9

1930

-193

9

1940

-194

9

1950

-195

9

1960

-196

9

1970

-197

9

1980

-198

9

1990

-199

9

2000

-201

2

0

100

200

300

400

500

600

700

800

Number of Bonds with Sovereign Guarantees 1833-2012 (N=931)

Non-European

European

1985 1990 1995 2000 2005 2010 20150

20

40

60

80

100

120

140

# of Bonds for Six Non-AAA Euro Countries (1988-2013)

Six Non- AAA Coun-tries: # of Bonds

2008

1985 1990 1995 2000 2005 2010 20150

20

40

60

80

100

120

140

# of Bonds and Guaranteed Bonds for Six Non-AAA Euro Area Coun-tries (1988-2013)

Six Non- AAA Coun-tries: # of Bonds

Six Non-AAA Countries: # of Guarantees

2008

But the question for me is – How do I restructure it? Remember Greece 2012 ?

The key there was that 90% of the bond debt (the $400 billion) was under local law – easy to restructure

So, what about this?

1995-1999 2000-2004 2005-2009 2010-present0

5

10

15

20

25

30

35

40

45

50

Number of Greek Bonds with Sovereign Guarantees by Law of Bond (1995-2012)

Foreign

Local

Exercise in class - How do you solve this?

In March 2012, Greece basically tried nothing (they were paid 100%, unless they voluntarily took the haircut)

Next time, it won’t have the money to pay (and there will be a next time).

Time to read the contracts –

This is what the bond looks like – scary words

Page 14 Proton Bank K

The Guarantee Structure (As we see it in the bond)

Greece

Proton Bank

Creditor

The Real Structure (in the fine print)

Creditor

Unknown

Greece

Unknown

Proton Bank

U n k n o w n

But the key contract is the Guarantee, not the bond

What does Ministerial Decree No. 251235671773 say?

At page 53 of a bond of an altogether different company EFG – It says

Governing Law: This Guarantee . . . . is governed by and shall be construed in accordance with Greek law.

Jurisdiction: The Greek courts in Athens are to have jurisdiction to settle any disputes which may arise out of or in connection with this Guarantee

Implications In 2012, these Greek guarantees got paid in full

Historically, in restructurings, they have gotten paid in full

That is partly why they have become so popular (plus capital reserve treatment)

Next time, in Greece, maybe not . . .

If you are an investor though, there is a tiny subset of these bonds that have foreign law govern the guarantee too (just like there were a tiny subset of Greek bonds in 2012 that had foreign law )

Criticisms from Prior Talks

This is European Financial Accounting; it is complicated and you don’t understand how it works. There is no problem.

These are fake bonds that you are looking at; no one really bought them – they are all sitting in the ECB as collateral. There is no problem.

These are part of the Euro area bailout packages and the new banking union. Not a Greek problem. Rather, a German problem. There is no problem.

<192

0

1920

-192

9

1930

-193

9

1940

-194

9

1950

-195

9

1960

-196

9

1970

-197

9

1980

-198

9

1990

-199

9

2000

-201

2

0

100

200

300

400

500

600

700

800

Number of Bonds with Sovereign Guarantees 1833-2012 (N=931)

Non-European

European

Background Sovereign bond data, in about 2008, started

showing a bunch of guarantees where we couldn’t find documentation;

The last time we had seen this in our data was in the 1880s (Argentine railroads) and the early 1900s (Russian cities and railroads);

Greek debt stock that had to be restructured in 2012 had more guaranteed bonds (36) than any prior restructuring – and it was not obvious how to restructure them.

<192

0

1920

-192

9

1930

-193

9

1940

-194

9

1950

-195

9

1960

-196

9

1970

-197

9

1980

-198

9

1990

-199

9

2000

-201

2

0

100

200

300

400

500

600

700

800

Number of Bonds with Sovereign Guarantees 1833-2012 (N=931)

Non-European

European

1985 1990 1995 2000 2005 2010 20150

20

40

60

80

100

120

140

# of Bonds for Six Non-AAA European Countries (1988-2013)

Six Non- AAA Coun-tries: # of Bonds

1985 1990 1995 2000 2005 2010 20150

20

40

60

80

100

120

140

# of Bonds for Six Non-AAA European Countries (1988-2013)

Six Non- AAA Coun-tries: # of Bonds

2008

1985 1990 1995 2000 2005 2010 20150

20

40

60

80

100

120

140

# of Bonds and Guaranteed Bonds for Six Non-AAA European Countries (1988-2013)

Six Non- AAA Coun-tries: # of Bonds

Six Non-AAA Countries: # of Guarantees

2008

1998 2000 2002 2004 2006 2008 2010 2012 20140

50000

100000

150000

200000

250000

300000

Amounts of Bonds and Guaranteed Bonds for European Countries (1988-2012) – 100s of millions (euros)

Amount of Bonds

Amount of Guran-teed Bonds

2008

Comments from prior talks

Don’t talk about it; it is too scary

Many of these are fictional issuances – no one holds them (they are used as collateral to borrow from the ECB)

This is European internal financial accounting; something you would not understand

What about Fannie and Freddie? This is no different.

01/05/98 03/15/00 05/24/02 08/01/04 10/10/06 12/18/08 02/26/11

-0.05

0

0.05

0.1

0.15

0.2

Spread (Yield on GGB – Yield on Guarantee: March, 1998-July, 2011)

Sp

read

10/24/11 12/3/11 1/12/12 2/21/12 4/1/120

1

2

3

4

5

6

7

8

9

10

Spread (August, 2011-April, 2012)

Sp

read

4/1/12 5/21/12 7/10/12 8/29/12 10/18/12 12/7/12 1/26/13 3/17/13 5/6/13 6/25/13 8/14/13

-1

-0.5

0

0.5

1

1.5

2

Spread (May, 2012-August, 2013)

Sp

read