Insolvency Law and Debt Restructuring - Essay Example

Name Tutor Title: Insolvency law and debt restructuring Institution Date Insolvency law and debt restructuring Question 2 Principal defeasance Introduction All the four options entail principal defeasance whereby assets are held within trust to the advantage of bondholders to cover up all or element of principal due. For the initial three options, the assets include AAA-rated 30-year bonds issued by single or more sovereigns, supranational bodies, sovereign organizations as well a sovereign-backed agencies. The bonds increase interest at a particular fixed rate, compounded yearly and have an initial face value in a way that on maturity, their redemption sum covers up the estimation of the principal-guaranteed bonds (new ones). As a result, Greece is relived its responsibility of paying back the principal after the new bonds matures since defeasance assets cover the new bonds (Haworth 2011). The hypothesis has routinely been that the collateral will be EFSF-issued zero coupon bonds. Nevertheless, this might not essentially take place. The cost of this collateral will affect the valuation of the exchange options. There is a case for ascertaining that the collateral is of the highest probable quality and the purpose of this is to promote participation. In case the EFSF were the source, the result will be that a significant total sum of the EFSF’s existing lending ability would be tied. Apparently, this is a negative signal especially when the market has sought to increase the market size many times unsuccessfully. In addition, it would also need the ratification of EFSH modifications, and this could result to detrimental delays in execution of the Private Sector Involvement (PSI) (Haworth 2011). For the forth option, 40 percent of the principal of the new discount repaying bonds is defeased; this means that the sum of defeasance assets is retained within trust for the bondholders to gain. Nevertheless, the assets vary considerably from the assets guaranteeing the other options. AAA-rated and provided by similar agencies like before, the bond are floating rate note and they posses equivalent maturity as well as amortization schedule just like the latest discount amortizing bonds. Additionally, to ascertaining all or component of the principal of the new bond, the underlying principle for principal defeasance would seem to lower the Greece’s debt to GDP ratio (Haworth 2011). Since Greece needs official loans for financing the purchase of the collateral, devoid of any offset, there is a risk of the process leading to a rise in the debt of Greece to GDP ratio, instead of the projected decline. For instance, for 100 billion Euros face value of new debt, in case the government of Greece needs €30 billion of loans to buy the collateral for the principal guarantee, gross debt can in fact rise up to €130 billion: this includes the total amount for the principal owed in addition to the loan. Nonetheless, since the loan fund the collateral that provides security for the principal, the net debt has not actually risen and hence possibly the level of the debt stays at € 100 billion. Through defeating the principal in the way put forward: consequently, due to such principal of defeasance, the Hellenic Republic will be relieved the responsibility of paying the principal of the new par bonds (Warren 2012). Actually, it would seemingly be probable that the key aim is for the debt exchange to reduce Greek debt significantly to GDP ratio. As a result, the €100 billion face value of new debt ceases to be the debt of Greek: the debt is covered by the trust asset, whereby in this illustration, the trust assets cost Greece €30 billion. This implies that the net debt would have reduced by € 70 billion. Accordingly, this is an addition to any reduction within net debt outstanding due to the bonds traded for discount instrument (Warren 2012). New debt is under English law The GGBs and also Hellenic Railway bonds are governed by Greek law and signify the highest amount of Greece’s outstanding debt. Of the total sum €207 billion entitled bonds, only 6% are under international law and therefore the change in law for all other bond is important for several reasons. One, the change of the law to English law offers extra comfort for bondholders choosing to exchange, since Greece will no longer have influence over the new debt and hence has less elasticity to change the terms. The occurrence of CACs implies that due to the supermajority of bondholder, it is possible to modify the terms even though there is the allied probability for a CDS trigger and the procedure resulting to a restructuring has the probability of being more potential. Second, there are connotations for the hold-out in case there is an additional restructuring, because there is the probability for them to be handled in a different way from new bondholder, with the prospective for a low recovery. Third, there is standard that is set up for all other nation using Euros. After the ESM starts working, is this a sign that all euro region nations will be issuing using the English law (Stanley 2011). The new securities General features of the new bonds All the new bonds are not secured or subordinated and are issued under English law and in addition are expected to be ECB eligible. The instrument have negative guarantee, cross default as well as joint action clauses. Participants can select between bonds that can be traded freely or bonds having limited trading (for ten years for option one, two and three and five years for option four). Herein, there is no much vale in selecting the limited trading option. From an accounting view, banks will require taking losses during the transactions and they are not exposed to mark-to-market risk within their hold-to-maturity books in the entire life of the bonds. Therefore, investors are better off if they retain the option to trade the bonds on the secondary market any time (Khalkis 2008). Factors to Consider when Deciding if to Participate Since Greece at present does not trade at 9%, the present market value of the option varies from 79%. The concern for investors reflecting on participating is where the Greek yield curve is expected to trade following the exchange and therefore the pot-exchange value of new bond. The supposition motivating the 79% is that post-exchange, Greece will trade at the same level that Ireland and Portugal are presently trading at. The value of the four exchange option basing on the present Greece curve as well as different post-exchange curves will be considered. Through comparison of the valuation to present bond prices, the indication is that there is a potential value for taking part in the exchange package and also draws attention to the least costly bonds to exchange (Stanley 2011). Seemingly, the exchange package is attractive in comparison to the potential recovery heights in case Greece defaulted. Nevertheless, this is uncertain. Therefore, investors should weigh the prospects for the value post-exchange and vice versa. In case the wider second bailout gets in the equation, Greece has less incentive to go ahead with the planned PSI because at a minimum Greece is paying for the collateral and in failure to pay it can provide far more retaliatory terms to bondholders. The present political within Greece as well as the stand-off that seemingly is developing with the IMF due to failure to make any progress in terms of reforms and privatizations, the worsening financial state and also rigor fatigue indicate that both the second bailout and the next disbursement from the initial bailout are questionable. Accordingly, until when certainty surfaces with reference to if the PSI will go ahead as planned, the bonds of Greek government are apt to remain under pressure (Stanley 2011). It is advisable to consider the relative liquidity of the different options when making a decision regarding which option to participate. What’s more, those who are participating within the exchange are supposed to exchange their complete holdings. Numerous exchange options can be chose, but the entirety of holdings should be integrated (Warren 2009). Eligible assets for Greek debt exchange It is difficult to estimate the present period of the portfolio because of exact pricing for each and every bond. However, the standard life of the portfolio is 3.84 years. The exchange of thee bonds will be either into thirty-year bonds or seventeen-year amortizing bond under option 4. The main concern is if the owners of the new bonds will hedge the rise within their exposure period. This will be the case and the outcome will be paying within the swap market. Investors are permitted to select a new discount bond that will be subjected to trading restrictions for a period of ten years. Banks that have held Greek paper within hold-to-maturity books can select this option. As a result, the bonds would not be traded and hence the bonds might also not require to be hedged (Vinod 2006). The composition of European government bond indices has been obscured by Greece, Ireland and Portugal dropping their investment ranking position. The fact that Greece has dropped out of the official indices is an off-index postulation. For the indices not to include Greece, Greece transaction should not produce a prevalent demand for period. Consequently, the hedging will be compelled by the period an investor requires on the back of the debt exchange (Leonard 2010). Collateral This transaction also includes “defeasance asset” which are thirty year accreting bonds issued by sovereigns, supranational bodies, sovereign bodies or sovereign-backed organizations that are rated as Triple A. Since there is no information regarding the identity of the issuer, the issuer’s identity has the likelihood of driving the decision if this issuance can be swapped. The 30-year bonds shall be issued but will be held within trust and hence it will not hit the market directly. The market relevancy is if the issuer of these bonds will swap the exposure. This will lead to obtaining interest within the swap market and hence will balance a quantity of the paying interest and hedge exposure to the new 30-year Greek bonds. In an event where the collateral would be issued by another sovereign organization, for instance, there is a higher probability that the issuance would be substituted (Frank 2004). Four options Option 1: Par exchange The initial option is to substitute into 30-year bonds with a system coupon and with a principal security through accreting security. Bonds that are entitled are exchanged into New Par Bonds of equivalent nominal sum, and hence there will no indirect haircut (Ross 2010). The first coupon is set in a way that the present value of the coupons on the bond on sale at nine percent plus of the collateral is equivalent to 79, which is the head of NPV. In case of failure to pay, the claim total sum on the bond is positioned to be (100 + accrued – Par Value of the collateral. This implies that the defeasance assets will go on being held within trust to the advantage of bondholders until the New Par Bonds mature (thirty years from the exchange). As a result, the recovery value is greater than the value of the collateral: the major uncertainty within the valuation is the value of the collateral. The present market value of all the exchanges options are based on the present Greece’s government curve. Consequently, the New Par bonds are valued at 64.5 and this indicates a rise within NPV for each and every bond with a maturity higher than single year (John 2006). Option 2: Committed Financing Facility (CFF) The bondholders who will choose to take part in CFF, which is the second option, will make an irreversible and absolute pledge to roll over their exposure to the government of Greece at the start of the quarter where the primary bonds of the bondholders will mature. In particular, bondholders will commit through the profits from the maturity of the older bonds to purchase a 30-year par bond. According to the law, the bondholders can buy and sell the original bonds and are not needed to hold the original bonds to maturity. Normally, the Rollover Par Bonds that are produced in this manner have requirements equivalent to the requirements of the New Par Bonds, in option 1. However, there is a difference whereby these Rollover Par Bonds will only begin their 30-year life after maturity of old bonds and hence they will mature once the old bond matures (Stanley 2011). Instead of buying the new bonds, on the other hand bondholders can make a cash proceed to Greek government for the primary bond principal, for equivalent return and exposure as if they had bought Rollover Par Bonds. One requirement is that the bondholders have to give their holdings of Greece bonds. For the reason of valuation, it is important to differentiate two states of affairs; one scenario is where Greece defaults prior to the maturity of the old bond and the second scenario is where the Greek government does not default prior to the maturity of the old bond (Crawford 2008). What’s more, beholders who will take part in the Committed Financing Facility are faced with the uncertainty regarding what is likely to happen to their Committed Financing Facility-related claim and commitment as well in case Greece defaults on its debt service before the old bond matures. There is a legitimate uncertainty regarding this, but the postulation is that the contractual responsibilities on both the creditor’s and debtor’s side of the Committed Financing Facility would stop being legally binding (Leonard 2010). Assuming that the Committed Financing Facility will stop being in existence in case of a default, there is a possibility of inferring the projected Net Present Value benefit of the Committed Financing Facility to a beholder. In case there is a default prior to the maturation of the primary bond, there will be no disparity between holding the old bond and holding the Committed Financing Facility and hence the incremental gain from choosing the Committed Financing Facility will be zero. Therefore, the focus should be solely in the circumstances where there is no default before the original bond matures, where the NPV benefit is equivalent to: Probability (no default before GBB matures) * (new Par Rollover Bond’s price - 100) * (Risk-free discount factor), The first term is the likelihood that the Committed Financing Facility is legally binding and the second term is the projected rollover value. It is worth to note that the price of the old bond is not included within the calculation: this means that the bondholder will continue to won the old bond and might potentially trade the bond at a market price without affecting the NPV of the commitment. The outcomes of the NPV calculation are that the NPV is negative, in particular for the bonds with short dates. The high default prospect on Greece debts makes NPV small for bonds having longer duration (Crawford 2008). The NPV of the Committed Financing Facility option if the option continues to exist is difficult to compute since it would need a postulation on the Rollover Par Bonds price following the default. The higher likelihood is that the new Par bond would trade below par and hence the rollover option that will continue existing will have a greater negative NPV. The further consideration for Committed Financing Facility option is the liquidity of the new bonds, which has the likelihood of being lower as compared to the other options, since all rolled bonds will have a dissimilar maturity (Crawford 2008). Option 3: Discount option This option is the same as the first option apart that in discount option the beholder takes twenty percent haircut which is recompensed for through a higher primary coupon. However, the first option will have better value as compared to discount bonds for greater discount rates (Stanley 2011). Option 4: Discount A option This option enables the bondholder to exchange into a repaying discount bond with a standard life of fifteen years. Basically, only bonds that will mature within 2013 or earlier are projected to be qualified for discount A option, with complete participation restricted to a maximum of twenty five percent of eligible bonds taking part in the cumulative exchange (Stanley 2011). The principal of 40 percent of the discount A bond will be collateralized through a floating rate, high quality security that will sustain par value during the entire life of the bonds. Therefore, the collateral will cover the 40 percent of planned paying back, whereas the Greece government will pay the 60 percent of the amortizations. In case there will be default; all remaining collateral as well as interest in collateral will be discharged to the investors. As a result, investors will have an outstanding claim equivalent to accumulated interest in addition to 60 percent of principal. On the other hand, collateral on New Par Bonds as well as the New Discount Bonds will be discharged just on the stated maturity date of the bonds and hence the value of the collateral in case of a default will be probably to be below par (Paul 2010). Additionally, in New Discount Amortizing bonds, collateral can be discharged early in case of failing to pay the principal or in case there is a Restructuring Credit Event on Greece CDS. In such an event, collateral is liquidated in order for the bondholders to be paid. Moreover, the government of Greece has the obligation of taking care of the interest alongside amortizations on the outstanding principal. The early release option and hence, might be important in some situations (Rhett 2006). Expected outcome Option 1 is the most eligible option amongst all and it generates an NPV gain for the greater part of bondholders unless the quality of the collateral is low. In such an event, option 4 is the most eligible option within a rally: the Par exchange is at all times the best option within a sell-off, regardless of the quality of the collateral. Option 2 is the least attractive option and would end up in an NPV loss for the majority of bondholders while option 3 is inferior as compared to option 1 will all incidences apart from an extremely significant rally. As mentioned earlier, option 4 is the most appealing option within a rally in case the quality of collateral is poor. Additionally, it might add value in case there is a technical default that prompt CDS due to the hurried discharge of the collateral. It is also ought to attract investors who cannot hedge the high interest rate period of the option one (Paul 2010). Relative attractiveness of all the options can change in line with credit and market risk of the principal collateral Because the collateral within Discount A option comprises of securities, market as well as credit risks are significant elements to be considered. Whereas the maximum protection level from the collateral in this option was 4o percent of the new principal sum, further information on the collateral shows that the protection cap is on a moving mark since it is a function of the credit spread of the principal bonds. In case the collateral assets rally, bondholders are able to recognize the benefit and in essence raise the size of the collateral protection. Nonetheless, the disadvantage is limited because Greece will be required to make whole for the outstanding sum, in case the price of the collateral bonds will be below par in case some or all collateral is discharged; early discharge of the collateral because of a credit incident, acceleration or even maturity (Mathew 2009). Even though this can be applied to the other options, options one to three have equivalent collateral and therefore their protection outline as compared to each other doesn’t change. The defeasance assets within option four are nonetheless different, and hence the relative attractiveness can change to some extent with the moves within the principal markets until the transaction. It is important to note than because of the latest drop within core yields, the primary protection level within options one to three has increased, whereas the accretion rate has reduced. This is a benefit for the investors participating within the PSI: less for Greece, since this indicates a rise of the collateral financing costs (Brown 2008). Risk-reward not positive for option 2 Option 2 indicated a rollover of old Greece bonds into a 30year par bond when the bond matures. The exchange term sheet illustrates a “committed funding facility” and the rollover model comes out just in the new securities’ name which is rollover par bonds. Consequently, investors will be committing themselves to refinancing Greece at the start of the calendar quarter within which the qualified bond expires. There are two options which include buying new bonds and making cash advance with similar prerequisites as within the first option. The second option is load rather than a bond transaction (Atherly 2006). Option 2 carries an unattractive risk-reward outline since investors appear to run wholesome Greek risk for longer, devoid any allied benefit. Moreover, investors who purchased Greek bonds within the original market would continue getting coupons on old GGBs which are averagely lower as compared to the new securities within equivalent loss of investors who choose option one in future (Smith 2011). Probability of PSI success Even though the dual 90 percent target participation rates seem to be quite difficult, the greater NPV of the transaction because of the latest market sell-off on the whole with political moral suasion on legalized investors is supposed to assist Greece put into operation the PSI. Financial Times suggest that the most recent sign of participation rate is around 70 percent of the eligible debt. As a result, there is much to be done to realize the target. Seemingly, Greece is aiming at convincing investors to take part in line with the ninety percent target and is at the same time ready to continue with fairly lower participation rates (Hugh 2002). In case PSI does not succeed, the likelihood of a near-term ‘hard’ reorganizing would rise significantly and Greece could be obligated to go on with a principal reduction up to 65 percent and this implies severe losses on investors (Fabozzi 2008). Implementation risks and potential restructuring inferences Meeting the participation standard is the key Basically, there is more emphasis on the 90 percent participation rate within two diverse maturity buckets. In case any of the participation criteria is not met, Greece can make a decision not to proceed with the transaction. In case the PSI fall through, it could also imply that the second bailout package will not proceed. Officials began with the projected financing requirements of Greece and then agreed on the sharing of the burden between the certified lenders and investors, who are the PSI. Therefore, in case PSI is less efficient than projected, then either Europe will raise its economic commitment or Greece will be forced to face credit event at some pint. Accordingly, Greece would recover a sustainable debt path in an event where GDP/Total Public Debt goes to about 90 percent. In addition, the figure would be politically feasible. A successful PSI would indicate a significant liquidity relief, whereas the medium-term debt sustainability challenge will remain. Actually, even after PSI, there will be a medium-term risk of additional principal defeasance reduction (Fabozzi 2008). Conclusion In terms of the New Greek bonds, the duration risk for each and every bond cannot be hedged and accordingly the defeasance asset might be swapped. This could imply that there is some balancing out of the paying and receiving interest within the transaction. There is also a risk that the market will get less steepening that it is projected. Nevertheless, there are factors to be considered, for instance, hedge funds have 10s30s type structures and hence benefits from richness of 30y and positive roll. The investors may choose to take earnings on any normalization of 30y; efficiently putting a cap on how much the 30y can depreciate. Simultaneously, the market has already been moving within expectation of the Greek PSI and 30y swap has been depreciating, which implies the move may be entirely discounted by the time it occurs. In conclusion, selecting option one within the PSI is an extremely attractive strategic strategy. Bibliography Atherly, G., 2006,The touchstone of common assurances: being a plain and familiar treatise on conveyancing, Brooke, Pennsylvania. Brown, R., 2008, Raising capital: private placement forms & techniques, Aspen Publishers Online, London. Crawford, M., 2008, Local Government and Single Audits, CCH, Turkey. Fabozzi, F., 2008, Asset-backed securities, Frank J. Fabozzi Series, Vol. 13/3. 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