barcap - euro themes greece - what works and what does not

ECONOMICS RESEARCH 11 July 2011

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EURO THEMES Greece: What works and what does not Piero Ghezzi

+44 (0) 20 3134 2190

[email protected]

Antonio Garcia Pascual

+44 (0) 20 3134 6225

[email protected]

Frank Engels

+49 (0)69 7161 1832

[email protected]

www.barcap.com

The fiscal consolidation and growth potential that Greece can deliver will not stabilize debt-to-GDP, in our view. A debt reduction is needed, and we believe now that it could take place as early as H2 2011, allowing Greece to tackle its debt overhang and preventing further contagion across the euro area. In this report, we analyze current proposals and determine whether they can bring Greece back to solvency.

We find that voluntary or quasi-voluntary debt re-profiling would have at best an insignificant impact on solvency, or at worst cause it to deteriorate. The French and German proposals “share the burden of funding”, but provide marginal debt relief.

Market-friendly debt buybacks, “attractive” given current valuations, would provide modest debt relief, as they would effectively increase market prices close to par.

Partial solutions aimed at just providing liquidity while not restoring solvency are inefficient as they would leave Greece with a debt overhang and an imploding economic system. For investors, those imply high exit yields and low debt valuations.

Ultimately, to address Greece insolvency, a full bailout of Greek private sector creditors or a debt restructuring is needed. We find that a bailout where the EU swaps all existing Greek debt into EU-guaranteed debt at c.3.5% interest rates would largely restore solvency. We cannot dismiss a full bailout, especially as an emergency to avoid a disorderly default, but we consider it politically and legally challenging.

Debt restructuring is the main option, in our view. By our estimates, restructuring requires a c.60% reduction in outstanding debt (c.EUR200bn). If the burden were to fall fully on bondholders, the haircut would be massive, with recovery values in the 20s.

A restructuring with “fair” burden sharing between bondholders and the official creditors may be optimal as it could help limit contagion. For example, a haircut on bondholders close to that implied by current prices (about 50%) would lead to a c.EUR100bn net contribution by bondholders and the remaining EUR100bn by the EU, via the European Financial Stability Facility (EFSF) long-term loans (20y) at a rate close to the EFSF’s funding cost (mindful of Art. 125 of the Lisbon Treaty).

A Greek restructuring should be part of a broad package of policy measures to address contagion, in our view; a standalone Greek restructuring may not be sufficient. First, the scope of the EFSF should be extended to conduct secondary market purchases of sovereign bonds and to create a new liquidity line (Flexible Credit Line-type facility) for countries with liquidity problems and without systemic imbalances. Second, EFSF loan charges should be reduced to (marginally above) EFSF funding costs. This would significantly ease debt service payments for Greece, as well as for Ireland and Portugal, and thus improve solvency without incurring any additional costs to EU taxpayers. Third, the ECB would create a new liquidity facility for Greek banks and other banks in the periphery, allowing for a broader set of qualifying collateral. If needed, and as a pre-cautionary measure, the ECB could temporarily re-introduce fixed-rate (over 3M) Long-Term Refinancing Operations (LTROs) and revive the Securities Markets Programme (SMP).

Barclays Capital | Greece: What works and what does not

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Figure 1: Costs of unresolved debt crisis

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Source: Barclays Capital

Introduction In Greece: The (long) countdown to restructuring, 11 May 2011, we argued that owing to weak growth and sizeable fiscal slippages, Greece had reached a point at which, under realistic scenarios, debt dynamics were unsustainable and Greece was de facto insolvent. We suggested that the countdown to restructuring had started. However, we thought that a restructuring might not be imminent because Greece first needed to be closer to achieving a primary surplus. We also thought contagion fears would continue to dominate EU decisions and that a restructuring would be most likely in H1 12.

The reasons to postpone restructuring are still valid and may eventually prevail. However, we increasingly believe that European authorities need a backup plan as two factors beyond their control may force them to act pre-emptively: 1) the possibility that Greece fails to implement the recently agreed austerity package; and 2) the market has started to focus increasingly on Italy and Spain.

European authorities need a backup plan as they may be forced to act pre-emptively

Despite recently approving the austerity package, implementation remains challenging, in our view. We believe Europe needs to prepare for the failure to deliver in the quarterly reviews ahead. If that occurred, a restructuring scenario would be likely. A restructuring would not necessarily affect markets negatively if executed well and pre-emptively, because markets appear to believe the main uncertainty with Greece is not whether it will default but when and how. Indeed, a disorderly restructuring would have significant consequences for global financial markets.

As for the second factor, in the past two weeks, Spanish bond spreads have reached nearly 300bp, while Italian spreads have reached over 250bp, both historical highs since the launch of the euro (the sell-off in Italy has been particularly aggressive). While these two economies have problems of their own (see Italy: the time to act 21 June 2011 and Spanish regions: assessing the risks, 15 June 2011), the ongoing crisis in Greece is an added risk factor. If these high spreads become protracted, they would worsen the debt dynamics of Spain and Italy, potentially making them unsustainable. This, in our view, is reason enough for EU policymakers to develop a backup plan that addresses Greece’s solvency and contagion fully.

Stresses in the Italian and Spanish bond markets are

signals of the severity of the unresolved debt crisis

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Revisiting the solvency gap Greece is insolvent in our baseline scenario. Our scenario assumes Greece achieves a primary balance of about 2.5% of GDP in 2015 (compared with the end-2010 primary deficit of -4.9% of GDP), average nominal growth rates of 3% (ie, c.1.5% GDP deflator and real GDP growth at c.1.5%), marginal interest rates of 6.75% (ie, 7y Bund at 3.75% and a spread of c.300bp), and a debt-to-GDP of c.165%. 1

Under our baseline scenario, fiscal consolidation alone cannot

close the solvency gap

Figure 2 shows the debt dynamics under those assumptions. We also show that a primary balance of 7.4% would be necessary to stabilise debt dynamics and bring the debt-to-GDP ratio back to 60% in 2050 (which implies a cumulative primary balance adjustment of over 12% of GDP in 2011-15). Since we believe the maximum economically and politically feasible primary balance is 2.5%, there is a solvency gap. Hence, under our baseline scenario the country is insolvent.

2: The fiscal effort needed to close the solvency gap is unrealistic under plausible macro scenarios (public debt-to-GDP, in %)

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Cumulative primary balance of over 12% of GDP in 2011 -15

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This solvency gap could be closed either by: a) continued adjustment efforts aimed at increasing the primary surplus above 7%, while providing financial support to close annual funding gaps; or b) a combination of a bailout and debt reduction. Approach (a) has failed so far; it is now time to think about approach (b).

In the next sections, we make use of a framework we introduced in a recent piece (Debt Sustainability and Restructuring: a Unified Approach, 17 June 2011) to analyze the solvency properties of a number of proposals currently on the table. We summarize the framework in appendix (B).

Options that do not address insolvency

Policymakers, market participants and the press have been proposing and debating “solutions” to alleviate Greece’s burden, but we think that at best most of the proposals

1 Obviously, 6.75% is very low compared to current yields on Greek debt. However, the fact that debt dynamics are unsustainable even under a very optimistic assumption on market rates simply strengthens our conclusion of insolvency.




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would have an insignificant impact on debt dynamics, or at worst cause them to deteriorate. We have grouped the proposed “solutions” that do not address solvency into: 1) market-based solutions that entail debt re-profiling; and 2) quasi-voluntary debt exchanges and debt roll-overs (the private sector involvement (PSI) proposed thus far falls into this second category).

1) Market-based debt re-profiling would not work We define a market-based (or voluntary) debt re-profiling as an offer to extend maturities at market rate that would not result in NPV losses for creditors. At current yields, a market-based debt re-profiling would make the solvency gap worse rather than close it.

Proposals, such as debt re-profiling, which do not address

the solvency problem, would not work

Here, an example is helpful. We calculate that a 7y Greek bond with a 5% coupon, EUR100 of face value and a yield of 17% would be worth:

Price Old Bond = NPV (yield=17%, coupon=5%, 7-year maturity) = 52.9.

If we exchange it for a new bond with a 20-year maturity and the same value, the coupon would need to be 6.9% (as the current market yield on a 20y bond would be 14%):

Price New Bond = NPV (rate=14%, coupon= 6.9%, 20-year maturity) = 52.9.

The cost of extending duration is the replacement of 5% of debt with debt that has a coupon almost 40% larger. This obviously worsens debt dynamics as Figure 3 shows.

Figure 3: Market-based re-profiling of debt worsens debt dynamics… (public debt-to-GDP, in %)

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Reprofiling, market based

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Market-based debt re-profilings normally work for solvent countries that want to smooth their debt service over time. For insolvent countries, such operations worsen debt dynamics as they mean having to issue at (and hence validate) current market rates. As the Argentina’s “Mega Swap” of June 2001 showed, they can actually accelerate a restructuring.

2) “Quasi-Voluntary” debt exchanges and rollovers would not work either Based on the above logic, a Greek debt re-profiling to extend maturities would require higher coupons to be NPV neutral (and hence truly voluntary) to investors. If, in the


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previous example, the proposal was to extend coupons of a 7y bond into a 20y bond, the price of the new bonds would be:

Price New Bond = NPV (rate 14%, coupon= 5%, 20 year maturity)= 40.4.

This would imply a loss of almost 30% compared with the price of the old bond. A few investors may be willing to exchange bonds, possibly owing to moral suasion and other factors, but we would expect the participation rate to be low because of the large NPV loss. With low participation (say ¼ of outstanding debt), the loss incurred by private sector creditors would improve debt dynamics (as the exit yield is expected to be above the average coupon of outstanding bonded debt), but only marginally. Even if participation were 100% (extremely unlikely), the debt relief would not stabilize debt dynamics (Figure 4).

Extension of debt maturities would not work either, as the

amount of debt relief would be very limited

Figure 4: … and maturity extensions alone would not work either (public debt-to-GDP, in %)

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Maturity extension to 20yr with 25% participation

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One quasi-voluntary plan being considered for Greece is the recent proposal by the French Banking Association. We refer readers to our report Greece: The French proposal for private sector involvement – buying time rather than providing debt relief, for more detail. A summary of the proposal is presented below.

Box 1: The French Banking Association proposal for private sector involvement (PSI)

In contrast to its initial decision to require some form of PSI only from mid-2013 onwards (ie, at the inception of the new permanent rescue mechanism, ESM), the euro area government has decided to condition a second financial rescue package for Greece on, inter alia, burden sharing from private financial institutions. While this new stance was initiated by the German government, the underlying technical PSI format is based on a French proposal, following discussions between private sector banks, regulators and government representatives.

At the heart of this proposal lies the objective to reduce short-term stresses on the Greek debt profile by offering long-term financing for Greek sovereign debt falling due between July 2011 and June 2014. The proposal, which provides two different options to investors, does not generate any noteworthy debt relief for Greece through a sizable NPV reduction.

Option 1 provides 30-year financing to Greece in that a minimum of 70% of the debt maturing between July 2011 and June 2014 would be rolled by private investors into a new




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Greek 30y sovereign bond, with the latter being principal-guaranteed by a special purpose vehicle (SPV). The remaining 30% of the maturing debt would be redeemed by the Greek sovereign. Moreover, for the minimum 70% principal amount to be re-invested by private sector investors, Greece would de facto pay roughly 30% of that amount to an SPV in cash (ie, about 20 cents of the 70 cents that Greece receives). The SPV would use the capital to buy AAA-rated 30y zero-coupon bonds, which in turn would be used to collateralise the new 30y Greek sovereign bonds. The coupon of the new 30y Greek bond would be 5.5% plus the annual Greek real GDP growth capped at 2.5% and floored at 0% per annum. Trading restrictions for the new bonds would be in place until 1 January 2022.

Option 2 suggests issuance of new 5y Greek government bonds and private-sector participants would invest a minimum of 90% (and preferably 100%) of the received redemption payments from the Greek sovereign in this new security. This bond would carry an interest rate of 5.5%, be listed on an EU-regulated market and come with trading restrictions.

Both options would be subject to the following conditionality: Rating agencies would need to clarify ex-ante that the proposal would not trigger a downgrade to default or similar status on the existing and new Greek sovereign bonds; the ECB would need to indicate its willingness not to sell its existing Greek government bonds during the period of the roll-over; a significant majority of (private sector) bondholders would need to participate (the proposal presumes 80% participation as a baseline); Greece would need to respect its commitments under the EU-IMF programme; and the EU and the IMF would continue to disburse funding as provided under the joint programme and continue to provide assistance to promote the medium-term sustainability of Greece’s sovereign finances.

The proposal does not improve solvency. If we assume average GDP growth of 1.5% over the next 30 years, Greece would be paying a coupon of 7.0%. This would imply that Greece would be replacing maturing debt carrying a 5% coupon with longer maturity and higher coupon (ie, 7%) debt. We can assume (optimistically) that 70% of all maturing debt (around EUR94bn) would be replaced by new debt. Figure 5 shows that such a proposal does not stabilize debt dynamics and could even worsen it.2

2 Mathematically, there are two main reasons why the proposal worsens solvency relative to our baseline: 1) We are replacing 5% debt coupons with 7% coupons; and 2) the 7% coupon is below the marginal funding rate of 6.75% we assumed in our sustainability exercises.


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Figure 5: Recent proposals for roll-over of debt at high rates do not work either (public debt-to-GDP, in %)

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French proposal


Not surprisingly, value would be high for investors. For each EUR100bn of debt maturing, private sector creditors would receive EUR30 cash plus a bond carrying a coupon of 7%. Depending on the assumed exit yield (we assume 12%, as this plan would not address solvency), the present value (PV) of the coupons would be 7%*.70/0.12*(1-1/(1.12)^30), ie, EUR39.4. In addition, the EUR70 cents principal is fully guaranteed and hence needs to be discounted at the risk free rate (with a value of 20). In total, private sector investors would receive EUR89.4bn (30+20+39.4) for each EUR100 of debt due. If the exit yield were lower, value may actually be above 100 for investors.

The French proposal aims to address liquidity rather than solvency – so we think it is focused on the wrong target. It aims to buy Greece time to address its problems through a long-term partial debt re-scheduling exercise. Given the limited scope of PSI, it may have a high participation rate. Nevertheless, the French proposal could be a first step in the right direction – the proposed measures include the possibility of a Brady-type exchange, ie, government guarantees would enhance the value of the new debt. This is something we explore in future sections.

The recent French proposal aims to address liquidity rather than

solvency, so it would not work either

Solutions that use GDP kickers need to be studied with care. Theoretically, they make sense as countries pay more when they grow more. Historically, however, investors have tended to undervalue the GDP kickers (sometimes significantly) and hence, it is not obvious that the countercyclical properties of GDP-linked coupons are worth the cost of selling at heavy discounts.

The above examples show that voluntary or quasi-voluntary exchange solutions fall significantly short of closing the solvency gap. Ultimately, in our view, there are really only two types of permanent solutions: a full bailout or a restructuring, where the size of the haircut may be determined by willingness of the EU to partially bail out the bondholders of Greek debt.

Options that may work

Workable solutions need to aim to close the solvency gap. These can be grouped into two main types: 1) a full bailout of private sector creditors to Greece by the EU; and 2) a restructuring of sovereign debt, possibly in the context of “burden sharing” between the EU and bondholders.


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A full bail-out The existing EU-IMF programme, where the official sector slowly increases the ownership of Greek debt, has not dispelled investor concerns about an eventual default. Increasing the percentage of senior debt is de facto reducing recovery for market-bonded debt. In our view, this almost certainly guarantees that spreads on Greek debt remain high and that contagion fears to other periphery countries will continue.

If concerned about sustained contagion, EU authorities could eventually decide to fully “bail out” Greece, which would mean that its private sector creditors would be taken out of their exposure. A full bail-out (FBO) would face some implementation challenges (see below on legal and political constraints), but it is not an option that can be discarded outright.

A full bail-out of Greece’s private sector creditors would work but

it may be politically and legally challenging to implement

We believe a FBO could take three forms: (a) an unequivocal decision to keep funding Greece in the medium term and avert default; (b) a debt exchange where Greek debt becomes guaranteed by an EU entity (as recently suggested by Jeffrey Sachs for example); and (c) a buyback of Greek debt.

The first option would imply a change with respect to current ambiguity about PSI participation. In order to be credible, it would also need to be very front-loaded, which in turn would imply operational challenges regarding the available funds. In the current institutional setup of crisis prevention at the EU, this would most likely imply that the EFSF would need to effectively own most or all of Greek bonded debt.

Alternatively, as suggested for instance by Jeffrey Sachs recently, there have been a number of proposals that implicitly aim to take advantage of the rate differential between Greece and the funding cost of the EFSF. At the risk of oversimplifying, the argument goes as follows: “Greece appears insolvent partly because creditors charge high interest rates. If investors were to charge French or German rates, the country could become solvent”. Obviously investors need, for instance, German risk to charge German rates. This can only be achieved if all Greek debt is fully guaranteed by Germany (or by AAA obligor). In principle, if EFSF were willing to guarantee all Greek debt AND all debt that Greece needs to issue in the foreseeable future, the above statement is correct. The steady state calculation proves useful in this context:

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Instead of reducing the debt, one could reduce the coupon. For example, with a debt to GDP ratio of 165% and a maximum realistically achievable primary balance of 2.5% of GDP, the maximum interest rate that would stabilize debt dynamics is 4.5% (ie, above current EFSF or, alternatively, German yields). Hence, theoretically, it would be possible to stabilize Greek debt dynamics if the entirety of outstanding and new Greek sovereign debt would be guaranteed by the community of euro area member states through the EFSF. 3

As is often the case, the devil is in the detail. One would need to incentivize investors to participate in the debt swap. For that to happen, the value of participating would need to be at least as high as the value of holding out, which will be in turn determined by the exit yields. Using exit yields of 6%, 6.75% and 7.5%, the average price of the existing bonds (average coupon of 5% and average maturity of 7 years) becomes:

3 Recall in this regard that we had called for a substantial lowering of EFSF charges to euro area member countries requesting financial support. Doing so would not only reduce the debt service burden, but also improve solvency (see Euro Themes: Growing out of the crisis).



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Figure 6: Value of outstanding debt at different exit yields

6.0% 6.75% 7.5%

94.4 90.5 86.8


The right exit yield is debatable. The bailout indicates that authorities are unwilling to let Greece default, in order to give Greece time to implement reforms and fiscal adjustment over the medium term. This would suggest the use of an exit yield that would be consistent with a solvency, but still risky, scenario (eg, 6.75%, which implies 300bp over our long-term projection for the 7y Bund)4. With an exit yield of 6.75%, investors would need to be offered a new bond with a value of at least 90.5. The new bond would be coupon- and principal-guaranteed by a AAA entity such as the EFSF. Greece/EFSF could hence issue a bond with a principal face value of 90.5 and coupons of about 3.5% (which we assume to be the risk free rate). This would obviously be a significant improvement in solvency to the extent that the participation rate would be high. Indeed, Figure 7 shows the debt-to-GDP path under two alternative scenarios: one where all existing and new debt is guaranteed by the EFSF at a rate of 3.5%. And a second alternative where existing debt is guaranteed but new debt has Greek credit risk at a marginal rate of 6.75%.

A guarantee by a AAA entity of all the outstanding would clearly

move debt dynamics towards solvency

In principle, this proposal could achieve the objective of restoring solvency to the extent that the EFSF would guarantee not only current Greek debt but also all new debt. If only current debt is included, it would not fully restore solvency but it could buy valued time. However, a full guarantee of Greek debt without some form of PSI is something that we deem as politically and legally challenging at present (see below).

Figure 7: Bailout by the EU of private sector creditors to Greece would address solvency (public debt-to-GDP, in %)

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Exchanging EFSF-guaranteed bonds for existing Greek debt is quasi equivalent to having the EFSF issuing debt and using those proceeds to buy back the Greek debt and having the EFSF issuing a jumbo loan to Greece at EFSF rates (a proposal similar to Alfonso Prat-Gay’s in the FT, 21 June 2011).

4 Assuming a recovery value of 50% and ignoring risk premium, a spread of 300bp is consistent with a default probability of 25% within 5 years.


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To divide it that way helps identify that the main source of saving is in the lower coupon owing to the guarantee provided by the EFSF. The savings of the buyback per se are relatively modest. If a buyback were launched, the market-clearing price would almost certainly not be close to current market prices (of around 50). Instead, it is likely to be closer to par.

If the EFSF or the Greek government were to offer a buyback (subject to a minimum participation threshold), investors would demand a price that would be at least as high as the one of keeping the bonds. Under the assumption of a 6.75% yield post buyback, the price of an average Greek bond would be 90.5. This implies that the EFSF or the Greek government would need to pay creditors c.EUR90 on average for each EUR100 of face value. This would imply a debt reduction of c.10%. One could argue that the yield post buyback may be even lower than 6.75% as European authorities would have shown limited willingness to let Greece default, suggesting a buyback price even above 90. The bottom line is that buyback operations would result in a debt reduction of 10% or less, providing very little debt relief. Alone, that can’t restore solvency, in our view (Figure 8).

Debt buybacks alone would not work, as investors would

demand a price that would be at least as high as what they would

obtain by holding out. Thus, it would provide very little

debt relief.

Figure 8: Buybacks alone would not work without further EFSF support (public debt-to-GDP, in %)

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This implies that the main debt relief of the bailout proposals don’t come from buying back the debt but instead from receiving a subsidy from the EFSF in the form of much lower coupons for Greek risk.

However, such a form of FBO would face legal and political challenges. On the legal front, a FBO would have to be mindful of Art. 125 of the Lisbon Treaty. Specifically, a bailout cannot be done by assuming all the liabilities or guaranteeing all the liabilities of the Greek sovereign. Instead, we argue that it could be done by the EFSF providing a long-term loan to Greece to buy back its debt.5 This would however require that the enlarged lending capacity of the EFSF to EUR440bn effective lending receives approval from the Eurogroup. Under current EU plans, a new three-year programme to Greece of c.EUR120bn is likely to be provided by September 2011 (in addition to the EUR32.8bn of EU bilateral loans committed

Any form of bail-out must be mindful of Art. 125 of the Lisbon

Treaty. Hence, a viable option for a full bailout would be a long-term loan to Greece from the EFSF at reduced rates to buy

back its debt.

5 “The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”


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and yet to be disbursed). Assuming PSI of c.EUR25bn and privatization receipts of EUR10bn, the plan would require c.EUR85bn from the EFSF. In total, this implies that the EFSF would have EUR311.3bn of free lending capacity left to engage in a FBO of Greece (ie, EUR440bn-85bn-43.7bn; there are EUR43.7bn commitments to Ireland and Portugal). Alternatively, a plan B that implies a FBO of private sector creditors to Greece could be implemented instead of the new three-year programme. The cost of a full bailout would be close to EUR270bn as indicated.6 Pursuing an EFSF-funded FBO would probably make another top-up of the EFSF effective lending capacity necessary in order to have a credible residual back-stop in place

s to be by far the base scenario, even if the haircut is small. We examine restructuring next.

e

contagion are also crucial and should be deployed along with the 7

associated with sovereign restructuring and contagion. We look at these issues in detail.

should another euro area member country request support.

More importantly on the political front, we believe there is no European appetite for a FBO of private sector creditors to Greece without PSI. In recent months, there has been clear indication by policymakers in several European countries of limited additional support of Greece and, if anything, this support would need to be flanked by some form of PSI. The most prominent examples have been Austria, Finland, the Netherlands and Germany, which

Politically, it would be difficult to implement a full bailout without

n sharing by private sector creditors. This makes debt

ucturing the base scenario,

burde

restreven if the haircut is small.

much the EU ato “subsidize” it.

is why the French proposal for private sector involvement was launched (see Box 1 above).

The bottom line is that the EU and Greece would really need to be willing to accept default as an option. If that is the case, debt restructuring ha

Debt restructuring It is clear from the previous section that politically it would be difficult to implement a FBO of the private sector. A more likely outcome would be one that entails private sector involvement (PSI). However, as we have argued above in the context of the French PSI proposal, a truly voluntary exchange, with sufficient NPV losses to restore solvency and substantial private sector involvement is a “quasi-impossible trinity”, which is why wbelieve that an orderly debt restructuring would be the most feasible and likely scenario.

The size of the NPV loss in a restructuring is a function of how much European authorities decide to subsidize it. We think that a “subsidized” restructuring could be the preferred (and most effective) alternative by European policymakers as it would achieve two objectives: it would maximize the probability of success AND reduce/eliminate the increase in spreads to the rest of the periphery. The latter would be achieved as investors are likely to react much more positively to a restructuring with perceived fair burden sharing with the public sector. Measures to mitigate

The size of the NPV loss for bondholders in a restructuring

scenario would depend on how uthorities decide

restructuring plan.

Along those lines, assuming that a restructuring is unavoidable, policymakers need to decide on: 1) the timing of restructuring; 2) the amount of debt relief and the extent of burden-sharing to close the solvency gap; and 3) operational aspects in the implementation of a restructuring. Some of the key implementation aspects entail mitigating the risks

The timing of restructuring

The optimal timing to restructure Greek debt is unknown. If Greece was taken in isolation, the optimal timing to restructure would probably be soon. In the past we had argued that it was

6 Additional EFSF funds (c.EUR15-20bn) may be needed to cover fiscal deficits from mid 2013-2014, which would not have been covered under the current programme. 7 Solving the coordination problem will also be crucial to the success of the restructuring. The higher the participation rate (everything else equals), the more likely the restructuring would be comprehensive and hence the lower the exit yield. At the same time, the lower the exit yield the higher the recovery value and the higher the participation rate.


11 July 2011 12

necessary to understand how much fiscal adjustment Greece could do before deciding on solvency. This is no longer relevant. To postpone would only exacerbate the costs associated

that Greece is insolvent. Hence, contagion remains the most

EFSF. This would reduce the debt service burden and improve

’s (4 notches down) is

ould allow financial institutions to maintain the exposure in their

my and the largest bond market, which

ply and investment

likely trigger rating doand CDS.

insolvencyof risk and contagion

with the "debt-overhang" and the economic system implosion due to the debt burden.

But Greece cannot be considered in isolation. Contagion fears to Portugal and Ireland, and to some extent to Spain, have been the dominant factor guiding the EU’s decision to continue funding Greece over the past 18 months. The uncertainty about whether Greece was solvent was another reason to postpone this. This latter factor is less relevant as most investors have concluded important decision factor.

a) Why restructuring could make contagion worse:

A partial bailout of Greece may be a catalyst for similar requests by Ireland and Portugal. While we consider that neither Portugal nor Ireland are likely to voluntarily embark on a sovereign restructuring following Greece’s default, it is likely that both countries would demand a partial EU bailout, especially if Greece gets one. For example, Portugal and Ireland may demand that the maturity of EU loans be further extended and rates be cut. With EFSF funding itself at less than 10bp over mid-swap, there is space for reduction of at least 200bp on current rates charged by

Restructuring of Greece debt may face similar requests by

Portugal and Ireland, and would wngrades

solvency of both countries.

Downgrades by rating agencies of other periphery countries are more likely following a Greek restructuring. The recent downgrade of Portugal by Moodybased on the premise that Portugal is heading down Greece’s path.

Another source of contagion is the direct exposure of financial institutions to GGBs and sovereign CDS. We have addressed these issues at length in Implications of Greece restructuring for banks and CDS, 3 June 2011. Suffice to say that while the costs for financial institutions are not negligible, we consider them manageable and unlikely to put systemically important institutions at peril. In the event of restructuring, avoidance of haircuts to the principal may help to mitigate the immediate need for bank loss impairment and recognition, which wHeld-to-Maturity books.

b) There are also important factors that could mitigate contagion:

To the extent that a significant factor behind the widening in spreads is contagion, addressing Greece’s solvency problem (instead of a piecemeal approach that only postpones the inevitable) can be a stabilizing force for other periphery countries. This is particularly relevant for the systemically important countries, Spain and Italy, which are fundamentally stronger than Greece. The risk of persistently high spreads for these economies is too costly for them and for the stability of the euro area. It is the recent rapid widening of Italy, the third largest euro area econo

However, addressing Greece may resolve a source

has brought contagion to the centre of the debate.

Besides the direct impact of contagion on the sovereign, contagion also has a significant impact on the funding costs of financial institutions. Profitability is a key concern, as margins are further squeezed. Deposit wars are still ongoing in Spain and are becoming a threat in Italy as well. More generally, elevated sovereign spreads add pressure on financial and nonfinancial corporates, putting downward pressure on credit supdecisions, thereby creating a negative-feedback loop into the economy.




11 July 2011 13

In sum, it is not clear whether contagion will increase or reduce uncertainty and, consequently, there is no obvious “optimal timing” in our view. But regardless of the eventual timing, it is absolutely necessary to be prepared for a plan B. A pre-emptive plan B reduces the possibility of being rushed by political or market events into last minute decisions. The elevated contagion risks make it critical not only to address Greece insolvency, but also to prepare a more comprehensive plan aimed at mitigating contagion. We spell out the ingredients of

ppens to

50 cents to the euro)

ry balance of c. 2.5% of GDP), a debt reduction of about EUR200bn (nearly 60%

k banks and the ECB.9 Bondholders would have to provide (in net

t suffer from contagion.

the comprehensive plan in the next two sections.

The amount of debt relief and “fair” burden sharing

The next step is to decide how the debt relief is shared between bondholders and the official sector. Policymakers need to strike a balance. On the one hand, the larger the haircut on bondholders, the more likely that deal will be perceived as unfair and the higher the impact on spreads of other periphery economies. On the other, domestic constituencies in EU countries need to recognize there was sufficient PSI to support a partial bailout. Interestingly, a solution with a haircut on bondholders close to market prices hadeliver a nearly 50-50 split in terms of burden sharing between bondholders and official creditors and thus could be considered “fair burden sharing”. Here are the details:

Burden sharing between bondholders and official creditors can help to restore solvency: an offer close to (or marginally above) current bond prices (of around

A deof the

(c.EUR200bn) is needed torestore solvency…

c50) would

between(EUR100bn) and official creditors

(EUR100bn).

bt reduction of nearly 60% stock of Greek debt

… and a solution with a haircut of Greek bonded debt close to urrent market prices (of about

deliver a nearly 50-50 split in term of burden sharing

bondholders

would help to restore solvency together with a partial bailout from the public sector. To see how this is the case we use again the debt sustainability framework.

In our medium-term baseline scenario (3% nominal growth, 6.75% average interest rate, and a primaof outstanding debt) would be needed to reduce debt-to-GDP to about 60% of GDP in the long term.

The current outstanding bonded debt is of c. EUR270bn (excluding T-bills), therefore a 50% haircut (as implied by current market prices) would yield c.EUR135bn debt reduction, leaving EUR65bn for the EU to contribute. There are two caveats to this. First, note that c. EUR35bn of the outstanding debt (excluding T-bills) are probably held by Greek banks, and any haircut imposed on these institutions would require a recapitalization from EU funds. Second, a similar argument can be made for the ECB holdings of GGBs (c.EUR45bn), as it might require recapitalization by EMU member countries.8 Alternatively, one could first take the ECB out of its current exposure to GGBs through purchases from the EFSF, as this would not change the net cost of a restructuring for the official sector but avoid a situation where the ECB could end up undercapitalised. Thus, effectively, the EU would need to contribute c. EUR100bn of debt relief: the remaining EUR65bn (EUR200bn-EUR135bn) plus c.EUR35bn for recapitalization of Greeterms) EUR100bn. In sum, bondholders and official creditors would split the bill, arguably a politically viable solution.

Instead it could also be argued that the c.EUR200bn debt reduction required to restore solvency might be extracted entirely from the outstanding bonded debt without further official sector burden sharing. In that case, the debt reduction required on bonded debt is of c.2/3 and the recovery values would fall to 28 cents to the euro (Euro Themes: Greece: The (long) countdown to restructuring, 11 May 2011). Yet, that solution could be perceived as overly punitive and spreads in other periphery countries migh

8 While the ECB has sufficient reserve and capital and may not require recapitalization after a Greek restructuring, EMU countries may prefer the ECB not to take the losses. 9 Note that both the ECB and Greek banks may have purchased some of the bonds below par.




11 July 2011 14

Instead, a haircut on bondholders close to market prices (arguably largely discounted by the markets) delivers a 50-50 split between the EU and bondholders.

Figure 9: Restructuring options also work, including burden sharing between private and public sector (public debt-to-GDP, in %)

60

120

180

240


02000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Burden sharing: bonholders 50% haircut + EFSF loan at 3% rateCreditor pain: 2/3 reduction in bonded debt


To facilitate an orderly outcome, and consistent with previous restructurings, we consider that alternative options can be offered to investors in order to impose a 50% NPV haircut on bonded debt. For example, there may be a zero (or very low) coupon par bond without haircut on the notional claim. Indeed, options that avoid notional haircuts and instead consider maturity extensions and lower coupons may be the preferred choice for those institutions keeping Greek bonds on their hold-to-maturity books. In addition, there may be

nds

operational for Greece? A comprehensive plan

we would implement in practice a comprehensive plan to address contagion and Greece insolvency:

national financial

extended: 1) to conduct secondary market purchases of sovereign bonds; and 2) to create a new liquidity line (FCL-type of facility) aimed for countries that are solvent and without systemic imbalances but that may face temporary liquidity problems. 10

10 In the event of contagion to systemic countries, we presume that the ECB could and would resume its SMP programme. Markets would then

a discount bond with higher coupons but with a haircut on the notional claim. Those bomay need to have a similar price at the suggested exit yield. Other options, such as bonds with step-up coupons, GDP kickers, etc, are also likely to be considered.

How to make debt restructuring

Mitigating contagion risks is as important (if not more) as addressing Greece’s insolvency problem. Here is how

Several measures should aim at addressing contagion to other sovereigns and to the financial system:

First, the Greek and European governments, jointly with the interinstitutions, the EC and the ECB, would publicly emphasise the rationale for the restructuring with a view to explaining that the situation in Greece is more challenging than in Portugal or Ireland, and notably more so than in Spain and Italy.

Second, as we have argued previously (see Euro Themes: Growing out of the crisis) the scope of the EFSF should be

face two large-scale official potential buyers of European government bonds, which in turn should help contain contagion in the EGB market.

impoptions that avoid notional

haircuts and instead consider matu

address Greece insolvenalso include measures to mitigate contagion risk

including…

…enhancing the scope of the

EFSF…

Alternative options can be offered to bondholders to

ose a 50% NPV haircut; eg

rity extensions and lower coupons may be preferred.

A comprehensive plan to cy must

s,


11 July 2011 15

Third, the ECB would need to “enhance” its liquidity facilities for Greek banks because these banks would lack sufficient repo-able assets post restructuring. This facility would also be made available to other banks in the periphery. As we discussed in previous reports (eg, Greece: The (long) countdown to restructuring), a new facility for addicted banks could be set up with new rules: 1) a broader set of qualifying collateral; 2) a revised haircut policy; and 3) different rates on repo operations. The new liquidity facility would be in place at least as long as the EU-IMF programme. Also, as a pre-cautionary measure, the ECB would temporarily re-introduce fixed-rate (over 3M) LTRO operations with a view to reducing the potentially destabilising influence a Greek restructuring could have on the European banking system.

…enhancing the scope of the ECB liquidity facilities…

Fourth, the EFSF loan charges should be generally reduced to or to only marginally above EFSF funding. This would significantly ease debt service payments for Greece as well as for Ireland and Portugal on debt owed to the official sector and, thus, improve solvency without incurring any additional costs to EU taxpayers. It would also provide additional incentives to Ireland and Portugal to adhere to their respective adjustment programmes.

…reducing EFSF lending rates…

Fifth, liquidity in the EGB markets, especially in Spain and Italy, must be ensured, including through coordinated intervention in the secondary markets by the EFSF and ECB as needed. On the positive side, exposures of Spanish and Italian FIs to Greece or to Ireland and Portugal are very limited. Exposures by other EMU FIs to Greece, Portugal and Ireland are also better understood by the markets thanks to enhanced disclosure. While losses from restructuring would require recapitalization of several FIs, in our view, these are manageable because: 1) systemically important FIs can absorb the losses by themselves; 2) those FIs that cannot are either in countries that can recapitalize their FIs or are not systemically important FIs; 3) in the event of restructuring, avoidance of haircuts to the principal may help to mitigate the immediate need for bank loss impairment and recognition, which would allow FIs to maintain the exposure in their HtM.

…coordinating action between EFSF and ECB to address liquidity

concerns in the EGB market…

EFSF would provide a long-term loan (20y) of c. EUR150bn to the Greek government at a rate of c. 3% similar to EFSF’s funding costs. Simultaneously, the EFSF would need to issue debt to fund the loan to Greece. The EFSF would also buy the ECB’s debt holdings of GGBs (c. EUR45bn) at a price that implies no loss for the ECB (c. 85-90 cents to the euro). In this case, the EFSF would incur the losses of the restructuring process. Alternatively, the EU would have to recapitalize the ECB through the ESCB by a similar amount to the losses imposed in the restructuring (in terms of costs for the EU, both are equivalent).

The Greek government would offer a buyback of all the outstanding debt stock (EUR270bn, excluding T-bills) at about 50 cents to the euro, with a clear indication that bondholders who choose not to participate would not get any better deal going forward (ie, a coercive offer). This should induce nearly full participation by bondholders, with the possible exception of international bonds (EUR18.6bn).

With part of the loan from the EFSF the Greek government would need to recapitalize Greek financial institutions (banks, insurance and pension funds) by an amount similar to the haircut imposed on the banks’ holdings of EGBs (excluding the T-bills).

Greece would remain under an EU/IMF programme with conditionality at least through end 2014 and possibly longer (until Greece is able to reach and sustain a primary balance of at least 2-3% of GDP), with a view to focusing on a growth-enhancing strategy to improve competitiveness.



11 July 2011 16

Note that a financially similar strategy is for the EFSF to give a loan to Greece. Greece then can buy EFSF bonds and offer Greek bondholders an exchange of current GGBs for EFSF bonds, where the bond exchange entails a 50% NPV haircut on bondholders. Again, the offer would entail a forced participation by bondholders, as tendering would be the dominant strategy (ie, holding out would entail further losses relative to accepting the offer). A coercive offer would trigger default downgrades by the rating agencies and would very likely result in a trigger of Greece CDS, as we discuss more fully in our 3 June report (Implications of Greek restructuring for banks and CDS).



11 July 2011 17

Appendix A: Who owns Greek debt The holdings of Greek debt are quite concentrated. The top 10 names account for 50% of holdings, and the top 30 for 70%.

Figure 10: Top holders of Greece debt

Rank Country Industry Name Bonds and bills (€ bn)

Loans (€ bn)

Cumulative bonds holdings (€ bn)

Cumulative % of bonds

Cumulative debt (€ bn)

Cumulative % of debt As of

1 Euro Official Eurosystem SMP* 45.0 - 45 16% 45 13% Q1 11 2 Euro Official EU loans 38.0 45 16% 83 23% Q1 11 3 Greece Official Greek public sector funds 30.0 - 75 26% 113 31% Q1 11

4 SWF Official RoW official institutions (probably 3-5, Asia)* 25.0 - 100 35% 138 38% Q4 09

5 IMF Official IMF loans 15.0 100 35% 153 43% Q1 11 6 Greece Bank National Bank of Greece 13.2 5.4 113 40% 172 48% Q1 11

7 Euro Official Euro area NCBs (BoG, BdF, BoP, BoI, etc)* 13.1 - 126 44% 185 51% Q4 09

8 Greece Bank Eurobank EFG 9.0 - 135 47% 194 54% Q4 10 9 Greece Bank Piraeus (net) 8.0 - 143 50% 202 56% Q1 11 10 Germany Official FMS (ex Depfa/Hypo Real Estate) 6.3 - 150 52% 208 58% Q4 10 11 Greece Official Bank of Greece legacy loans 6.0 150 52% 214 59% Q1 11 12 France Bank BNP 5.0 - 155 54% 219 61% Q4 10 13 Greece Bank ATE 4.6 - 159 56% 224 62% Q4 10 14 Greece Bank AlphaBank 3.7 - 163 57% 227 63% Q1 11

15 Bel/Lux/France Bank Dexia 3.5 - 166 58% 231 64% Q4 10

16 Greece Bank Hellenic Postbank 3.1 - 169 59% 234 65% Q4 10

17 Italy Insurance company Generali 3.0 - 172 61% 237 66% Q4 10

18 Germany Bank Commerzbank 2.9 - 175 62% 240 67% Q4 10 19 France Bank Societe Generale 2.9 - 178 63% 243 67% Q4 10 20 Greece Bank Marfin 2.3 - 180 63% 245 68% Q4 10

21 France Insurance company Groupama 2.0 - 182 64% 247 69% Q4 10

22 France Insurance company CNP 2.0 - 184 65% 249 69% Q4 10

23 Greece Bank Bank of Cyprus 1.8 - 186 65% 251 70% Q1 11

24 Germany Bank Deutsche Bank/Deutsche Postbank 1.6 - 188 66% 252 70% Q4 10

25 Germany Bank LBBW 1.4 - 189 66% 254 70% Q1 10 26 Netherlands Bank ING 1.4 - 191 67% 255 71% Q1 11

27 Germany Insurance company Allianz 1.3 - 192 67% 256 71% Q4 10

28 France Bank BPCE 1.2 - 193 68% 258 72% Q4 10

29 Belgium Insurance company Ageas 1.2 - 194 68% 259 72% Q1 11

30 France Insurance company AXA 1.1 - 195 69% 260 72% Q4 10

31 UK Bank RBS 1.1 - 197 69% 261 73% Q4 10 32 Germany Bank DZ Bank 1.0 - 198 69% 262 73% Q4 10 33 Italy Bank Unicredito 0.9 - 199 70% 263 73% Q4 10 34 Italy Bank Intesa San Paolo 0.8 - 199 70% 264 73% Q4 10 35 Austria Bank KA Finanz 0.8 - 200 70% 265 73% Q4 10 36 UK Bank HSBC 0.8 - 201 71% 265 74% Q4 10 37 Austria Bank Erste Bank 0.7 - 202 71% 266 74% Q4 10

38 Germany Insurance company Munich Re 0.7 - 202 71% 267 74% Q1 11

39 Netherlands Bank Rabobank (gross)* 0.6 - 203 71% 268 74% Q4 10 40 France Bank Credit Agricole 0.6 - 204 71% 268 74% Q4 10 41 Belgium Bank KBC 0.6 - 204 72% 269 75% Q4 10 Others 80.7 10.6 285 100% 360 100% Total 285.0 75.0 285 100% 360 100%

Note: this is not including some of the asset management companies, which may have some exposures above €500mn. Source: Barclays Capital, Greek Top 40 and the ‘voluntary’ question, 16 June 2011




11 July 2011 18

Appendix B: The math of debt dynamics We know from that the evolution of the debt-to-GDP ratio in a given period T (D/Y)T when we have non-constant growth, primary balance and interest rates are:

dspbdvgrdvgrYD

YD

sT

svv

Tvv

T∫ ∫∫ −−−⎟

⎠⎞

⎜⎝⎛=⎟

⎠⎞

⎜⎝⎛

000

))(exp())(exp(T

(a.1)

where r and g are nominal interest and growth rates, respectively. We can also assume that the country can borrow at a marginal rate r1.

The existing stock of debt has an average coupon r0 with average maturity T0. This means that at every period (and for T0 periods) my existing debt has interest payments of:

00 ⎟

⎠⎞

⎜⎝⎛

YDr

However, new debt borrowing comes at a cost r1, different from r0. Assuming g=0, this means that the exiting debt will be growing until T0 according to the following equation:

01

01

00

001

000

)1)(exp(

))(exp(0

⎟⎠⎞

⎜⎝⎛+−

⎟⎠⎞

⎜⎝⎛

⎟⎠⎞

⎜⎝⎛+−⎟

⎠⎞

⎜⎝⎛∫

YD

rTr

YDr

YDsTr

YDr

T

Which then will keep growing from T0 onwards at rate r1:

⎥⎦

⎢⎣

−−+⎟⎠

⎜⎝

)(exp()1()exp( 011

110

TTrr

TrrY

⎤⎡⎞⎛

−⎥⎦

⎤⎢⎣

⎡⎟⎠⎞

⎜⎝⎛+−

⎟⎠⎞

⎜⎝⎛ )(exp()1)exp(

00

0101

01

00

rrD

TTrYD

rTr

YDr

)exp(0∫−T

sdsg

DY

Since GDP growth will (generally) be non-zero, the expression above will need to be multiplied by the increase in GDP:

Equation (a.1) then becomes:

⎛ ⎝ ⎜

⎞ ⎠ ⎟

T

= DY⎛ ⎝ ⎜

⎞ ⎠ ⎟

0

exp(−gT )( r1 − r0

r1exp( r1T )) − exp( (rv − gv )dv )

s

T∫0

T

∫ pbsdsexp( r1(T − T1)) + r0

r1

And assuming an initial period of 4 years before steady state is reached in terms of primary balance (pb) and growth (g):


11 July 2011 19

( ) ( )( ) ( )

( ) ( )( )( )( )14expexp

expexpexp

4

11

011

1

01

0

−−−−⎟⎞⎜⎛ −−

⎟⎟⎠

⎞⎜⎜⎝

⎛+−−−⎟

⎠⎞

⎜⎝⎛=⎟

⎠⎞

⎜⎝⎛

∫ ∫ Tgrpbdpbdvgr

TrrrTTr

rrrgT

YD

YD

T

T

11

0 −⎠⎝ grsss vv

( ) ( )( ) ( )

( ) ( ) ( )( )( )( )14expexpexp 11

4

0 4 1

4

110

−−−−

−⎟⎠⎞⎜

⎝⎛ −⎟

⎠⎞⎜

⎝⎛ −−

⎠⎝⎠⎝⎠⎝

∫ ∫∫ Tgrgr

pbdpbdvgrdvgr

rrYY

ss

T

ss vv

T

expexpexp 10

1101

⎟⎟⎞

⎜⎜⎛

+−−−⎟⎞

⎜⎛=⎟

⎞⎜⎛ TrrTTrrrgTDD

( ) ( )( ) ( )

( )( )( ) ( ) ( )( )( )( )14expexp3exp

expexpexp

11

4

0

4

1

11

011

1

01

0

−−−−

−⎟⎠⎞⎜

⎝⎛ −−−−

⎟⎟⎠

⎞⎜⎜⎝

⎛+−−−⎟

⎠⎞

⎜⎝⎛=⎟

⎠⎞

⎜⎝⎛

∫ ∫ Tgrgr

pbdpbdvgrTgr

TrrrTTr

rrrgT

YD

YD

sss vv

T

This equation allows us explore the impact of the different alternatives:

A debt exchange (Figure 3) is equivalent to changing the coupon on existing debt (r0) and increasing the average duration of the debt (T0).

A debt rollover at the existing coupons (Figure 4) is equivalent to increase T0.

A full bailout (Figure 7) implies reducing r0, increasing T0 and reducing the debt-to-GDP ratio by a factor (determined by the difference between par and the price of the existing debt at a yield higher than the coupon on old debt).

A pure buyback (Figure 8) implies reducing the debt-to-GDP ratio by a factor determined by the savings of buying existing debt at exit yields above current coupons.

A debt restructuring (Figure 9) also implies a combination of reducing the stock of the debt (D/Y), the interest rates on the debt (r0) and lengthening the maturities (T0).

Analyst Certification(s) We, Piero Ghezzi, Antonio Garcia Pascual and Frank Engels, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

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This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital. In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. 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This material is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as defined by the DFSA, and Business Customers as defined by the QFCRA. This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. This material is distributed in India by Barclays Bank PLC, India Branch. This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles Quay Level 28, South Tower, Singapore 048583. Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined by Australian Corporations Act 2001. IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. © Copyright Barclays Bank PLC (2011). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.

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