Today I thought I would run through a couple of outstanding areas of concern with the latest Greek bailout.
As I have discussed previously, there are a number of “technical” steps that need to occur before this deal is actually done. These include EFSF issuances and parliamentary approvals from various countries including Germany. As we saw in Tuesday’s Euro Group statement the deal is held together with quite a few interconnected agreements:
It is understood that the disbursements for the PSI operation and the final decision to approve the guarantees for the second programme are subject to a successful PSI operation and confirmation, by the Eurogroup on the basis of an assessment by the Troika, of the legal implementation by Greece of the agreed prior actions. The official sector will decide on the precise amount of financial assistance to be provided in the context of the second Greek programme in early March, once the results of PSI are known and the prior actions have been implemented.
The current agreement for the PSI appears to be a nominal write down for bond holders of 53.5% which is approximately 74% net present value. The issue is that the IMF’s involvement in the deal is subject to Greece entering into the bailout under the premise that debt to GDP will be around 120% as of 2020, about what Italy’s is today ( not that this is a coincidence). However, as the IMF ‘s own Debt Sustainability Report states, this is based on a quite a few optimistic assumptions including a private sector participation rate of 95%:
Private sector involvementThe assumptions about PSI now incorporate the design now in the process of being agreed between Greece and the IIF-led creditor group: (i) a reduction in the nominal value of eligible Greek government bonds by 50 percent (15 percent paid upfront in EFSF short-term notes, with the remaining 35 percent exchanged into 30-year bonds amortisable after 10 years); (ii) couponsof 3 percent in 2012-20 and 3 ¾ percent from 2021 onwards; (iii) a GDP-linked additional payment (capped at 1 percent of the outstanding amount of new bonds); and (iv) a co-financing structure with the EFSF concerning the 15 percent upfront payment. The pool of debt for the debt exchange has also been updated (although an exemption for retail investors, now under consideration by the authorities, is not assumed). The creditor participation rate is assumed to be 95 percent.
But 95% is not the voluntary target set out by the Greek government according to the Wall Street Journal:
The Greek government is aiming for a minimum participation of least two-thirds [66%] of bond holders in a planned debt exchange, a finance ministry official said Tuesday, with a formal offer on the exchange expected to take place by the end of this week.
However, even 66% is a little confusing when you consider the following from Reuters:
If Greece can get the go-ahead from about two-thirds of private creditors, it plans to pass laws to coerce reticent bondholders, like the hedge funds, into taking losses, sources have told Reuters.
To counter this, some hedge funds are going for defensive strategies and buying up some of the 18.3 billion euros of Greek bonds that were drawn up under English or foreign law, industry and legal sources said. These would be immune from any changes to Greek law.
The English law bonds do contain so-called collective action clauses designed to force outliers into a deal — but they state Greece would have to get 75 percent of creditors to back a deal, most likely higher than the threshold Athens would impose in domestic law bonds in its bid to get a deal done.
They also contain precise clauses that could help hedge funds sue or eke out a settlement if they are forced into an unfavourable bond swap.
That last line sounds a lot like a “negative pledge clause” which makes me wonder if the recent ECB swap agreement haven’t already been triggered. That point aside, my understanding is that there is a percentage of bonds issued under foreign law after 2004 that require at least 75% of bond holders to consent to a deal for it to be binding under collective action, and therefore 66% is not enough to bind these bonds.
The rating agencies also recognise the difference between the two classes of bonds as shown in a recent ruling by S&P on retrospective collective action:
In the case of the Greek parliament passing legislation that would permit the amendment of Greek-law governed outstanding sovereign debt issues to retroactively include CACs, we would lower the issue ratings on debt issues concerned to ‘D’ from ‘CC’. For non-Greek-law governed sovereign debt issues unaffected by any change in Greek law, we would maintain our issue ratings on such non-Greek-law governed issues at ‘CC’, but subsequently lower the issue ratings to ‘D’ if and when they became eligible for the upcoming debt exchange
So the first question is obviously is why isn’t Greece targeting 75%? And secondly will they get it ? What does Charles Dallara, managing director of the International Institute of Finance (IIF) and the chief negotiator for private creditors , have to say about this? (click on image for video ):
The answer to the questions appears to be “hopefully yes”, but that still doesn’t answer the question why Greece would only be targeting the lower rate. Second to that, even if they do get above 75% it doesn’t appear that this will satisfy the IMF. So without a very high percentage of voluntary involvement Greece will be forced to use collective action across all bonds.
According to recent ISDA statements this means:
The possibility of retrospectively applying Collective Action Clauses (CACs) to existing Greek debt has been discussed of late. Would the inclusion or activation of a CAC trigger a Credit Event?
The determination of whether any action constitutes a credit event under CDS documentation will be made by ISDA’s EMEA Determinations Committee on the basis of the specific facts and if a market participant requests a decision from the DC. Generally, however, the inclusion of a CAC would not, in and of itself, be expected to trigger a Credit Event. On the other hand, the use of such a clause to effect a reduction in coupon or principal or one of the other events set out in the definition of the Restructuring Credit Event could trigger if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt.
I guess we’ll find out if that actually means anything over the coming days.
The other big issue I see is that the Greeks populace, justifiably in my opinion, are likely to slowly-but-surely push against the deal.
Under the conditions of the bailout Greek politicians have agreed to be placed under permanent fiscal surveillance along with the implementation of an escrow account to service its debts. This includes an an agreement enshrined in law to guarantee repayments to creditors over payments to the country itself.
In addition the government has agreed to more spending cuts worth 1.5 percent of GDP this year. This includes 1.225 billion euros of cuts from health spending, 300 million euros from public investment, 400 million euros from the defense budget, 425 million from pension cuts and 400 million from the central government. After the elections in April, the new government is also expected to outline additional austerity measures of approximately 10 bn Euro over the 2013 – 2015 period.
These changes are in addition to the already agreed 22% reduction in minimum wage, abolishment of automatic pay increments labour agreements, lowering of social security payments, and the staged reduction of the public service by 150,000 workers over 4 years.
We have already seen a significant rise in Greek unemployment, a rise in suicides and stories of hospitals not being able to provide adequate medical care for patients.
Basically the deal is setup so most of the bailout money is simply recycled to creditors while the Greek populace continue to suffer from austerity based policy that has already subjected them to 5 years of recession, now depression. It is no wonder that recent opinion polls show a significant weakening in the ruling parties popularity and a rise in the hard Left.
Will the Greeks take another 5 years of this? I’m doubtful, and given the very large risk of continued fiscal slippage, as already identified by the IMF, I am also doubtful the official sector creditors believe it either.
However, at least for now, even the struggling ones appear to be willing to pay the price for continued failure.
Spain will provide about 15,000 million for the rescue of Greece. The Minister of Economy and Competitiveness, Luis de Guindos, explained today that Spain will contribute about 12% of second bailout for Greece , while the Bank of Spain will allocate another 1,000 million euros to forego the benefits of Hellenic bonds that have portfolio. “In the case of Spain, to us to just under 12% of the 130,000 million euros, because it is the weight of Spain [in the Eurosystem] leaving out countries that are on a rescue plan”, ie , the very Greece, Portugal and Ireland.