Greek bailout depends on debt swap take-up

Greece will only start to receive a second €130bn bailout, agreed in the early hours of Tuesday morning by eurozone finance ministers, if private sector investors agree to a tougher than expected haircut of 53.5% on their existing €206bn nominal holdings of Greek Government Bonds.

In its statement the Eurogroup said: “A successful PSI [private sector involvement] operation is a necessary condition for a successor programme.” The Greek finance ministry agreed and said the full terms of the transaction would be set in memorandums “expected to be made available in the coming week”.

The last minute changes were given a lukewarm welcome by the IIF steering committee, which said that the key terms of the voluntary exchange would have to be put to its wider committee of 32 institutions.

The deadline for accepting the debt swap, which theoretically would reduce Greece’s debt by €107bn, thus becoming the largest ever sovereign debt restructuring, is anticipated to be March 8. That would give enough time to avert the country from defaulting on a €14.4bn bond which comes due for repayment on March 20.

“The second package depends on a successful PSI, which will be launched in a few days,” said David Mackie, European Economist at JP Morgan. “Most of the money in the second package is front loaded because it is related to the PSI.”

However, the accompanying conditions of the bailout, whilst tough, still leave Greece in control of its own destiny. This may prompt the country’s more radical politicians, if they come to power, to consider leaving the eurozone once Greece has reached a primary fiscal surplus, envisaged by 2013.

“Once Greece reaches a balanced primary position, which we anticipate will occur next year, the rest of the region loses considerable leverage over the country,” said Mackie. Before then, “the new Greek government could refuse to follow through on its commitment to generate a sizeable primary surplus and to continue with the reform program.”

Leaving the euro would lead to an effective devaluation and ease the day-to-day pain on the populace, who have now endured two years of austerity measures. However, that still leaves open the possibility that other countries could also ultimately split from the single currency.

Revised PSI terms

The central pin of the deal remains the plan to offer Greece’s private sector bondholders the opportunity to swap their holdings for a package of new instruments with a nominal value of just 46.5% of the old bonds’ par value. Around €206bn is outstanding.

Originally, under an agreement last October private sector bondholders, via their representatives at the Institute of International Finance, agreed to a 50% haircut, so the latest deal, apparently only agreed this morning, is a worse outcome for them.

The new package consists of 15% in bonds of up to two years maturity issued by the European Financial Stability Facility and 31.5% in new Greek bonds that will mature over 20 years from 2023 in annual chunks of 5%.

The new bonds will pay a coupon of 2% annually for the three years until February 2015, then 3% for the following five years to February 2020 and 4.3% until the final maturity in February 2042. The weighted average coupon for the first eight years is 2.6% and for the full period 3.65%.

Again that is less than originally envisaged and will mean the effective value of the new instruments may be as little as 75% of the original bonds held. However, investors will also be offered strips of securities linked to Greece’s GDP growth that could enhance the yields by 1%.

Any accrued interest on existing bonds eligible for the bond swap, previously estimated at €5.5bn, will be paid in EFSF 6-month notes. The new instruments will be governed by English law and rank pari passu “with all borrowed monies of the Hellenic Republic”.

That should give protection from any separate deals the official sector might cut with Greece in the future and provides the model of a classic emerging markets debt restructuring for any future negotiation. This would normally see official creditors discuss any deal at the Paris Club first.

The last minute changes were given a lukewarm welcome by the IIF steering committee, which said that the key terms of the voluntary exchange would have to be put to its wider committee of 32 institutions.

The steering committee, led by BNP Paribas’ Jean Lemierre, said the new offer built upon and was “broadly consistent with the voluntary agreement reached…on October 27”. If successfully carried out it would cut Greece’s debt by €107bn.

However, although the exchange is expected to be launched this week, some eurozone parliaments will need to ratify the agreement. Germany’s will vote on Monday, February 27 for instance and the Dutch on February 29.

Retroactive CAC’s

Legislation is also to be proposed this week by the Greek parliament to introduce collective action clauses, retroactively, on existing Greek bonds. These could be used to coerce investors holding out from any offer to be rolled in. But as long as they are not used the swap will be voluntary.

Greek banks, most of whom are on the IIF committee, will have little option but to accept the offer if they are to receive up to €50bn of support to recapitalise them via loans given to the Greek Government. Collectively they are the largest holders of Greek government bonds.

To monitor the programme the Eurogroup said the EC would have “an enhanced and permanent presence in Greece”. It also said that Greece itself would hold enough money in a separate account to pay for each quarter’s debt servicing as it comes due.

However, JP Morgan’s Mackie said: “None of these provide a cast iron guarantee that the new program will be implemented in full over the coming years. Hence, the excruciating difficulty of the negotiations in recent weeks.”

The IMF, alongside other Troika members the ECB and EU, will make its final decision on participating in the second bailout once the results of the PSI are known.

Managing director Christine Lagarde said: “As soon as the prior actions agreed with the Greek authorities are implemented and adequate financial contribution from the private sector is secured, I intend to make a recommendation to our Executive Board regarding IMF financing to support a program.”