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Wednesday, March 07, 2012

A credible Greek threat?

The Greek Public Debt Management Agency put out an interesting press release (PR) yesterday. We won’t go over all of it, since it’s been heavily covered in the press, but it did raise one interesting point:
“The Republic’s representative noted that Greece’s economic programme does not contemplate the availability of funds to make payments to private sector creditors that decline to participate in PSI.”
This is widely being seen as a warning to those who hold Greek bonds governed by foreign law and who therefore may be more inclined to hold out due to the extra protection offered under foreign law (they are also subject to higher CAC threshold, meaning CACs are harder to use). Greece essentially says that any bondholder who doesn’t take write downs will be defaulted on (except the ECB).

So, is this a credible threat?

Well, firstly we won’t find out until 11 April since that is the settlement date for foreign law bonds under the restructuring plan.

But more importantly it raises the question of whether Greece could be setting itself up for a second default, at least in technical terms. Let us explain:

Greece will certainly be judged to be in default by the rating agencies after CACs are triggered, but once the bond swap is completed and new bonds are issued it should come out of this rating fairly quickly. Yet, a month later it could again trigger CACs on foreign law bonds. Even worse, it could just leave these bonds and default on them through non-payment as and when payments are due (this could run long into the future). If this constituted another default it would have a negative impact on funding for Greek banks and the stability of the economy - so would be something to avoid.

Ultimately, it comes down to whether the new Greek bonds have ‘cross-default clauses’ in them – which means if Greece defaults on other bonds it will default on these too. From what we can see, the new bonds do not have general cross-default clauses (despite earlier versions of the plan including them), only ones which apply to the new group of bonds which exist after the restructuring.

This makes the threat to default on the remaining foreign law bonds much more credible. It would still be an extreme course of action, but one which looks increasingly attractive given the extra debt relief it could deliver (which Greece will need).

This is something which bondholders would do well to keep in mind if they are planning to try and get paid out in full.


Rik said...

The problem for Greece is that a real default on the foreign law bonds will mean most likely a long rating at default level. And subsequently not allowed as collateral at the ECB. This is solved for the short term by letting the Greek CB do that. But letting the Greek CB doing that longer term will not be undisputed.
This CB is probably already at real value under water and it would mean that it gets pretty deep under water, with all sorts of CBs and the ECB having huge claims on it.

The amount involved is relatively small if I recall it correctly around 10% is foreign law. Minus part held in public hands. Minus part that are held in private hands with arms that can be twisted (like effectively happens with the Greek law bonds). Minus the percentage 30% to be paid as compensation. Leaves a relatively small amount.

Doubtful that the EZ will not come up with this (especially as it is not upfront) and let Greek carry a default rating for the foreseeable future. Iso onbe only for a few months.

Open Europe blog team said...

Thanks for the comment Rik.

It seems to us that, due to the lack of cross default clauses, Greece could actually default on the foreign law bonds (a small percentage as you point out) but still not be in default on its other bonds or its loans to the Troika. It is not certain that the rating agencies would then push Greece back into a default rating. This means these bonds would still be acceptable as collateral at the ECB. That is exactly why we believe the threat of default on the foreign law bond is actually much more credible.

As we note it is still extreme and the eurozone could well come up with the funds to pay off the bonds but the threat is definitely more credible than it may have seemed at first.

Rik said...

Of course it is a bet.
The foreign law bondholder has a choice. He/she has a 40% (roughly) bond,which can be:
a)exchanged against the PSI (so roughly 30% as it is now);
b)sold at 40% (as people prefer foreign bonds clearly over Greek law ones); here also plays possibly the legal issue of the auction risk on Greek law bonds (you donot have Greek bonds left but new ones after the exchange and CAC, which problem is solved with foreign law bonds, possibly part of the explanation of the price difference next to not having to go to a Kangaroo Court);
c)exchange together with CDS.
d) go for it and receive basically either 100% or (possibly) nothing.

At the end it is basically sell now at 40% or wait. As long as prices are higher than PSI remuneration one will always sell.
Leaving the complicated issue of the relation foreign law bonds and CDS (with possibly different conditions aside).

Unlikely that before this PSI is finished we will hear that there will be paid anyway.
Likely that there will be pressure as we see now with eg this statement. They will have to do it as otherwise it is a 10% option (40 minus 30) against a 60 or 70% upside, depending how you calculate it. Which would make the choice very easy

I personally doubt if they want to get into this discussion on mainly 2 issues:
-lateron not give the opportunity for a delayed PSI aka 0% means no more downside risk. Which means as the amounts are huge for a or several legal cases everybody will be sued. The ECB, the IMF,Everything Greek. Especially the position of the ECB looks very dodgy to me plus would be dealt with be a more or less decent court. So likely there is a delayed possibility may be not at 30% but lower, but maybe higher as well to get it off the table. Anyway Greece will likely be seen as a pariah until this is properly solved and no claims are hanging in the air.

-the huge uncertainty about continued default rating and subsequently the Greek CB getting de facto deeper and deeper underwater and the risk of it all is basically put with the ECB (who will clearly not like it).

Effectively we are talking 5 Bn probably (which will have to be paid lateron furthermore).
10% of total debt,
minus publicly held
minus held by parties whose arms can be twisted,
minus 30% remuneration,
minus percentage held by peple who gamble otherwise.
minus foreign law bonds already with CAC clause (at least a part, apparently there are some).

It is simply using pain in the whatever, value. Or in a different way next to a claim on Greece only, it gives an option to make trouble for the EZ and ECB as well.

But as I see it the downside realistically more like 20 % the upside 100% with low amounts at stake for the EZ.

It is difficult to see that the EZ wants to pay 130+ Bn to avoid the mess they see happening and do all the effort not to trigger CDS and not have a formal bust in anyway and let all this happen for say 5 Bn. For 50 maybe, but 5 is hard to believe.

However imho Greece will really default somewhere probably not too far from now. So I would mainly go for shorter term debt and very likely sell them anyway if it is clear that basically nominal will be paid. Because as Greece really goes I donot see amy money coming back for private creditors.