While we await for Thomas Stolper to issue his latest flip flop and to go long the EURUSD again ("tactically", not "strategically"), here is Francesco Garzarelli's take on the Greek bailout.Here is the biggest issue: "Increased likelihood of CDS: Moreover, higher losses inflicted on the private sector, involving the likely activation of CACs and the triggering of CDS, represent sources of near-term volatility." Bingo. Now as we pointed out in the previous post, a "successful" and completely undefined PSI program is a key precondition to the program. However, with bondholders now certain to throw up, and the requisite 75% (forget 95%) acceptance threshold unlike to be reached, will the use of Collective Action Clauses, and thus a CDS trigger constitute a PSI failure, and thus deal breach? In other words, since we now know that the March 20 bond payment will be part of the PSI, is last night's farce merely a way to avoid giving Greece a bridge loan, and putting its fate in the hands of creditors, which as we noted back in January is a lose-lose strategy?
Overnight, Finance Ministers in the Euro area reached a deal on Greece, aimed at achieving a 120.5% (sic) debt to GDP ratio by 2020, and paving the way for parliamentary approval in member countries of a second package of official aid worth EUR130bn. This would bring the total committed EMU tax-payers funds to in excess of EUR200bn. Below are our initial impressions, drawing on official statements and press reports.
The positives include:
- Progress on Greek PSI: Relative to the tensions last week, progress has been made towards a substantial reduction of Greek debt through the PSI (estimated at EUR107bn, or 50% of 2011 GDP, will be pardoned), and a mutualisation of the remaining portion on the Euro area’s official sector’s balance sheet. As we have noted in the past, after the liability management exercise, the share of Greek liabilities still in private hands will be substantially reduced (and estimated to be roughly 25% by end-2014, including the part relating to the EFSF guarantee on new Greek debt).
- Reduced risk of disorderly default: The introduction of a segregated account in which each quarter’s debt service will be paid in advance, together with a national law giving priority to debt servicing payments, should reduce the risk of a disorderly default and thus the systemic relevance of Greece.
The negatives include:
- Growth concerns: In its communiqué, the Euro group insists that the agreement is conditional on Greece fully implementing a revised adjustment program (official details of which, including crucial assumptions on expected nominal growth, are not yet available). To this end, surveillance by the ECB/EU/IMF ‘troika’ is strengthened. But with ongoing economic duress and the upcoming general elections, uncertainty remains around how fast the country will be able to bring its non-interest deficit (estimated at 2.5% of GDP in 2011) into surplus of at least 1.5% of GDP. And the slow progress so far in delivering politically unpopular structural reforms and privatizations are not reassuring. This may lead to further frictions with EMU partners, leaving the risk of Greece's EMU exit in place.
- Increased likelihood of CDS: Moreover, higher losses inflicted on the private sector, involving the likely activation of CACs and the triggering of CDS, represent sources of near-term volatility.
The market has already rallied substantially in anticipation of a deal being reached. We continue to see tail risks in the upcoming two-three months linked to the implementation of the PSI and Greek elections.
Turning to the details of the deal itself, the official sector will contribute in two ways:
- The interest rate charged on bilateral loans under the first package will be reduced to 150bp over Euribor. Our understanding is that this reduction will apply retroactively, implying that previous interest payments will be reduced, allowing greater relief (the debt level will be 2.8% lower by 2020, according to the official statement). Incidentally, this raises the possibility that Portugal and Ireland will also seek a reduction in their borrowing terms from the official sector.
- The ECB will receive new ISIN bonds at par in lieu of its SMP holdings, estimated at around EUR40bn face value and marked at 70c. An intra-Eurosystem transaction between the ECB and national central banks will release anticipated profits to NCBs and hence to governments for debt relief. Admittedly the Eurogroup statement is pretty sketchy on this. But that would not imply a reduction in the debt coming from the SMP holdings themselves, but rather only from the profits. Moreover, Eurosystem national central banks will contribute all income generated by their holding of Greek government bonds through 2020 (the Bank of Greece owns around EUR 8bn worth of GGBs).
As far as the private sector is concerned:
- According to a statement by the Steering Committee of the Private Creditor-Investor Committee for Greece (PCIC), existing bondholders will be offered the opportunity to enter a ‘voluntary’ deal envisaging a face value reduction of 53.5% (hence higher than the 50c announced since October). Old securities will be exchanged into a portfolio of ‘short-dated’ EFSF paper, with face value of 15c, and a notional 31.5c of Greek government bonds issued under UK law and pari passu with other liabilities. The new GGBs securities will have maturities ranging between 11 and 30 years, replicating an amortization of 5% per annum commencing in 2023. The securities will pay a step-up coupon of 2% from Feb 2012 to Feb 2015; 3% from Feb 2015 to Feb 2020 and 4.3% from Feb 2020 to Feb 2042 (the weighted average coupon is 3.65% over the full 30-yr period, and 2.63% over the first 8 years). The effective NPV loss depends on the discount factor applied to the Greek cash flows after the deal. We make it close to 80c. Separate securities linked to future Greek GDP will also be offered, but the valuation of this component at this stage remains uncertain and in any case small. An exchange transaction will be launched in early March.
- The PSI results will determine the exact size of the official sector’s contribution to the second bailout package. A low participation will likely entail the triggering of retroactive collection action clauses (CACs, to be introduced by national legislation this week), and thus activate CDS contracts. The breakdown between resources provided by EMU member states (through the EFSF) and the IMF will be decided in mid-March. It is understood that the IMF’s share may be lower than the 30% in the first three EMU programs.