What Is Going On With The PSI For Greece?

Via Peter Tchir of TF Market Advisors

I remain confused why the Private Sector Initiative isn't finished yet? 

For option 1, banks can swap their bonds for a new asset that is principal protected by the EFSF.  Greece will provide payments that act to provide current income.

Greek 5 year bonds are trading at 40 today.  So are the bonds that mature in June 2020.  These bonds are part of the proposal.  So in theory, you could buy bonds at 40 to exchange them for the new plan.

Well, the French 2041 zero trades at 35.  The German 2042 zero trades at 45.5.  Where should an EFSF zero price?  I figure that using French rates as a benchmark is a pretty decent proxy.  Germany and France guarantee a total of 370 billion Euro, out of a proposed total exposure of 440 billion, so that's why using French rates as a proxy for EFSF rates seems fair to me.

In that case, the first thing you get by exchanging bonds is an asset worth 35 points.  Since the market value of the assets being exchanged is only 40, you only need the "Greek" portion of the exchange to break even.  Using a discount rate of 20% on the Greek flows, that portion should have a value of about 20 points.  So the entire package is worth 55 points, higher than where the bonds trade.

The fact that the NPV is nowhere near the 79% originally predicted is probably an issue.  As Greece has deteriorated the value of those flows has diminished. But still, if you think a Greek default is likely, with a 40% recovery, you should do the exchange, as the zero coupon floors your recovery at 35% plus whatever recovery you get on the Greek payments.  In event of default, you would have been better off doing the exchange.

Then why aren't banks doing the exchange?  Are they worried their accountants or the markets would see through the ploy of a "par" bond exchange and not give them any benefit from that trick?  Are the governments finally getting concerned that the EFSF should not pay banks par for 40% of their Greek holdings?  The IIF proposal must have been structured by Robin Hood's evil twin - the one that steals from the poor and gives to the rich.  The swap, that switches Greek exposure from banks to the EFSF ensures the banks lose less, but the people of Europe lose more directly.

Are banks reluctant to agree because they think that the IMF and ECB and EFSF and EU (the "quoitra"?) will continue to provide money to Greece allowing them to be paid par on their bonds as they mature?  Is it a game of chicken where banks cannot afford the losses, so rather than taking them, they just keep hoping that the powers that be are too scared to ever stop bailing out Greece?

Maybe they are scared that this new SPV will be able to negotiate with Greece and reduce their future payments?  Maybe they see this whole thing as a ploy to make it easier for the governments to take control of any rights the creditors have?  The SPV would consolidate all the voting, making it easier for the governments to take control of negotiations, so maybe this initial deal sounds good, but the banks know it is just the first step in an effort to wipe out their Greek debt.

Option 2 seems to be just a future commitment to do Option 1.  It may give them more flexibility than agreeing up front.  I am not sure how this is accounted for and if Greece were to default, I'm not sure how they would roll into the nice EFSF zero once Greece had defaulted.

Option 3 forces a write-down now.  I don't think many banks will choose that. High on the list of bank priorities seems to be the desire to avoid taking losses that everyone realizes they are sitting on.

Option 4 remains confusing, and not in the way that makes it look like banks are getting a sneakily good deal, just confusing. 

From everything I can tell about the proposal, very little will have changed from the perspective of Greece.  They will have shifted their debt to a slightly longer maturity profile, but the coupons are in line with their existing coupons and it seems to just shift the balance of payments - some to the EFSF and some to this vehicle the banks will own.  Maybe the ability to negotiate with the SPV for future reductions is their real goal, and they don't care that the EFSF is giving the banks a great deal.

We will likely rally on some announcement of the PSI being successful but I would really like to know why it has taken so long?  I would also love a clear explanation of how much it really does for the distribution of Greek payments. Let's not forget, Greece never expected to simply pay off all these short dated bonds as they matured.  They were going to issue new debt to rollover existing debt.  This deals with that rollover process on a bigger basis, so that is helpful, but how much are the cash-flows really shifted?  The annual payments from Greece will still be large enough that they alone could cause default.  

Nothing has been solved in Greece.  Until Greece is fixed or defaults, the markets will remain manic/depressive.  This proposal would shift some risk out of the banking system, which is good.  But it puts it directly on the EFSF guarantors.  One way to stop contagion is to put people in quarantine.  Here, we are doing the opposite.  In the effort to survive a few more months, the powers that be are helping ensure contagion.  They are turning some very shaky banks into merely shaky banks, and the governments are taking on obligations that will reduce their flexibility going forward.  That will make the contagion real, and harder to contain, as more are infected. 

In the meantime, we can wait for the single most powerful man in the world to speak.  And after Charlie Sheen's press conference, we can wait for Bernanke.