Greece and the IMF appear to be pushing for as much as a 75% haircut
Most accounts suggest that the talks over the private sector involvement in Greece’s second aid package broke down, but rarely has a break down been coupled with immediate plans to resume negotiations. What is really better characterized as a pause will last two business days and negotiations are expected to resume Wednesday, January 18.
As we have pointed out, Greece needs a resolution of the PSI to allow the second aid package to be finalized. It is important to finalize the second aid package to allow the continued pay out of the first aid package. This is needed by March 20, when Greece has a 14.5 bln euro bond maturing. The point in reiterating this chain of events is to illustrate the brinkmanship "game" has more room to run.
Three aspects of a PSI agreement appear to have been struck. Private sector holders will be asked to voluntarily forgive half of the Greece’s debt that it holds (~200 bln euros). Of the 50% they will get back 15% is likely to be in cash, to be paid out of the second aid package. Greece and the banks also appear to have agreed in that in principle the PSI should be governed by UK law rather than Greek law.
For the other 35%, private sector will be given a new bond. Here is where the challenge really begins. What should the coupon be on the new bond ? The Greek government and the IMF, of course, are seeking a low coupon, with some suggestion (IMF/Germany) as low as 2%, while the group representing the banks wants a 4%+ coupon. There also seems to be some disagreement on the maturity of the new bond, with the IMF and Greece seeking 30 year, while the banks are willing to accept 20-year duration.
There is also some disagreement on other credit conditions. For example, how long of a grace period can there be ? Also, the banks want the new bonds to be of the senior status on par with the IMF and ECB.
Another challenge is the extent of participation. Recent reports suggest that the participation rate among the private sector may be 70-75%, not the near universal acceptance that was sought. Low participation may mean Greece needs a large aid package to make up the difference.
There has been some reports that under Greek law, collective action clauses can be retroactively introduced and this would force unwilling participants to accept the deal struck by a qualified majority. However, this would create new problems.
If the collective action clauses were invoked, this would challenge the voluntary nature of the exchange. This would in turn risk being regarded as a credit event though would trigger the credit default swaps.
If collective action clauses are retroactively introduced, they would seem to apply to ECB holdings as well. It is not clear how much Greek bonds the ECB owns. Estimates ranges from around 40 bln euros to 70 bln. Regardless of the particulars, the ECB is thought to be the single largest owner of Greek bonds, which it acquired at deep discounts (estimates range between 20 and 30%).
If bond holders are going to vote on whether to introduce collective action clauses, will the ECB vote in favor and thereby risking it holdings? If it votes against will there be sufficient votes to allow for the collective action clauses? What if the ECB abstains?
This underscores the difficult dilemma the ECB finds itself. Participating in the haircut damages the ECB. It is possible that the loss, even from the discounted levels it purchased the Greek bonds, would wipe out the ECB’s capital. Alternatively, as we have point out previously, if the ECB does not take a haircut, it undermines the effectiveness of its sovereign bond purchases. The more the ECB buys the greater the haircut the private sector ultimately faces.
There has been a suggestion that one work around would be to have the ECB sell its Greek bonds to the EFSF at purchase price, which would keep the ECB whole. The Greek bonds sold to the EFSF could then be returned to the Greek government as part of the second aid package.
Another potential challenge comes from the hedge funds. There have been press reports that some hedge funds have reportedly been buying Greek bonds with the idea in mind to refuse to participate in the PSI. The argument is that in this case it could become a credit event that triggers the CDS they own on Greece. Alternatively, the Greek government pays the hedge funds off in full.
Reuters (Jan 10) called the positions accumulated by the hedge funds as "powerful". Bloomberg reports have claimed that hedge funds have "amassed stakes". But none one seems to know how much Greek bonds have been acquired by the hedge funds.
Reports list 4-5 hedge funds by name. An estimated 20-25% of Greek bond holdings are not unidentified. This is where the hedge funds are likely to be found. There are some estimates that the hedge funds could account to half of the unidentified creditors.
The PSI has many moving parts and this makes for a complicated process. These negotiations lend themselves to brinkmanship tactics. Ultimately what is at stake is the real losses taken by the private sector and this is a function of net present value. Greece and the IMF appear to be pushing for as much as a 75% loss on NPV basis, while the banks, many of whom have written down 50% of their Greek holdings, appear willing to accept a 60-65% hit on the NPV basis.
Given the deeper losses that the private sector may suffer, it still appears to be in most of the creditors interest that a deal is forthcoming, even if it takes a few more weeks to finalize negotiations.