Greek Bond Swap Accord Hinges on Collateral to Avoid Default: Euro Credit

Europe’s efforts to persuade bondholders to forgo part of their Greek loans without triggering a default hinge on how writedowns are twinned with the provision of top-rated collateral.

Collateral is “the sweet spot of the whole deal,” according to Ioannis Sokos, a fixed-income strategist at BNP Paribas SA in London. Giving investors longer-dated AAA bonds and aiding Greece’s burdens by paring interest payments on the renegotiated securities is better than increasing the amount of capital bondholders have to sacrifice, and “should be preferred versus a heavy haircut,” he said.

A July agreement envisaged holders giving up 21 percent of the value of their Greek investments by swapping into one of four proposed arrangements. Lawmakers meeting in Brussels during the past three days considered five scenarios to update that accord, people familiar with the deliberations said. They range from sticking with a voluntary swap to a so-called hard restructuring that forces investors to exchange Greek bonds for new ones at 50 percent of their value, the people said.

European Union officials are seeking deeper cuts to improve Greece’s finances and to equip the European Financial Stability Facility with enough firepower to halt contagion that drove Italy’s 10-year borrowing cost above 6 percent last week. As politicians try to reduce the cost of a deal to taxpayers, bond prices already suggest bigger losses for money managers. Two- year Greek notes were at 38.19 percent of face value at 1:21 p.m. London time, with 30-year debt worth 29.89 cents on the euro.

French-German Gap

Government leaders will gather again at a summit on Oct. 26 in an attempt to reach final decisions. The yield premium investors demand to own French 10-year debt rather than German bunds climbed to a euro-era record of 121 basis points last week as disagreements between the two nations prompted the need for an additional round of talks.

The world’s biggest banks, represented by the Institute of International Finance, have proposed a loss of 40 percent on Greek debt, said a person with knowledge of discussions on the debt writedown, who declined to be identified because talks are confidential. The European Union is calling on investors to forfeit as much as 60 percent, making a compromise at 50 percent possible, the person said.

Accepting bigger losses in exchange for “carrots” including AAA collateral may provide investors with a better outcome than “the alternative scenario of a default,” according to Mohit Kumar, head of European interest-rate strategy at Deutsche Bank AG in London.

Halting Contagion

“A Greek private-sector involvement, version 2, along with a credible plan to recap banks would, we believe, provide a first step to isolate the financial sector from any potential future contagion risks, as well as provide Ireland and Portugal time to distinguish themselves from Greece,” Kumar said.

The European Central Bank is opposed to obliging bond investors to sacrifice capital. An Oct. 21 report, co-authored by the ECB, European Commission and International Monetary Fund, said Greece’s finances have “taken a turn for the worse” and called for losses beyond the 21 percent negotiated in July. The central bank added a footnote saying it “does not agree” with the inclusion of bond-loss scenarios.

The ECB may have to acknowledge a drop in the value of Greek government bonds it amassed under its asset purchase program under a “forced restructuring,” Gary Jenkins, head of fixed income at Evolution Securities in London, wrote in a research report.

‘Coercive Restructuring’

Credit-rating companies have said efforts to reduce Greece’s debts by imposing losses on bondholders will qualify as a default. Ignoring the voluntary element may also stoke concern about other nations reneging on full repayment.

“A more coercive restructuring might unleash a new wave of contagion forces in the EU’s periphery and European banks,” said BNP Paribas’s Sokos. It would be difficult to achieve a reduction in the value of Greek bonds greater than 40 percent that still has a “sufficient participation rate” among lenders, he said.

European leaders are holding talks with representatives of global bank lobby group Institute of International Finance, including Deutsche Bank Chief Executive Officer Josef Ackermann, as part of their efforts to revisit the July proposals. That package “failed to solve the problem,” Commerzbank AG Chief Executive Officer Martin Blessing said in an interview published last week by Bild newspaper in which he said Greece should declare itself insolvent and begin restructuring its debts.

Collateral Damage

Among the options Europe’s leaders have discussed to achieve support for debt reduction are offering longer maturities on new bonds swapped for existing securities. Greece’s existing longer-dated securities might for the first time be included in the plan, with some of the initial options canceled, UniCredit SpA strategists wrote in an Oct. 18 report.

A surge in the cost of collateral proposed in the July agreement made the option favored by most investors, which involved swapping existing securities for a 30-year bond at full face value backed by top-rated debt purchased by the EFSF, more expensive for Greece, Harvinder Sian and Simon Peck, London- based interest-rate strategists at Royal Bank of Scotland Group Plc, wrote in a report. The price of zero-coupon 30-year French government bonds climbed to 35.5 points on Sept. 22 from 27.4 points on June 30. It traded at about 29 today.

“Out of the four solutions that were presented to the private sector back in July and August, in actual fact they boiled down to one,” said Spyros Politis, CEO of TT-ELTA AEDAK, a Greek manager of mutual funds with 262 million euros ($363 million) of assets. “Maybe this time round we will have a smaller number of options that are equally acceptable. This would be a real service to the international investor community.”

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net

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