Greek CDS May Pay Out If Bondholders Forced to Take More Losses

Luxembourg Prime Minister Jean-Claude Juncker
Luxembourg Prime Minister Jean-Claude Juncker triggered speculation that so-called haircuts on Greek bonds could exceed 60 percent when interviewed on Austrian television yesterday. Photographer: Jock Fistick/Bloomberg

Credit-default swaps insuring Greek government debt may pay out should proposals to increase losses on the bonds exceed the 21 percent already agreed, according to analysts.

Deeper cuts would likely have to be imposed on bondholders, triggering a credit event on the swaps contracts, analysts at Barclays Capital, Evolution Securities Ltd. and Credit Agricole SA said.

Luxembourg Prime Minister Jean-Claude Juncker triggered speculation that so-called haircuts on Greek bonds could exceed 60 percent when interviewed on Austrian television yesterday. Finance ministers are considering reshaping a July deal that foresaw investors contributing 50 billion euros ($69 billion) to a 159 billion-euro rescue.

“There’s increasing evidence everything is going to a bigger restructuring of Greece and that’s going to be difficult to engineer without triggering CDS,” said Thomas Harjes, a senior European economist at Barclays Capital in Frankfurt. “It’s very likely banks won’t voluntarily agree to that.”

Credit-default swaps on Greece cover a net notional $3.7 billion, according to the Depository Trust & Clearing Corp., which runs a central registry that captures most trades. That’s less than 1 percent of the government’s $471 billion of bonds and loans outstanding, according to data compiled by Bloomberg.

The increase in private sector involvement, or PSI, involving debt exchanges and rollovers may put finance ministers on a collision course with the European Central Bank which has insisted since the start of the crisis that there should be no credit event that triggers credit-default swaps.

Restructuring Event

A restructuring credit event can be caused by a reduction in principal or interest, postponement or deferral of payments or a change in the ranking or currency of obligations, according to the International Swaps & Derivatives Association. Any of these changes must result from a deterioration in creditworthiness, apply to multiple investors and be binding on all holders. ISDA’s determinations committee rules whether credit swaps can be triggered.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Juncker, who leads the group of euro-area finance ministers, said through a spokesman yesterday that haircuts on Greece could exceed 21 percent. The statement clarified interpretations of the television interview that losses may exceed 60 percent.

Swaps Costs

Credit-default swaps insuring $10 million of Greek debt for five years cost $6.1 million in advance and $100,000 annually, according to CMA. That implies a greater than 90 percent chance the government will default in that time, assuming investors recover 32 percent of their holdings.

The 10-year Greek bond was little changed at 37.24 percent of face value at 10:41 a.m. in London today. The yield on the securities was at 24.06 percent.

A 21 percent haircut “looked overly generous for banks, so it’s no wonder many volunteered themselves to participate in the PSI,” said Harpreet Parhar, a strategist at Credit Agricole in London. “The touted 60 percent changes the dynamic considerably and we are not sure how many banks would volunteer themselves this time around, so politicians are likely to twist some arms further to get banks on board.”

European leaders have gone back and forth over the sanctity of bond contracts as the crisis escalated. German Chancellor Angela Merkel has insisted on the participation of banks, insurers and other private investors as a condition for bailouts, while politicians have opposed any move that would trigger insurance payouts on concern it would spread contagion.

“If they do impose a much higher haircut then yes, it might well trigger CDS,” said Gary Jenkins, head of fixed income at Evolution Securities in London. “But the much more interesting aspect is: is that seen by investors as a template for future defaults? And if it is, what’s the impact for sovereign bonds?”

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