Greece’s Creditors Agree to Forgive More Than Half Debt

Evangelos Venizelos, Lucas Papademos
Greek Finance Minister Evangelos Venizelos, left, and Greek Prime Ministers Lucas Papademos give a joint press conference after their Eurogroup Council meeting on February 21, 2012 at EU headquarters in Brussels. Photograph: John Thys/AFP/Getty Images

Greece reached an agreement with its private creditors to secure the biggest sovereign restructuring in history, paving the way for a second bailout of the debt-ridden nation and averting an economic collapse.

Investors will forgive 53.5 percent of their principal and exchange their remaining holdings for new Greek government bonds and notes from the European Financial Stability Facility, the International Institute of Finance said in a statement today after a final round of talks overnight. The coupon on the new bonds was set at 2 percent until February 2015, 3 percent for the next five years and 4.3 percent until 2042.

Greece needed to reach the deal to secure a 130 billion-euro ($173 billion) second bailout from European governments last night, or risk a default that could endanger the 13-year-old monetary union. The country’s debt was forecast to balloon to almost double the size of its shrinking economy this year without the write-off, the European Commission said in November.

“It’s better for banks to fork up a little bit more money than risk the contagion of an uncontrolled Greek default,” said Georg Kanders, a Dusseldorf, Germany-based analyst at WestLB AG. “Most investors will accept the deal. Banks have already written down the value of their Greek debt, so the impact should be limited.”

Collective Action Clauses

Greece’s government said separately it will introduce legislation to Parliament for so-called collective action clauses that will allow it to enforce losses on bondholders that refuse to take up the offer.

The 43-member Bloomberg Europe Banks and Financial Services Index fell 0.9 percent by 12:05 p.m. Frankfurt time. The benchmark has gained 9 percent in the past month.

“It will be up to individual investors to determine their own particular courses, following their own internal processes,” Charles Dallara, who as managing director of the Washington-based IIF led the talks on behalf of bondholders, said at a press conference in Brussels today. He expects strong participation from investors. “This is a solid deal for investors a fair deal for all parties and one that holds considerable benefits for Greece.” The swap could start as soon as this week, he said.

74 Percent Loss

The agreement will reduce Greece’s debt burden by 107 billion euros, about half the country’s estimated gross domestic product for 2011, the IIF said. The swap is meant to help reduce the debt to 120.5 percent of GDP by 2020.

Bondholders will exchange 31.5 percent of their principal into 20 new Greek government bonds with maturities of 11 to 30 years and the remainder into short-dated securities issued by the EFSF. The new securities will be governed by English law.

Investors will suffer a net present value loss of about 74 percent, said Guillaume Tiberghien, a London-based analyst at Exane BNP Paribas.

Separate securities linked to the future growth of the Greek economy will be offered to investors, potentially boosting the yield they receive in the event that growth exceeds currently anticipated levels, according to the statement. There will be an annual cap on the amount payable on the securities to avoid an “undue burden” on Greece in the future, the IIF said.

EU Summit

At an Oct. 26 summit of European Union leaders in Brussels, private bondholders agreed to take a 50 percent loss on the face value of about 205 billion euros of Greek debt. Subsequent talks between lenders, Greece and the “troika” of the European Commission, International Monetary Fund and European Central Bank revolved around structuring the swap in a way that would achieve the country’s debt target while keeping the transaction voluntary.

Negotiators struggled during more than three months of talks to try to craft a voluntary deal that provides the debt relief Greece requires while attracting enough participation from bondholders. After two years of wage cuts and tax increases, the Greek economy shrank 6.8 percent last year, compared with a 6 percent contraction projected in the government’s 2012 budget.

Greece is now in its fifth year of a recession. Prime Minister Lucas Papademos’s government on Feb. 13 passed through Parliament a new package of austerity measures demanded by the troika in exchange for the second bailout. It got its first financial lifeline in May 2010.

Shrinking Economy

The debt sustainability analysis provided by the EU and IMF, dated Feb. 15, shows the Greek economy will contract by 4.3 percent to 4.8 percent this year. The baseline scenario shows debt peaking at 168 percent of GDP in 2013. The economy won’t return to growth until 2014, the report found.

The worsening economy put the debt-cutting target in doubt and forced bondholders to accept bigger losses. At the start of talks in November, creditors wanted an 8 percent coupon on the new securities, a person with knowledge of the discussions said. By the turn of the year, the parties were converging toward 4 percent, before the IMF and Germany intervened, demanding an interest rate below 3 percent, said the person, who declined to be identified because the discussions were private.

Jean-Claude Juncker, Luxembourg’s prime minister and the head of the panel of euro finance ministers, outlined a middle path on Jan. 24, saying the bonds should have a coupon of less than 3.5 percent until 2020 and below 4 percent “over the total period.”

Deutsche Bank

Deutsche Bank AG Chief Executive Officer Josef Ackermann, who has played a key role in negotiations as chairman of the IIF, has warned that a failure to rescue Greece could lead to a “meltdown” far beyond the collapse of Lehman Brothers Holdings Inc. in 2008. The fall of the New York investment bank sparked the biggest financial crisis since the Great Depression, which led to losses of more than $2 trillion and taxpayer bailouts from London to Berlin to Washington.

Hedge funds holding Greek bonds may resist the deal and seek to get paid in full, either by the Greek government or by triggering payouts from insurance contracts known as credit-default swaps. Investors in Greek debt that are hedged with credit-default swaps would be paid the face value of their holdings in exchange for the underlying securities or the cash equivalent if the insurance contracts are triggered.

A trigger would be avoided if Greece and its creditors reach a voluntary agreement, or one that’s not binding on all holders, while use of a collective-action clause to impose losses on investors holding out against the exchange could trigger the contracts, according to rules of the International Swaps & Derivatives Association.

Credit-Default Swaps

Credit-default swaps cover a net $3.2 billion of Greek debt, less than 1 percent of the country’s bonds outstanding.

“If the voluntary participation is not close to full, using collective action clauses, and triggering CDS, would be necessary,” said Alberto Gallo, a strategist at Royal Bank of Scotland Group Plc in London. “There is a large gap between an agreement and implementation of reforms. Even with the haircut, the risk of the debt being unsustainable remains.”

Papademos came into office on Nov. 11 as head of an interim government charged with overseeing implementation of the Oct. 26 loan package, including the debt swap agreement. Antonis Samaras, leader of the country’s second biggest parliamentary party, has said that elections should be held after the debt swap has been implemented and the loan accord secured.

The amount of debt eligible to swap is more than three times the $81.8 billion that Argentina made eligible for its 2005 restructuring, previously the biggest sovereign debt swap.

Steering Committee

The creditors’ steering committee that negotiated the debt swap included representatives from banks and insurers with the largest holdings of Greek government bonds, including National Bank of Greece SA, BNP Paribas, Commerzbank AG, Deutsche Bank, Intesa Sanpaolo SpA, ING Groep NV, Allianz SE and Axa SA.

The 32 members of the IIF’s larger creditors’ committee have already taken at least 24 billion euros in combined writedowns on the country’s sovereign debt, and had at least 44 billion euros in residual holdings, according to data compiled by Bloomberg from their most recent reports.

Greece’s four largest banks are the country’s biggest private creditors, with almost 29 billion euros of remaining exposure to sovereign bonds, and have so far taken combined losses of only 4.3 billion euros, according to their most recent disclosures. National Bank of Greece, the nation’s biggest bank, still holds 12.3 billion euros of the country’s sovereign debt. The country’s lenders will have to be recapitalized with funds from the bailout package earmarked for that purpose.

French Banks

Among foreign bondholders on the committee, the eight French financial firms, which include BNP Paribas, CNP Assurances SA and Groupama SA, have the biggest Greek sovereign holdings. BNP Paribas, anticipating a debt restructuring, wrote down its Greek bonds by 3.45 billion euros last year, or 75 percent. Societe Generale SA also booked writedowns covering three-quarters of its Greek government debt.

Dexia SA, the Franco-Belgian lender being broken up after requiring two bailouts in three years, reported 2.7 billion euros of pretax losses on Greek sovereign debt by the end of September.

German firms, including Deutsche Bank, Commerzbank and Allianz, account for the second-largest residual foreign exposure to Greece’s debt. Deutsche Bank marked down its Greek holdings by 71 percent last year, booking 550 million euros in pretax losses.

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