• Indebted nation has guaranteed 49 billion euros of bank bonds
  • Bailing in bonds may trigger liability for Greek government

Writing down 4.7 billion euros ($5.2 billion) of privately held senior bonds to help fix Greek lenders may cost the nation 49 billion euros.

Banks may only be able to bail in the privately held bonds if they do the same to state-guaranteed notes used as collateral for European Central Bank loans. That would potentially hand the Greek government a 49 billion-euro obligation, even as it struggles to pay pensions and civil-service wages. Excluding the state-backed notes, also called phantom bonds, from a bail-in could lead to lawsuits from private investors.

“One potential target for aggrieved private bondholders being bailed in would be the senior phantom bonds if they were not equally bailed in,” said Michael Doran, a partner at law firm White & Case. “That creates a dilemma, as on its face, a bail-in of these bonds could trigger the sovereign guarantee, which would then leave the Greek state with a significant and perhaps unexpected liability.”

Euro-area finance ministers have suggested bailing in senior bank bonds to help refinance lenders after Greece’s economic crisis spurred bad loans, deposit withdrawals and cash shortages. Policy makers have pledged to make as much as 25 billion euros available to support the recapitalization.

Writing down the senior bonds as part of a bailout is a possible option following the completion of ECB stress tests and an asset-quality review next month. Alternatives for filling capital shortfalls include private offerings and European aid. The Greek government may also reach a deal that voids the guarantees and shields the ECB from losses.

Phantom Bonds

The government-guaranteed bonds are the legacy of measures taken to prop up Greece’s four major lenders, including National Bank of Greece SA, during the financial crisis. They are referred to as phantom bonds because the banks issued the notes to themselves to get round ECB emergency-funding rules.

The largest private holders of Greek senior bank bonds include Pacific Investment Management Co. and Carmignac Gestion, according to data compiled by Bloomberg. Both fund managers declined to comment on their holdings.

Moody’s Investors Service downgraded all four major Greek banks’ bonds to C, its lowest grade, last week. That means the ratings company sees little prospect of noteholders recovering the principal or interest.

Imposing losses on the phantom bonds could trigger the state guarantees and endanger the banks’ access to ECB-controlled emergency liquidity assistance, according to Erwin van Lumich, who runs Fitch Ratings Ltd.’s coverage of southern European financial companies. The program provides as much as 89.1 billion euros of liquidity for Greek lenders.

EU Directive

Bail-in tools under the European Union’s Bank Resolution and Recovery Directive, which comes into force in Greece on Jan. 1, could be central to bank recapitalization. These let authorities exempt some senior debt from losses if the exclusion is “necessary to avoid the spreading of contagion and financial instability.”

Greece could claim this applies to phantom bonds because of the lenders’ reliance on them for liquidity, Van Lumich said. Still, private bondholders could cite directive rules saying bank restructurings can’t leave creditors worse off than if the lender was liquidated.

“If investors are bailed in then there will be those who will try that argument because there is nothing else they can do,” Van Lumich said. “But it may be quite difficult to demonstrate what you would receive in the event of a liquidation.”

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