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Greece has defaulted the french plan the ecb and rating agencies


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The French plan to "voluntarily" entice banks (against their will) to accept to buy new Geek debt at below market rates whent older debt matures is a default, whatever it is called. In my earlier days …

The French plan to "voluntarily" entice banks (against their will) to accept to buy new Geek debt at below market rates whent older debt matures is a default, whatever it is called. In my earlier days the "temporary default" rating agencies would ascribe to Greece did not exit: you either default on your debt obligations or you don't. Anyway, Greece has already technically defaulted last year when the ECB started to buy sub-investment grade Greek debt and the inevitable is now appearing in full ligth.

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  • 1. Greece has defaulted: The French plan, the ECB and rating agenciesThis is the best analysis I have read so far on Greece’s salvation, since Greece has de factodefaulted, however European (and other) official are disguising it. Since I do not see thepoint of reinventing the wheel, I post this analysis in-extenso without any comment.Making Sense of the French Rollover PlanConfusion continues to reign supreme over what the French rollover plan does for thevarious entities. The details and mechanics are a bit sketchy, but I have attached theproposal that I found, and will use that as a basis for the analysis. As I go through thedetails, and incorporate the latest rating agency comments, the conclusion remains thesame – this is a good deal for the Participants, a mediocre deal for the Troika, and punitiveto Greece.What a real rollover would look likeThe French proposal is slightly complex at best and convoluted at worst. Before digginginto the specifics, let’s look at what a true rollover would look like. If Participants agreedwith Greece to extend the maturity AND reduce the coupon AND do itimmediately, that would be a clear example of a rollover that benefitted Greece.There are 3 key elements to a real rollover. The first is that they would agree to therollover now. That would take away uncertainty. The maturity extension is the rollover,and the longer it is delayed, the better for Greece. The coupon on the new debt should belower than the coupon Greece is currently paying. If all 3 of these criteria are met, and thenew bonds are pari passu with the existing bonds, then I think everyone would agree thatGreece benefits, the Troika would benefit, and the Participants would have made asacrifice. The French proposal, as we will see, potentially does not satisfy any of the 3aspects listed – it is not immediate, the coupon will be higher than existing debt, and thematurity extension is linked to taking some debt out of the market, so it’s not as clearly abenefit as the headlines make it seem.The Rollovers Should Not Trigger a CDS Credit EventIn any case, let’s assume Participants actually did the proper rollover. That should NOTtrigger CDS. The ISDA credit derivative definitions for a Restructuring Credit Event haveto meet 2 tests. The first part of the test is straightforward and is met if bonds areextended, or the coupon is reduced, for example. This condition would be met. Thesecond condition is effectively that it is involuntary. If the actions of some bondholders 1
  • 2. force other bondholders into an agreement then this condition would be met and therewould be a CDS Credit Event. In the case of Greek bonds, that looks unlikely. I have onlylooked at the offering circulars from a couple of bonds, but there does not appear to byanything that could force a bondholder to change the terms of the debt. There is noreason, that on a €1 billion issue, €950 million could be exchanged and €50 million couldremain outstanding. If that is the case, then there would be no CDS Credit Event underthis true rollover.The Rating Agencies can be largely ignoredOf all the rating agencies, S&P, so far, has come out with the most comprehensivedefinition of what they would do. The first thing S&P said it would do is lower the GreekIssuer Rating to “SD”. First, I have to admit, that in all the years that I have followed thecredit markets, I cannot remember seeing an “SD” rating before. I am almost certain thatno regulator and no Participants have any rules based on the “SD” rating. So while Greeceis rated SD, the regulators and Participants should have a lot of leeway on how to treat thedebt, and since it would be performing, I don’t see why the status quo would be changed.S&P goes on to say that a D rating would be applied to bonds that are maturing and aresubject to the plan. When will they do that? If they do it now, they will be rating bondsthat are paying interest and will pay par at maturity as D. The rating agencies, which haveenough problems with rating obligations too highly, will now be saying something is indefault, when it is paying. I suspect that regulators and Participants would ignore the Drating and rely on the fact that the bonds are performing and are expected to be paid backat par. The rating agencies could apply the D rating right at the time of maturity, but thatdoesn’t have any impact on the Participants, because they would receive par on thoseobligations and no longer hold them. So any downgrade of existing obligations to “D”based on the proposal is unlikely to impact the Participants or regulators at all. Thedowngrade will only serve to keep track of defaults for the rating agencies’ annual defaulthistory studies.The key question will be what are the new bonds rated. S&P makes it seem as though thenew bonds would have the current rating of the old bonds (“CCC”). So, again, status quowould be retained.A real restructuring would help Greece, help the Troika, and cost theParticipants some money, and would avoid a Credit Event and demonstratethat the rating agency characterizations of default have no meaningfulaccounting or funding impact for the Participants. The French Rollover Plan in Detail 2
  • 3. Rollover Does Not Alter the Existing Maturity ScheduleAccording to the proposal I have attached, the following sentence seems to be theoperative one regarding timing:During the period from July 2011 until June 2014 (the “Period”), following eachredemption of Existing GGB’s, each Participant undertakes to participate in one of thefollowing optionsSo, it looks like Participants agree to the plan now, but rollovers do not occur until eachindividual bond matures. The immediate impact on the debt maturity schedule for Greeceis negligible. The Participants only share in the bailout if the Troika continues to provideGreece with funding. Retaining the original maturity schedule is useful for theParticipants. If there is a default by Greece, the Participants will still hold their existingshort dated bonds which can get higher recoveries in sovereign debt restructurings.Since the Participants do not provide a maturity extension up front, the key to Greecepaying its debts is the continued willingness of the Troika to release tranches of promisedbailout money. By waiting until each bond is repaid, the rollover plan addresses a coupleof key issues. The rating agencies can rate the debt whatever they want, but if the bondsare paid in full at maturity the Participants will not have to take a write-down, so theypreserve non mark to market accounting. That is important for some of the Participants.By waiting until the debt is repaid at maturity, it reduces the risk of some other creditclaiming “fraudulent conveyance” or arguing about “off market price” transactions.Waiting until the bonds mature and are redeemed at par by Greece before “purchasing”the new bonds is better from an accounting standpoint for the Participants than agreeingnow to extend the maturities when the bonds are trading below par.Funds from a maturing bond are rolled into 3 assetsWhen a bond is redeemed at par, the Participant really receives 3 assets. The language isconfusing, the use of the SPV obfuscates the actual investment, but it is actually fairlytransparent to see through the headlines.For every €100 million of maturing debt a Participant holds, they will be able to retain €30million to do with as they please. Of the remaining €70 million, they purchase 2 assets, aAAA rated 30 year, zero coupon bond, and a 30 year Greek amortizing bond. Yes, the plancalls for them to purchase 1 asset, an SPV, but it is a simple SPV and is worth breaking theSPV into its two components.The Participant will buy €70 million of an SPV. The SPV will be “principal protected” by a 3
  • 4. rated asset and provide a coupon of between 5.5% and 8.0% depending on the GDPgrowth of Greece. But let’s look through the SPV and see what the Participant really gets.€20 million is spent to buy the AAA zero coupon bond. The zero coupon bond should costabout 30% of face 1 and the actual proposal uses a price of 28.5%. So the investor owns aAAA rated, zero coupon bond, that they spent €20 million to buy and has a face value of€70 million. This asset might be used to get a principal only AAA rating on the SPV Note.It might help with regulatory capital even, if the Participants can use a principal onlyrating, but in any case it should be viewed as a separate asset.So the remaining €50 million actually goes to Greece. Of the €100 million of debt theParticipant owned, €30 million is repaid in cash, €20 million they agree to use to buy a 30year zero and €50 million goes to Greece. Since Greece clearly needs all the money it canget, the only logical place for Greece to receive the €50 million the Participants arekeeping is from another loan from the Troika. Whatever entity (possibly some iteration ofEFSF) sold the zero coupon bond to the SPV is likely to provide financing to Greece. Itonly makes sense since they will have €30 million of proceeds that needs to be investedsomewhere. The remaining €20 million must come from the promised tranches of Troikabailout funds.What does the loan to Greece look like?It is possible to back out the details of the €50 million loan to Greece. The Participantsexpect to receive €70 million at maturity from the SPV, so that the asset they paid par forcan be redeemed at par. Therefore it is logical to conclude that the SPV is not relying onany money from Greece for principle redemption at maturity. The SPV is supposed to paya minimum of 5.5% coupon on the €70 million face amount of the SPV note. That is €3.85million per annum. That has to be coming from the Greek loan – the SPV only has 2assets, the Greek loan, and the zero coupon bond. The SPV (and Participants) are relyingon Greece to pay €3.85 million per year for 30 years. This is just like a mortgage. In fact itis a 30 year mortgage, with initial amount of €50 million with annual payments of €3.85million. That is equivalent to a 6.55% mortgage rate. Since none of the GGB bondsmaturity in the next 18 months, has a coupon higher than 5.25%, the Participants aren’thelping Greece on their annual interest payments. If Greece is going to see a reduction inaverage coupon, it would have to be coming from the loans from the Troika. So far, thoseloans still seem to be coming around 5%, so there is no current interest expense benefit forGreece.This mortgage loan to Greece is very creative by the Participants. It helps explain whythere are no details of the loan terms in the proposal. It is a bit difficult to work out, but a30 year, 6.55% mortgage is the only possible way to explain the cash flows. Not only is the 4
  • 5. rate above current coupon rates, so Greece will be paying more, the duration ofthe mortgage is far less than 30 years. The Participants would have you believe that theyhave lent Greece money for 30 years. The reality is the loan has a much shorter durationand will be half paid off in the 20th year. The terms, as you dig deeper, once again seem tobe better for the Participants than for Greece.I almost forgot something. The 0 to 2.5% additional interest the SPV will be paying basedon the GDP of Greece for any given year. That would be an additional payment of up to€1.75 million each year. That payment has to be coming from the Greek loan asset theSPV holds, since it cannot be coming from the zero coupon bond, by definition. If thathappened in the first year of the SPV it would represent a payment by Greece of 3.5% ofthe amount borrowed. Since the loan is a mortgage and principle is being paid down, thepotential additional payment by Greece as a % of interest is astronomical near the end ofthe loan. If Greece only owes half the original principle by the end of year 21, that samepayment would be 7% from the perspective of Greece, on top of the 6.55% they are alreadypaying.This coupon “kicker” linked to GDP that is paid on the full notional of the SPV isproblematic for Greece since they are paying a “kicker” on a notional that is 40% morethan they received. The problem becomes onerous because that kicker is linked to a fixedamount, yet the money Greece borrowed from the SPV is being repaid annually like anyother mortgage. It is only safe to assume that the annual principle payments have to befunded elsewhere, so Greece will owe interest on those borrowings too.The Participants are not lending to Greece for 30 years, the duration is muchshorter, and the coupon payments start out potentially high, and becomeusurious in the later years.The structure is designed in a such a way to make it look like the Participants are beinghelpful – 30 years at a low coupon, but separating the SPV into its zero coupon componentand the loan to Greece clearly demonstrate that the terms being offered to Greece are farworse than the headlines that the Participants are selling to the public.I would be surprised if Greece agrees to the loan terms as included in theFrench proposal and wonder if they have even been consulted? 5
  • 6. Hedge: Guest Post - Making Sense of the French Rollover Planédération Bancaire Française: Long-term investor initiative for Greece 6 © Markets & Beyond