Thursday 29 October 2015

Greek Bank Bonds. A new PSI dilemma?

More than 3 years have passed since the Greek bond PSI. For those, who do not recall what happened, you can read “PSI lesson to investors”. I copy here just a relevant paragraph:
“The conduct of the PSI restructuring is very instructive for the lessons learnt and very destructive for the future of the bond market. Let me explain. Greece needed to restructure its debt. This is no secret. However, European politicians thought that it can be done “voluntarily”. In other words, they believed that they had enough political power over bondholders to convince them to take losses. When they realised that this was not the case they resorted to the good old argument “L'État, c'est moi” .
Many may have heard the story on how they found a so-called loophole in the Greek law. Greek bonds did not have any Collective Action Clauses and Greece could retrofit these in order to facilitate the restructuring. That is pure and utter baloney. The so-called retrofitted CACs were just a sleight of hand.
Greece in effect exercised its prerogative not to pay the creditors and Europe gave its blessing. The law that they passed (4050/2012) suspended contract law and made it a “Public Interest” and with “mandatory provisions”. Plainly speaking they could have done this even if CACs did exist in the Greek law bonds. They basically unilaterally changed the Bond contract claiming it was in the Public interest. They engaged article 9 of EU 593/2008 in order to suspend European legislation. If this sounds like a legal coup it is because it is a legal coup.”

Greek Bank Bonds
I am mentioning this because few days ago Piraeus and Alpha Bank of Greece (the other two would follow suit no doubt) made a “voluntary” offer to exchange their senior and subordinated bonds with (mostly) worthless equity and cash peanuts. The implicit threat here is the feared Bail-in. Eurogroup members have been outspoken with their views. They do not want to pay for bank recap. And the way to do it is to threaten implementation of a bail-in whereby equity holders and bondholders, maybe even depositors could shoulder some the burden.

Another factor is the size of the Capital needs. They need to come up with a low number so as to entice investors to put up the cash. But if it is too low no-one would believe the number. If it is too high then the Eurogroup member must cough up the cash. So this is a thin line.
Where is the Catch?
The famous BRRD (Bank Recovery and Resolution Directive) was transposed into Greek law last summer. However, crucially they left out the Bail-in articles. These articles become law after the 1-Jan-2016. This gives the Greek government a window of two months to play with the rules and structure a resolution that suits both Europe and the Gov.
So, can they bail-in the Greek bank’s senior bonds with minimal disruption? Here is the big catch. All the bank bonds have been issued by shell companies in the UK. These shell companies are the EMTN vehicles that issued all the Greek Bank bonds. They enjoy the explicit guarantee of the Greek mother bank. However the same vehicles have issued all the Pillar II and Pillar III bonds that enjoy in addition the guarantee of the Hell.Republic. And these bonds are Pari-Passu. And there are many! Around 50bln of these Pillar II bonds and another 8bln of Pillar III, all enjoying the government guarantee. If the bad Greek mother pulls the plug on the shell company (a UK plc) in order to restructure the 3-4bln of Senior bank bonds that do not have any government guarantees she would pull the plug on all Pillar II, III bonds. And this means that the state would have to pay, namely the taxpayer. And this goes against the principles or rather the so called “Key Attributes” of the resolution.
Bail in Equity and DTA
However, there is another issue. They have to respect the order. i.e. Equity and subordinate bonds must absorb losses before going to senior creditors and depositors (although they did not in the Cyprus case). Here is the second catch. Out of the 24bln of recognised T1 equity, 13bln is in the form of Deferred Tax Assets. What is this you might ask? A quick summary of the so called DTA is given here. In essence Greek Banks are allowed to net off any losses incurred from the PSI (also loans) for the next 30years. This creates a tax asset for the Bank. However, as it is not guaranteed that Banks would have profits for the next 30y, the Greek government stepped in with a guarantee. That way, 13bln have been recognized as capital. You may think that this is just another Greek gimmick, but it is not. Fatherhood of the idea belongs to the Italians who implemented first, followed by the Spanish and the Portuguese. Greece was the last to do it in Sep14.
This means that if you want to respect the order, the Greek tax payer must be hit with 13bln. And this is not all. The majority of the Greek bank equity is in the hands of the HFSF, the Greek government vehicle.
So, respecting the bail-in order and pari-passu basically means that Greek taxpayers would be hit. And this as I mentioned earlier goes against the resolution principles.
This is why I mentioned the PSI in the beginning. In the PSI the ECB assumed the status of a favoured investor and was exempted. Something similar may happen here too. 

Financial Stability Board
There is a way out of this and is called “Public Interest”. The resolution authority can actually bypass the pari-passu and bail-in only some investors and not others. I quote from the FSB (“Key Attributes of Effective Resolution Regimes for Financial Institutions”, 15 October14):
Page7: The objective of an effective resolution regime is to make feasible the resolution of financial institutions without severe systemic disruption and without exposing taxpayers to loss
Page15: Resolution powers should be exercised in a way that respects the hierarchy of claims while providing flexibility to depart from the general principle of equal (pari passu) treatment of creditors of the same class, with transparency about the reasons for such departures.
Thus the resolution authority may in the end exercise its powers and do an a la carte bail-in. Of course this is not a very good signal for European Bank bonds and the ECB is probably heavily against this idea but it can happen. ECB is against it since it would upset the bond markets. But they did not mind this discrimination 3 years ago when they self-exempted 56bln from the PSI.

Thus the bet for those holding Senior bonds is to pick the winner. Will it be the ECB or Eurogroup? Eurogroup said many times that Greece is a special case. Maybe not anymore.