Greece: heading for a credit event?

February 20, 2012

Markets have a happy face on today, as they have for much of this year, as investors look forward to the promise of a second bail-out for Greece.

But it all hinges on agreement in debt talks between private sector creditors and the Greek government over the size of the haircut those creditors will have to wear on their Greek bond holdings.

Any voluntary debt restructuring is supposed to be comforting for markets and avoid a so-called credit event, which would trigger expensive pay-outs to credit default swaps holders. Pay-outs to CDS holders after Lehman’s default helped to deepen the 08/09 financial crisis.

But some bank analysts think such an event is still likely for Greece, as not all bondholders will play ball.

Credit Suisse analysts say:

We remain of the opinion that participation in the debt exchange is likely to fall short of the 75% level on which current debt/GDP targets are based. This would call for the enforcement of collective action clauses (CAC), triggering a non-voluntary restructuring. The CDS contract would be triggered as a result, most likely with negative implications for risk appetite. We expect the euro and risk-sensitive currencies to struggle again as we move through the PSI (private sector initiative) process.

Analysts at ING have a similar view, but seem a little less worried about it:

If the voluntary terms are subsequently imposed on investors that decline the offer, then a credit event would likely be marked and CDS triggered….in our opinion it would be manageable. There may well be some lumpy exposures that come to light subsequently, but our best guess is that a credit event is practically in the price, and should not lead to aggravated contagion.

Greek debt is trading at around 20-25 cents on the euro, which fully discounts the size of the expected haircut, of 50 percent in nominal terms but 70 percent in net present value terms, according to ING.

The problem in the past (Lehman, or BTA) was that there was disproportionately big amount of CDS outstanding compared with actual bonds, and a potential triggering of CDS caused a collapse in bond prices.

JPMorgan thinks any CDS auction of Greek debt would be small, as it calculates 2.4 billion euros of Greek CDS outstanding, but 9 billion euros of bonds eligible for the auction. This positive ratio means “the final settlement price is likely to be…very close to market prices”.



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