Successful Debt Restructuring Deal Paves Way for Second Greek Bailout

Greece made a decisive step towards securing a second bailout with the successful completion of the largest private debt restructuring in modern history (see Eurozone - Greece: 21 February 2012: Eurozone Agrees Second Greek Rescue Deal). In a statement released this morning, Evangelos Venizelos, Greece's finance minister, announced that 85.8% of private investors holding bonds issued under local law had accepted the deal negotiated between the Greek government and the Institute of International Finance (IIF). Although this is below a target of 95%, Greece confirmed that it will activate the retroactive collective action clauses (CACs) on bonds issued under local law introduced last month. This will increase the participation to approximately 95.7%. At the same time, the activation of the CACs is also likely to trigger a credit event and thus activate credit-default swap (CDS) contracts on Greek bonds. The acceptance rate among investors holding bonds issued or guaranteed under foreign law—which represent around 10% of the debt being renegotiated—was 69%. These investors have until the 23 March to decide whether to accept the offer or not.

Investors who took part in the deal—or who are being obliged to do so—will now swap their holdings of Greek debt for new bonds. The new bonds will have a nominal value 53.5% lower than their previous holdings, although the loss on a net present-value basis will be around 75%. Investors will receive two-year bonds issued by the European Financial Stability Facility (EFSF) in an amount equivalent to 15% of their (pre-restructuring) nominal holdings of Greek debt and the remaining amount (31.5% of the pre-restructuring nominal value of their holdings) will be comprised by long-term Greek bonds. The latter will start maturing during a period of 20 years, starting from 2023, and their initial coupon will be 2%, but this will increase up to 4.3% by 2042.

Outlook and Implications

Restructuring Likely to Activate CDS Contracts

It will be interesting to see what will happen with holdouts of bonds issued under foreign law, and whether these will be paid in full or not. Moreover, it also remains to be seen what impact the now almost-certain triggering of CDSs will have. On the positive side, the amount of Greek CDSs is relatively low. Moreover, financial institutions are likely to have hedged these positions. This will certainly set a precedent, however, and it will be more difficult for the Eurozone to avoid using the word "default" when referring to the huge haircut private investors will have to suffer. This can be important given that, despite the assurances of Eurozone policymakers that this will be the last sovereign debt restructuring in the Eurozone, the Greek case is being seen as a template of what could happen in another highly indebted Eurozone economy. Although it is understandable that politicians want to calm markets—thus their promises—the commitment of limiting a restructuring to Greece is not credible amid a backdrop of still-high debt levels and a weak economic outlook across the area.

The Economy Will Continue to Struggle

What will happen now? The good news is that Greece's public debt is now lower than it was yesterday. Moreover, Greece should now gain the final approval of the second bailout agreed in February, thus avoiding a "hard" default in two weeks time, when a large bond matures. This is not only good news for Greece, but also for the Eurozone, as contagion risks stemming from a worsening Greek situation are not negligible, despite the easing of tensions in bond markets in recent months.

Unfortunately, not everything is rosy. Although debt levels are lower than they were, they are still very high. Under the "troika's" assumptions, the debt-to-GDP ratio will still remain slightly above 120% in 2020. Moreover, the economy still remains in dire straits and the outlook continues to be worrying. Greece is immersed in a vicious circle of austerity and economic depression, and the new plan agreed with its official creditors will not do enough to break this unhealthy cycle. Structural reforms are imperative if the country wants to stay in the Eurozone. However, plummeting activity and skyrocketing unemployment—apart from being socially undesirable—risk creating a toxic political and social environment in which the implementation of these reforms, so important for the economy, will prove to be impossible.

Greece is expected to struggle to meet the quarterly deadlines agreed in the new three-year plan, and therefore tensions are likely to resurface every time Greece has to negotiate a new tranche of funds. Even if Greece secures further funds, it is difficult to see it returning to long-term bond markets at the end of the current programme without a drastic change in the economic and political landscapes. Not only will the economy be likely to remain weak for an extended period, but around two-thirds of Greek debt will be owned by the Eurozone or official institutions following the debt restructuring. This is likely to deter investors who will now know, with a clear historical precedent, that they will be the last in the queue if Greece has to restructure its debts again. As a result, the second bailout, now a certainty, is unlikely to be the last if Greece still remains in the Eurozone.