Greek Debt Deal Talks: How Much of a 'Haircut'?

As negotiators arrive back in Athens today, Greece enters a pivotal period in which it must finish a crucial renegotiation of its more than $200 billion of debt.

Thus far, the plan is to offer bondholders 15 cents in new cash and 35 cents in new debt for every 100 cents of Greek debt they hold. According to several people familiar with the situation, the maturity on the new debt is likely to be 30 years, but the interest rate is yet to be decided and is the most contentious part of the deal.

The Parthenon in Greece
Scott E. Barbour | Getty Images
The Parthenon in Greece

The cut to the net present value (NPV) of the debt, a metric that is important to banks and bond investors, will be greater than 50 percent. The NPV of a bond is determined by a number of factors, including maturity, interest rate, and the bondholder’s belief in Greece’s future ability to actually pay it back.

The new bonds are expected to be under U.K. legal jurisdiction rather than Greek jurisdiction. Bondholders prefer U.K. jurisdiction because it prevents Greece from retroactively changing the terms of the debt. (The Greek Parliament can’t change U.K. laws). Also expected to be part of the offer, a structure that puts the new bonds on par with the European Financial Stability Fund.

Greece has a principal repayment of more than $14 billion due in mid-March and it doesn't have the money. In fact, the country remains cash-flow negative each week. The debt negotiation must get done in order to first reduce the size of that payment in March, and second to get the next tranche of bailout money from their European partners.

If those things don’t fall into place, a default is highly likely. The only other remedy would be a last-minute emergency injection of cash. Where could that come from? Perhaps other European countries, but that would be a tremendous political hurdle to climb.

Working backwards from the mid-March date, the debt renegotiation needs to get done by the end of January simply for logistical reasons; making sure the offer reaches bondholders and they have in turn enough time to tender their bonds. That is, if they plan to. Many do not.

Although European leaders Angela Merkel of Germany and Nicolas Sarkozy of France have demanded this deal be “voluntary” (i.e. that it doesn’t generate a credit event triggering credit-default swaps ), there is still a risk that is exactly what will happen. Short-term bondholders, especially if they have bought credit default swaps(CDS)or other types of insurance, have no incentive to hand in their bonds. Greece must pay them 100 cents on the dollar, and if Greece doesn’t pay, its insurance pays off. Investors are made whole either way.

One way to force bondholders to tender their existing debt is to impose a “collective action clause” retroactively. That means Greece could simply change the terms of the old debt, and decide that if a certain percentage of bondholders, say 75 percent to 90 percent, agree to tender, then the deal is imposed on every bondholder.

However, this, too, would trigger a credit event because changing the terms of a bond is understood to be a triggering event under the terms of CDS contracts. European leaders are concerned a credit event could trigger a Lehman-like contagion in the euro zone.

Yet another option is for Greece to change its laws at the parliamentary level, rather than changing the terms of the old debt. Passing that law in and of itself is not a credit-triggering event. But what remains uncertain to market participants is this: If enough bondholders still don’t tender their bonds, and then Greece imposes the Collective Action Clause, is that a CDS triggering event? That will be decided by a committee from the International Swaps and Derivatives Association, and some market participants say it is impossible to predict what a committee will do, especially when there is so much political pressure from European leaders to avoid it.