Careful about Private Participation in Greek Aid

Currency in Crisis

Many people in the market have concluded that new Greek aid is a done deal. The EU/IMF/ECB concluded their review before the weekend and it is expected to lead to Greece being able to draw down its next tranche of aid under the existing program. This in turn augers well for the second aid package, the one that just a few hours ago a German official suggested does not necessarily need the EFSF.

The second aid package innovates in terms of the privatization efforts and more emphasis on getting current holders of Greek obligations that mature in the next couple of years to roll-over into longer maturities.

There is a risk that is under-appreciated today about the private sector participation. At this juncture it is important to note that the shift that has taken place over the last couple of weeks is not so much that Germany has waived their desire for private sector burden sharing as the media clamored recently, but rather the ECB appeared to embrace what has been called the Vienna Initiative to get the private holders to keep some proverbial skin in the game.

In addition, it is also important to recognize that the Vienna Initiative is contrary to what had been anticipated to be a shift of Greek exposure from the private sector's weak hands, to the public sector's strong hands. This was thought to make the eventual debt restructuring easier and less disruptive.

S&P issued a warning on before the weekend that appears to have largely been lost in the shuffle of the disappointing US jobs data and the conclusion of the IMF/EU/ECB review of Greece with positive implications.

The warnings were over the role of the private sector. S&P realizes that within the context of increased default risk and falling ratings, that a volunteer rolling over of short-dated maturities may not be so voluntary after all. It referred to the possibility of a "distressed exchange" as the current holders fear less desirable consequences of declining to participate.

As an inducement to roll-over maturities, there has been some discussion of giving the new bonds more senior status. S&P warns that this would dilute the claim of existing holders and could be judged a CDS event. Nor will a higher coupon (than the maturing bonds) be a clear solution either as S&P seemed to indicate that the key yield is not existing coupons but market rates.

According to press reports (WSJ), the private sector roll-over was supposed to raise as much as 30 bln euros. But the risk is on the downside, especially if S&P concerns are taken on board, limiting inducement incentives. This means that the size of the second aid package may have to be a bit elastic. Der Speigel warns that a second package could be nearly as large as the first package which was 110 bln euros. Previously talk suggested about a 60 bln euro package. And of course, this says nothing about the substantial implementation risk.