As Greek Restructuring Looms, Bondholders Think Twice About Other Sovereign Debt -

The New York Times

February 24, 2012

Given Greek Deal, Investors May Reconsider Sovereign Debt

LONDON — As Greece starts sending out a formal debt restructuring offer to its private sector bondholders in the coming days, the hard-line approach Athens has taken, requiring steep losses for creditors, has prompted fears that other weak countries in Europe might do the same.
By passing a law this week that gives the government the right to impose a loss of as much as 75 percent on all investors who own bonds governed by Greek law, which covers 92 percent of bonds outstanding, Greece has, with one stroke, sharply increased its chances of erasing 107 billion euros ($144 billion) from its total debt burden of 373 billion euros ($496 billion).
The debt restructuring, if successful, would be the largest in recent history, and the losses by banks, hedge funds and other private investors would be among the most painful ever. In this regard Greece trails only Iraq, which imposed an 89 percent loss on its bondholders in 2006, and Argentina, with a 76.8 percent loss in 2005.
Greece has also raised the odds that, as the pain of austerity increases in countries like Portugal and Ireland — to say nothing of Spain and Italy further down the road — the temptation for other countries to turn a similar legal trick will grow stronger.
More than 97 percent of the outstanding bonds of Spain, Italy, Portugal and Belgium are governed by local law. In theory, these countries could enact legislation similar to Greece’s and thus pass on the cost of reducing their debt to well-heeled bondholders, rather than to retirees and civil servants.
“When push comes to shove, a government will always favor the interests of its domestic population over foreign creditors,” said Ajay G. Jani, a portfolio manager at Gramercy, an investment firm that is based in the United States and was involved in the restructuring negotiations in Argentina.
The Greek finance minister, Evangelos Venizelos, told opposition party lawmakers in Parliament on Friday that without the debt swap, the country’s pension funds would be wiped out, according to Bloomberg News.
Investors in Greek bonds will have weeks to consider the offer to trade in their old paper for longer-term securities, which was officially announced Friday. The hope is that enough investors sign up for the deal that it can conclude before March 20, when Greece faces a debt payment of 14.5 billion euros ($19.3 billion).
The restructuring proposal is a crucial component of the 130 billion euro ($173 billion) bailout that Europe and the International Monetary Fund have agreed to in return for a new round of Greek austerity measures.
But the deal would have no chance of getting done if there were not collective action clauses attached to the bonds in question, clauses that will require all investors to take a loss as long as 66 percent vote in favor.
Such a step is taken only in extremes, when a country’s debts are so punishing that it has little hope of ever persuading the private sector to lend to it, as is the case with Greece.
Italy, Spain and Belgium remain active international borrowers, albeit at higher rates. Bailed-out Portugal is hoping to return to the bond market in the coming years.
But after the Greek experience, investors might think twice before investing in those local-law bonds, no matter how high the yield.
Analysts expect that investors holding Greek-law bonds will accept the offer and trade for a package of long-term Greek bonds and two-year securities issued by the European Financial Stability Facility, Europe’s 440 billion euro ($585 billion) bailout fund.
As the thinking goes, better to get something — in this case, 25 cents on the euro — than nothing, which would be the long-term value of the Greek bonds that investors would be left with if they spurned the offer.
Investors who might oppose the deal, hoping to be paid in full, are probably not those holding the Greek-law bonds; they would be owners of the 20 billion euros ($27 billion) or so of Greek bonds that are governed by English or other European law.
Brokers and traders say that there has been a rush of interest on the part of hedge funds for these foreign-law bonds. Like their Greek-law counterparts, these securities have collective action clauses. But because they apply on a bond-by-bond basis, rather than to all bonds outstanding as with the local-law variety, it becomes easier for investors to challenge Greece over any attempts to impose a loss.
“That increases the likelihood of holdouts and makes it easier to buy a blocking position,” said Mitu Gulati, a sovereign debt specialist at Duke University Law School, referring to the strategy whereby a number of investors can effectively corner the market in a security and then force the government to rescind the discount and pay in full.
Foreign-law bonds can also be more attractive to foreign investors because they allow bondholders to pursue legal action away from local courts, which are unlikely to look with favor on foreign investor claims.
As their popularity has risen, the price of foreign-law bonds has surged. One English-law Greek bond that will pay out 450 million euros ($598 million) to investors on May 15 is being priced at 79 cents, more than double the price of similar local-law bonds, according to Bloomberg.
Traders warn that because there is so little trading volume in the bonds, pricing them is a precarious exercise, and there is no guarantee that the bonds will change hands at that price.
“There is buying interest,” said Gabriel Sterne, an economist at Exotix, an investment bank based in London that specializes in trading and analyzing distressed debt. “People think that the odds are pretty good that you will get paid out.”
While no one entity has emerged as a primary leader of the Greek holdout crowd, traders frequently mention Aurelius Capital Management, a hedge fund based in New York, as one that might bet there is money to be made by taking Greece to court.
Aurelius fought a bitter legal battle in Ireland over the forced losses that it took on the bonds of Allied Irish Bank, a failed lender bailed out by the government, and won a settlement that was favorable enough that it dropped the case.
A spokesman for Aurelius declined to comment.
It is far from clear, however, if any scramble to block the Greek deal by accumulating foreign-law bonds will pay off. Greece, after all, is broke, and the hard line taken by Europe with regard to forcing losses on investors leaves little chance that Athens may decide to pay off foreign bondholders so they will not sue. And if an investor were to sue, the process would take years and cost many millions in legal fees.
Mr. Jani, the portfolio manager, pointed out that 10 years after Argentina defaulted on its bonds, which were all foreign-law securities, holdout investors had not received a penny.
“If you get into a situation where you own bonds of a sovereign that does not want to pay, it does not matter what court you are in,” he said.