Greece Sets Out Plan to Help Banks Shed $83 Billion of Toxic Debt

(Bloomberg) -- The Greek government has set out its blueprint for helping the country’s banks reduce a 75 billion euro ($83 billion) pile of toxic debt left over from the last recession.

The plan aims to speed up sales of non-performing loans by Greek lenders, repackaging them into securities with the state guaranteeing the safest portions. It’s based on a model used in Italy but unlike that program, the safest tranches of Greece’s NPLs will have a BB- rating -- three steps into junk territory.

Those senior notes will be repaid first in a “waterfall” structure, according to an internal European Commission memo authorizing the program seen by Bloomberg.

Greece’s economic recovery is being hindered by the amount of bad loans held by banks, a legacy of the country’s debt crisis that forced it to seek multiple international bailouts.

After securing the approval of the EU’s executive arm, the government in Athens is now preparing a bill to launch the project. The program, known as Hercules, is likely to come into effect before the year end and contribute around 200 million euros annually to Greece’s public budget from the fees it generates, government spokesman Stelios Petsas said Tuesday.

The arrangement marks a first stage in government strategy to cut 30 billion euros of NPLs -- around 40% of the total backlog -- from the balance sheets of Greek banks, a finance ministry spokesman said. George Zavvos, Greece’s deputy finance minister will hold meetings with investors at the IMF’s annual meeting in Washington D.C., according to the spokesman.

Lenders including Piraeus Bank SA, Eurobank Ergasias SA, Alpha Bank AE and the National Bank of Greece need to cut NPLs by some 50 billion euros by 2021 to meet regulatory targets.

These are the key details of the Hercules program, outlined in the EU memo:

  • The legislation must follow the framework agreed with the commission, under which around 9 billion euros in state guarantees will be mobilized. For these guarantees to be activated, the banks will first have to sell at least half the junior bonds issued in the securitization.
  • Banks will pay fees for these guarantees that are calculated using Greek credit-default swaps. Three-year Greek CDS currently stand at 137 basis points, the lowest in a decade.
  • The senior tranche of the notes will need at least a BB- rating from two agencies to obtain the guarantee.

Six Steps

According to the commission document, there are six main steps in the plan:

  • Step 1: The bad loans will be securitized in three tranches - a senior, a mezzanine, if necessary, and a junior. The state guarantee will only apply to the senior part.
  • Step 2: Both the senior and the mezzanine will have a floating coupon and a flexible redemption structure to pass on cash flows from the securitized NPL portfolio. Coupons will be paid quarterly or annually and are based on the remaining notional value of the notes.
  • Step 3: The guarantee can be activated only if the rating of the senior tranche of the securitized note is not lower than a BB- and it will become effective only after the bank has sold at least 50% plus one share of the junior tranche. The junior and the mezzanine notes can’t be bought by the state or state-related bodies or companies.
  • Step 4: Upon securitization, the bank will appoint an independent servicer to work-out the underlying NPLs of the securitization structure.
  • Step 5: To manage potential liquidity mismatches between cash flows from the underlying NPL portfolio and contractually obligatory coupon payments on the senior and the mezzanine notes, the securitization structure will have a liquidity buffer sufficient to achieve the minimum required rating.
  • Step 6: The initial appointed NPL servicer can be replaced if the state guarantee is called upon and if after two consecutive interest payment dates it has recovered less than initial projections.

Pays First

Obligatory payments, such as fees to servicers, interest on the liquidity line, guarantee fees on the senior notes and interest on the senior notes will be paid first. Then, the order for the use of the cash flow generated by the underlying portfolio will be:

  • interest on the mezzanine notes, subject to performance triggers
  • repayment in full of senior notes
  • full repayment of mezzanine notes
  • pay-out of junior notes

Pricing of Guarantees

The fee that banks will have to pay for the state guarantees will be based on a “pre-adjustment fee” multiplied with an “adjusted spread ratio factor.”

The starting point of the pre-adjusted fee will be the average over the last two months of Greece’s CDS mid-prices at the time of the transaction and the step-up fee will be the following:

  • in years 1, 2 and 3, the price of the 3-year benchmark CDS
  • in years 4 and 5, the price of the 5-year benchmark CDS
  • in years 6 and 7, the price of the 7-year benchmark CDS
  • thereafter, the price of the 10-year benchmark CDS

On top of that, there will be a penalty if the senior tranche is not being repaid in full. Also, the adjusted spread ratio factor will take into account the difference in the rating class of the senior tranche and the average rating of the benchmark CDS.

©2019 Bloomberg L.P.

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