By Tyler Durden and Marla Singer

The media world is aflutter with recent revelations that Goldman may have facilitated Greece in creating an SPV that "rebalanced" budget payments via an interest rate swap arrangement, which the NYT describes as "a currency trade rather than a loan, [which] helped Athens meet Europe’s deficit rules while continuing to spend beyond its means." For those curious to get a much more detailed perspective on the mechanics of not just this, but a comparable Goldman-facilitated transaction, we suggest the following article in Risk Magazine, which focuses on a similar prior deal completed over six years ago. Yet we are fairly confident that all this barrage of information is merely a Houdini distraction act: the prospectus of the February 2009 securitization deal clearly delineates the mechanics of the deal; it was full public knowledge. Of course, a Europe gripped by sudden chaos due to their aggressive and quick "bail out" response with no regard for public backlash, is now taking full advantage of this recent "discovery" to make it seem that Greece and Goldman were hiding even more information: Bloomberg reports that "Greece was ordered by European Union regulators to disclose details of currency swaps it may have used to deal with the debts that threaten to swamp its economy." Germany's CDU has gone one step further and claims that the "Goldman deal broke the spirit of Euro rules." Alas, this is nothing but more scapegoating while Europe tries to find its bearings and, if possible, back out of the bail out while finding more pretexts to throw Greece out of the euro zone entirely. If it takes a Goldman smear campaign, so be it.

However, where the rub truly lies, and where things for Greece may get very hairy fairly quick, is in the interplay between the rating agencies and the rating of the Goldman underwritten swap agreement securitization SPV known better as Titlos PLC. As one recalls, it was precisely the rating agencies that were the proximal catalyst that started the collateral call cascade that ultimately resulted in AIG's failure and subsequent bailout (ignoring for a moment the pent up toxicity on AIG's books: both AIG then, and Greece now, are in deplorable shape: the question is what will bring it all to the surface). So here are some recent facts: On December 23, 2009, Moody's downgraded Titlos, following the prior day's downgrade of Greece itself from A1 to A2 with a negative outlook. Fact: last week Moody's said it could further downgrade Greece to Baa1. Fact: the Titlos PLC rating mirrors that of Greece itself. Fact: according to Moody's "Framework for De-Linking Hedge Counterparty Risks from Global Structured Finance Cashflow Transactions Moody's Methodology" a counterparty can enter into a hedge transaction with an SPV and continue to participate in that transaction without collateralizing its obligations so long as it maintains a long-term senior unsecured rating of at least A2. When (not if) Titlos is downgraded again, and its rating drops below the A2 collateralization threshold, look for AIG's margin call driven liquidity crisis escalation from the fall of 2008 to spread to Greece. And that's not all. The Titlos SPV itself may be null and void should the rating of the National Bank of Greece, as the Hedge Provider, drop below a "relevant rating" as defined in the hedge agreement. Should Greece then be forced, at Titlos' option, to unwind the swap agreement, and be forced to cash out to the tune of €5.4 billion (net of the 107.54 issuance price), look for all hell to break loose.

Some background

On February 26, 2009, with Goldman Sachs as arranger, Titlos PLC, a Special Purpose Vehicle, issued €5.1 billion of notes at 107.54 (rated A1 by Moody's, no S&P rating) to finance its purchase of swap rights from the National Bank of Greece (NBG) as part of a securitization transaction, whereby Titlos paid the NBG over €5 billion in "novation consideration", while at the same time effectuating a fixed/floating rate payment arrangement with the Hellenic Republic. It is this last bit that has the panties of a collective Europe in a bunch, as the actual payments are not indicative of the "true" budgetary situation in Greece. Keep in mind that the actual interest rate swap was closed, very much publicly, on December 31, 2008 (from the prospectus: On 31 December 2008, the Hellenic Republic and NBG entered into an interest rate swap transaction governed by an International Swaps and Derivatives Association, Inc. ("ISDA") (Multicurrency – Cross Border) 1992 Master Agreement dated as of 25 July 2005.) There is nothing hidden here. The danger is elsewhere.

A graphic representation of the securitization arrangement from the prospectus is provided below.

It is oddly curious that the Titlos transaction prospectus, which until recently could be hyperlinked from the Greek National Bank's website at the following location, has been mysteriously pulled. Note that not only the prospectuses but also the investor reports for the other (much more minor) GNB securitization deals Eterika PLC and Revolver 2008-1 PLC are fully accessible and available on the GNB site (and certainly worth the read). Zero Hedge has retained a copy of the Goldman Sachs arranged Titlos deal prospectus, which is presented in full below (we can provide pdf's upon request):

Those of you on a tight time schedule are in luck, for here is the summary version of the transaction courtesy of the only rating agency to have rated the deal (A1 at issuance): Moody's.

In December 2008, National Bank of Greece S.A. (“NBG”) (Aa3, Prime-1) entered into an interest rate swap transaction with the Hellenic Republic (the “Hellenic Swap”). On the closing date, NBG novated the Hellenic Swap to the Issuer (subject to certain amendments to its terms) pursuant to a Novation Agreement. The initial purchase price paid by the issuer under the Novation Agreement was equal to the issuance proceeds of the Notes. At the same time, the Issuer entered into a Hedge Agreement with NBG comprising two swap transactions (Swap 1 and Swap 2), to exchange its cashflows from the Hellenic Swap for cashflows matching the interest and principal payments under the Notes plus a margin to cover the Issuer’s on-going expenses.

And some additional summary deal details from Moody's:

Issuer established in the UK

The Issuer is established as a bankruptcy remote vehicle incorporated in the UK.

Novation Agreement

The rights and obligations of NBG under the Hellenic Swap were transferred by NBG to the Issuer by way of novation pursuant to a Novation Agreement between NBG, the Hellenic Republic and the Issuer. The Issuer used the proceeds of the Notes to pay NBG the initial consideration for the novation. The Issuer will also pay deferred consideration to NBG to the extent of excess funds on each interest payment date after all items ranking senior in the relevant priority of payments are paid in full.

Greek legal counsel has opined that the Novation Agreement is valid and enforceable and that, on the basis that NBG was solvent as at the time of the novation, the Issuer’s rights under the Hellenic Swap could not be “claw-backed” following the insolvency of NBG. Further, they have opined that the novation will not be re-characterised as a secured loan, despite the fact that NBG retains a right of re-novation (see below).

Under the Novation Agreement, the Hellenic Republic has waived any right to set-off existing claims owing to it by NBG against its payments to the Issuer under the Hellenic Swap. Further, the events of default and termination events in the Hellenic Swap with respect to the Issuer have been modified in accordance with Moody’s Hedge Framework.

Here is the actual detail of the underlying swap: dear CDU and Angela Merkel - we are fairly confident that you can afford Moody's as of circa February 2009, to not sound quite so indignant:

Hellenic Swap

The Hellenic Swap between the Issuer and the Hellenic Republic has a fixed notional amount of Euro 5.5bn and is scheduled to terminate on 20 September 2037. TheIssuer pays 4.50% annually and the Hellenic Republic pays 6 Month Euribor + 6.6025% semi annually. The Hellenic Republic (but not the Issuer) is required to gross-up for any tax in relation to its swap payments.In order to make scheduled payments to Noteholders, the Issuer relies on, among other things, the receipt of amounts payable to it under the Hellenic Swap. Payments under the Hellenic Swap are due to be paid on the same date as the corresponding payments under the Notes, giving rise to a potential operational risk.

Hedge Agreement for Swap 1 and Swap 2

The Issuer has entered into a Hedge Agreement comprising two swap transactions with NBG as Hedge Provider.

Swap 1 has a fixed notional amount of Euro 5.5bn and is scheduled to terminate on 20 September 2037. Under Swap 1, the Issuer exchanges a flow of floating rate receipts into a stream of fixed rate payments. By virtue of payments under the Hellenic Swap and Swap 1, the Issuer retains a net fixed amount semi-annually. The Issuer uses such net amount to (i) make fixed payments under Swap 2, (ii) make scheduled principal payments under the Notes and (iii) replenish the expenses reserve fund.

Swap 2 has a notional amount that tracks the amortising principal amount of the Notes and is scheduled to terminate on 20 September 2037. Under Swap 2, the issuer makes fixed payments in exchange for floating amounts that equal the interest due under the Notes.

The Hedge Agreement complies with Moody’s hedge de-linkage criteria for cash flow transactions1. Therefore Moody’s has not modelled the impact of NBG’s credit risk (as Hedge Provider) on the expected loss posed to investors.

The full Moody's New Issue Report can be found here.

Digging Deeper

So much for the smoke and mirrors. Everything that Europe is now complaining about has been public for about one year. Granted, it is extremely disingenuous of the entire European financial cavalry to bring attention to it now that they are looking for a scapegoat in backing out of the Greek rescue.

But that's the headlines for popular consumption. Reading between the lines reveals something quite nastier.

On Christmas Eve eve, with very little fanfare, Moody's quietly downgraded not just Greece From A1 to A2, but Titlos from A1 to A2 as well.

Paris, December 23, 2009 -- Moody's Investors Service has today downgraded to A2 from A1 the rating of the notes issued by Titlos plc. This rating action follows Moody's downgrade of the foreign and local currency ratings of the government of Greece to A2 from A1 on 22 December 2009. Moody's rating for the Titlos plc transaction is linked to the rating of the the Greek government on a one-to-one basis. Issuer: Titlos plc Downgraded to A2 from A1; previously Placed Under Review for Possible Downgrade on Nov 9, 2009.

This transaction, which closed in February 2009, represents the securitisation of a swap agreement (the Hellenic Swap) originally entered into between the National Bank of Greece, S.A. (NBG) and the Greek government. The issuer relies on payments by the Greek government under the Hellenic Swap in order to pay amounts falling due under the notes.

The issuer is also a party to two swaps (the NBG Swaps) entered into with NBG for the purpose or matching payments under the Hellenic Swap to payments of interest and amortising principal required under the notes. On 22 December 2009, NBG's deposit and debt ratings were downgraded to A1 from Aa3. However, the NBG Swaps fully comply with Moody's criteria for de-linking hedge counterparty risks from structured finance transactions and, therefore, the rating action in respect of NBG has not influenced the rating action on the notes.

The principal methodology used in rating and monitoring the transaction is "Framework for De-Linking Hedge Counterparty Risks from Global Structured Finance Cashflow Transactions" May 10, 2007, which is available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website. Further information on Moody's analysis of this transaction is available on www.moodys.com.

So we decided to dig into Moody's "sub-directories" to pull this fabled "Framework for De-Linking Hedge Counterparty Risks from Global Structured Finance Cashflow Transactions" which is the golden grail on how Moody's evaluates all structured finance transaction. The full 46 page report can be found here for those who have gobs of time to sift through the definitions and trigger clauses. Luckily, law firm Orrick (anchor tenant of 666 Fifth Avenue which will soon be making some pretty serious waves in CMBS land when the property defaults, but that is a story for another day) has provided a cliff notes version of the Moody's report. What immediately drew our attention is the definition that Moody's gives for threshold eligibility for counterparty rating "without the need to collateralize the underlying obligations":

The Moody’s Criteria permits a hedge counterparty to enter into a hedge transaction with an SPV and continue to participate in that transaction without collateralizing its obligations so long as it maintains a long-term senior unsecured rating of at least A2 and a short-term rating of P-1 (or, if such hedge counterparty has only a long-term rating, at least A1) (the “Moody’s First Trigger Required Ratings”).

Unfortunately for Greece, one more downgrade of either Greece itself, or, much more relevantly, of Titlos, and here comes the collaterialization brigade, demanding excess collateralization margin sweeps. For a country caught in a liquidity crunch, this is not a welcome development. Images of a defunct AIG promptly come to mind.

Digging even deeper

In addition to the nightmare scenario of having to start posting collateral on Titlos, the even nightmarier scenario is that Titlos itself may well have the right to unwind the transaction if certain trigger thresholds are met. Continuing from Orrick:

Within 30 business days of a downgrade of a Moody’s rating to the Moody’s First Trigger, the hedge counterparty is required to either (i) post the “Moody’s First Trigger Collateral Amount” (described below), (ii) obtain a guaranty from a guarantor rated not lower than the Moody’s First Trigger Required Ratings, or (iii) transfer the hedge transaction at issue to a replacement hedge counterparty rated not lower than the Moody’s First Trigger Required Ratings (or to a replacement hedge counterparty that does not satisfy the Moody’s First Trigger Required Ratings but is rated at least P-2 and A3 (or at least A3 if it has no long-term rating), provided that any such replacement hedge counterparty immediately posts collateral in an amount equal to the Moody’s First Trigger Collateral Amount).

Within 30 business days of a downgrade of a Moody’s rating to the Moody’s Second Trigger, the hedge counterparty is required to post the “Moody’s Second Trigger Collateral Amount” (described below).31 Also, within 30 business days of a downgrade to the Moody’s Second Trigger, the hedge counterparty is required to use commercially reasonable efforts to either (i) obtain a guaranty from a guarantor rated above the Moody’s Second Trigger, or (ii) transfer the hedge transaction at issue to a replacement hedge counterparty rated above the Moody’s Second Trigger. If the hedge counterparty fails to obtain such a guaranty or effect such a transfer within the thirty business day period, the Moody’s Criteria requires that it continue to use commercially reasonable efforts to either obtain an eligible guaranty or identify an eligible replacement hedge counterparty for so long as it remains rated below the Moody’s Second Trigger.

And the piece de resistance:

The Moody’s Criteria requires that the SPV have the right to terminate the hedge transaction under either of the following circumstances: (i) the hedge counterparty is downgraded to the Moody’s First Trigger and fails to take appropriate remedial action within the applicable grace period, or (ii) the hedge counterparty is downgraded to the Moody’s Second Trigger and either (A) the hedge counterparty does not within the applicable grace period post the Moody’s Second Trigger Collateral Amount and/or does not use commercially reasonable efforts to obtain an eligible guaranty or to locate an eligible replacement hedge counterparty, or (B) the applicable grace period has expired, the downgraded hedge counterparty has not obtained an eligible guaranty or transferred the hedge transaction to an eligible institution and at least one eligible institution has submitted a “live bid” to replace the downgraded hedge counterparty. If, in the last of these situations, the SPV cannot terminate the hedge transaction because no live bid from an eligible institution is available, it will become entitled to declare an early termination and replace the downgraded hedge counterparty at such time (if any) as a live bid is provided and the downgraded hedge counterparty will remain obligated until that time to post the Moody’s Second Trigger Collateral Amount.

Our read of this data, and granted we are as far from conflicted Greek legal counsel or Moody's as possible, is that should the barrage of downgrades persist in the adverse scenario where European leaders continue posturing and making it seem that all the bailout talk from last week was merely semantics, that Titlos will have the option to unilaterally unwind the swap following a green light from Moody's. Ironically, it is precisely Moody's which is doing all it can to prevent an additional notching of either Greece and, by implication, Titlos, and certainly of the Greek National Bank, as it is well aware of the margin scramble that would result, culminating with a feedback loop that could kill the actual securitization agreement, and force massive, formerly Greece-beneficial cash payments to be repaid.

And while there could be some "soft" interpretation of the rating threshold of the SPV, where there is complete lack of doubt is the rating threshold of Hedge Provider itself: the National bank of Greece (at least initially). To wit from the prospectus:

Hedge Provider NBG will be the initial Hedge Provider under the terms of the Hedge Agreement.

Specific early termination "Put" clauses:

Hedge Transactions under the Hedge Agreement may be subject to early termination by the Issuer in certain circumstances, including but not limited to: (i) the Hedge Provider being in default by reason of failure by such Hedge Provider to make payments; (ii) the Hedge Provider being otherwise in breach of the relevant Hedge Agreement or having made certain misrepresentations; (iii) the rating of a Hedge Provider being downgraded below the relevant rating(s) specified in the relevant Hedge Agreement and the requisite remedial steps not being taken by the Hedge Provider as described in more detail in —Rating Downgrade or Withdrawal of the Hedge Provider" below; (iv) certain insolvency-related or corporate reorganisation events affecting the Hedge Provider; (v) any action being taken by a taxing authority or there being a change of relevant law or a merger of the Hedge Provider which results or will result in the Issuer receiving a payment from which an amount is required to be deducted or withheld for or on account of tax; or (vi) a change in law resulting in the illegality of the obligations to be performed by it under the Hedge Transaction.

And more troubling:

Rating Downgrade or Withdrawal of the Hedge Provider [i.e., Greek National Bank]

In the event that the rating of the Hedge Provider is downgraded below the relevant rating(s) specified in the relevant Hedge Agreement, then the Issuer has the right, subject to certain conditions, to terminate the Hedge Agreement unless the Hedge Provider, within the time period specified in the Hedge Agreement and at its own cost, takes certain remedial steps which may include: (i) providing collateral for its obligations in accordance with the terms of the Hedge Agreement; or (ii) obtaining a guarantee of, or a co-obligor for its obligations under the Hedge Transactions from a third party whose ratings are equal to or higher than the ratings specified in the Hedge Agreement, where the terms of the Hedge Agreement so provide; or (iii) novating all of its rights and obligations under the Hedge Transactions to a third party provided that such third party's ratings are equal to or higher than the ratings specified in the Hedge Agreement; or (iv) obtaining a confirmation from Moody's that the then current rating applicable to the Notes will not be downgraded, suspended or withdrawn as a result of the downgrading of the Hedge Provider's debt obligations.

Lastly, from the prospectus' Risk Factors section:

Credit Risk on the Hellenic Republic

The ability of the Issuer to make payments in respect of interest, principal and any other amounts due under the Notes depends ultimately upon the due performance by the Hellenic Republic of its obligations under the Hellenic Receivable. Any failure on the part of the Hellenic Republic to pay amounts under the Hellenic Receivable as and when such payments become due could result in a default by the Issuer in payment of interest, principal or other amounts under the Notes.

In the event that the rating of the Hellenic Republic is downgraded by any rating agency, there is no requirement for the Hellenic Republic to post collateral or obtain a guarantee or co-obligor in respect of its obligations in respect of the Hellenic Receivable or to novate its rights and obligations under the Hellenic Receivable to a third party. As a result, any downgrading of the Hellenic Republic may also result in a downgrading of the rating of the Notes notwithstanding that there may not have been any default by the Hellenic Republic under the terms of the Hellenic Receivable.

As well as this:

The Rating Agency may downgrade, suspend or withdraw its rating with respect to the Hedge Provider. The Issuer expects under the terms of the Hedge Agreement that in such circumstances the Hedge Provider will be obliged to use reasonable efforts to novate the Hedge Transactions to a replacement Hedge Provider or post collateral to the Issuer or enter into other suitable arrangements. However, there can be no assurance that the Hedge Provider will be able to find a replacement counterparty to enable it to novate the Hedge Transactions or that the Hedge Provider will be able to post collateral to the Issuer and/or enter into other suitable arrangements in this event or that the ratings of the Notes will not be downgraded, suspended or withdrawn in this event. If any rating assigned to the Notes is downgraded, suspended or withdrawn, then the market value of the Notes may be reduced.

Indeed, all the inherent risks are there, laid out by Goldman's legal crack team, black on white.

Where does the National Bank of Greece stand in the downgrade cascade? On December 23, Moody's downgraded the NBG from Aaa3 to A1. As pointed out previously, the threshold eligibility criteria is A2. Should Moody's downgrade Greece to the first Trigger Rating of A3 or lower, let alone its threat to cut Greece to a whopping Baa1, and all Special Purpose Vehicle bets are off.

Financial analysts are all too aware of the liquidity bottleneck which Greece faces in April and May when roughly €8 billion in near-term bond maturities are due.

As it stands, absent a European "bail out", in the form of guarantees or German banks directly purchasing Greek bonds, this maturity would be unfundable, precipitating the Greek default. Should Titlos add another forced "put" option of over €5.4 billion, and it is surely game over for Greec, starting the on, and, as this story has shown, much more importantly off, balance sheet contagion.

In conclusion, the real story from this weekend is not that Goldman arranged the Greek swap: this information has been public for almost a year, and making waves out of it merely demonstrates European hypocrisy in doing (or at least saying) one thing last week, and now promptly seeking to undo it (and as to whether or not the Greek National Bank pulled the prospectus on purpose or this was merely a clerical error is not up to us to decide). What is the real story, however, is that far from mere observable, on-balance sheet funding needs, Greek has suddenly found itself at the mercy of a Moody's, whose just one additional notch down, would increase the funding needs by almost 40% in addition to near term maturity requirements. Score yet one more for the off-balance sheet securitization puzzle, so prevalent in our day and age, courtesy of Wall Street's "innovation" masters - Goldman Sachs.

Later today: Just Who is Titlos Anyhow?