Friday, 28 October 2011

The Thrill and Joys of Free Riding


Despite the EU statement’s vagueness on Greece, this new communiqué reiterates is the idea of the voluntary character of the PSI exchange and that the ECB will be exempt from participating.
ECB
While politicians muddled through the response to the Greek Crisis over the last 2 years, the ECB was forced over to engage in unorthodox monetary operations in order to firefight the European debt crisis. Part of it involved the activation of the Securities Market Program whereby the ECB purchased outright Government bonds of Greece, Ireland and Portugal and more recently Italy and Spain.
Although the ECB is no longer buying Greek Bonds in the secondary market, it is estimated that it still currently owns around 45billion worth of Greek bonds. Most market participants believe that the great majority (around 75%) is concentrated in the near maturities, namely 2012-2014. These bonds however, are not marked to market by the ECB but instead they are marked at the purchase price and amortized to Par. If the ECB participates in the current PSI proposal, the remarking of these bonds to their true value would result in a huge loss on their position. We guess-estimate that the average purchase price of its Greek bond holdings was around 78%.  Assuming they are marked at the purchase price, the losses would exceed €12bn and would be larger than the ECB €10.8bn of equity, forcing the ECB to raise capital from its shareholders (National Central Banks). However, as they are marked at Purchase price plus amortization to Par, the losses would be even greater if the ECB is forced to take a 50% cut on their position (18-20billion). Hence, the insistence of the ECB in exempting herself from any Greek restructuring. According to press reports the ECB tried to offload their holdings to the EFSF back in March but the European leaders refused the request. Apparently, Jean Claude was not pleased and henceforth hardened his stance towards the politicians who got him into this mess.

PSI
The new PSI that was announced on the 27th October however, involves a 50% outright haircut on the face value of the Greek bond, should one chose to participate. We do not have details on what is going to happen to the other 50%, but it is highly likely that holders would suffer some NPV losses on top of the notional loss. This means one thing. The incentive to Free Ride along the ECB has been greatly increased risking the PSI participation.

FREE RIDING
So, if you chose to free ride along the ECB, what is the best strategy and what can we say about the voluntary participation on the PSI. Let’s go through the process step by step: 
  • In December 2011 the IIF concludes the initial discussions on the exchange and collects commitments. By then, bond holders would know the size of the haircut (Face+NPV) and the options available. Given the large size of the haircut one of the carrots must be that the new bonds would be under English law (with CACs and Negative Pledges etc) and as much as possible collateralized with AAA zero coupon or upfront payments.
  • In January 2012 the exchange would take place. Following this, most of the Greek debt would be “External debt” (not under Greek jurisdiction) apart from the ECB holdings and any Free Riders. 
  • If now the EU or the Greek government wishes to punish these Free Riders it can do so easily by changing the terms of the bonds that are still under Greek law. The problem is that the great majority of the Free Riders consist of the ECB who owns 45billion. Thus, unless the ECB offloads these bonds to some third party the EU/Greece would have to wait until the stock has come down through redemptions.  Given that the ECB owns mostly maturities of 2012-2013 this pushes the punishment to 2013. These ties nicely with the introduction of the ESM. In conclusion, the risk of punishing the Free Riders increases after 2013 and is minimized the closer we are to 2012 (see table of bonds). 
  • The Free Riders who already own Greek bonds under English law (those with ISIN that does not begin with GR) do not have to do anything (see table). They can sit and wait to be paid. They are Pari Passu and are protected by English law as much as the PSI ones. If they try to punish them then they are risking punishing the PSI bonds too. Thus there is little incentive for bond holders of Greek bonds under English law to participate in the PSI and every incentive to go and buy them now and wait.

In conclusion, given the large size of the haircut that was decided and the large side of the ECB holdings, we expect many hold outs and Free Riders in Bonds maturing up to 2013 and in the bonds under non-Greek law. Whether this is enough to risk the PSI participation remains to be seen, but at least for investors holding bonds maturing in 2012-2013 the future looks brighter after the EU summit.

Bonds under Greek law maturing through 2014. There are 45billion maturing in 2012-13.
Currency
Coupon
Maturity
Size
EUR
4.30%
20-Mar-12
  14,400,000,000.00
EUR
5.25%
18-May-12
    8,000,000,000.00
EUR
4.10%
20-Aug-12
    7,700,000,000.00
EUR
4.60%
20-May-13
    9,100,000,000.00
EUR
4.00%
20-Aug-13
    5,800,000,000.00
EUR
6.50%
11-Jan-14
    4,600,000,000.00
EUR
4.50%
20-May-14
    8,500,000,000.00
EUR
5.50%
20-Aug-14
  12,500,000,000.00


List of bonds issued by the Hellenic republic and are under non-Greek law (up to 2020). For details one has to look at each prospectus. The size is around 15billion.
ISIN
Currency
Coupon
Maturity
Size in Currency
Size in EUR (appox)
XS0147393861
EUR
FRN
15-May-12
 450,000,000
 450,000,000
FR0000489676
EUR
4.915
13-Sep-12
 200,000,000
 200,000,000
XS0208636091
EUR
3.5625
21-Dec-12
 250,000,000
 250,000,000
XS0165688648
EUR
4.495
02-Apr-13
 430,000,000
 430,000,000
XS0372384064
USD
4.625
25-Jun-13
 1,500,000,000
 1,079,136,691
CH0021839524
CHF
2.125
05-Jul-13
 650,000,000
 532,786,885
XS0142390904
EUR
5.46
30-Jan-14
 197,000,000
 197,000,000
XS0097596463
EUR
VAR
21-May-14
 70,000,000
 70,000,000
JP530005AR32
JPY
7.35
03-Mar-15
 10,000,000,000
 95,238,095
JP530000CR76
JPY
5.8
14-Jul-15
 20,000,000,000
 190,476,190
FR0010027557
EUR
4.68
29-Oct-15
 200,000,000
 200,000,000
JP530000BS19
JPY
5.25
01-Feb-16
 30,000,000,000
 285,714,286
XS0165956672
EUR
4.59
08-Apr-16
 400,000,000
 400,000,000
XS0357333029
EUR
FRN
11-Apr-16
 5,600,000,000
 5,600,000,000
XS0193324380
EUR
FRN
24-May-16
 250,000,000
 250,000,000
JP530000CS83
JPY
5
22-Aug-16
 40,000,000,000
 380,952,381
XS0071095045
JPY
4.5
08-Nov-16
 40,000,000,000
 380,952,381
JP530005ASC0
JPY
4.5
06-Dec-16
 8,700,000,000
 82,857,143
XS0215169706
EUR
4.028
17-Mar-17
 450,000,000
 450,000,000
XS0078057725
JPY
4.5
03-Jul-17
 30,000,000,000
 285,714,286
XS0079012166
JPY
3.8
08-Aug-17
 50,000,000,000
 476,190,476
XS0160208772
EUR
5.014
27-Dec-17
 165,000,000
 165,000,000
XS0260024277
EUR
FRN
05-Jul-18
 2,100,000,000
 2,100,000,000
XS0286916027
EUR
VAR
22-Feb-19
 280,000,000
 280,000,000
IT0006527532
EUR
5
11-Mar-19
 200,000,000
 200,000,000
XS0097010440
JPY
3
30-Apr-19
 25,000,000,000
 238,095,238
XS0097598329
EUR
VAR
03-Jun-19
 110,000,000
 110,000,000
XS0280601658
EUR
4.218
20-Dec-19
 255,000,000
 255,000,000
XS0224227313
EUR
VAR
13-Jul-20
 250,000,000
 250,000,000