Wednesday, 29 February 2012

Trading the PSI Invitation

The offer to exchange the Greek bonds is under way and the question everyone is asking is what is going to happen. Would the hold outs in March 12 be paid? Would the Hell.Republic activate the CAC’s or would it proceed voluntary? What would happen to the Foreign Law bonds?

90% or more? CAC or Voluntary?

The Hell.Republic’s invitation states that if the participation in the offer is more than 90% then it would proceed with the exchange. It does not say however, whether it would proceed with or without activating the CAC. In other words it leaves the room for a possible 10% holdouts.

Let us do a thought experiment (Gedankenexperiment were introduced by Einstein in his Theory of Relativity). Suppose that the 90% is reached. Who are the 10% holdouts? Well 10% is equivalent to 20.5billion of bonds. A rational investor in order to maximise his chances of holding out would either hold the near maturities or own the Foreign law bonds.
  • 22billion of Greek bonds maturing in 2012 (no PSI). The other 11billion are owned by the ECB!!
  • 3.1billion out of the 21billion of Foreign law bonds mature up to and including 2013. From 2014 up to and including 2016 there are 8.2billion of Foreign law bonds.
I use 2012 and 2013 since the probability of Greece doing another “liability exercise” (Official Greek euphemism for default) is very high even after the PSI restructuring. Out of the 22billion of Greek law bonds my guess is that much of it is in the hands of Greek banks and Greek pension funds or banks that are amenable to the gentle German pressure. If half of it is in the hands of holdout investor and retail bondholder then we need no more than 10billion of Foreign law bonds to hold out in order to proceed with the 90% exchange. We also know that many of the Foreign law bonds are in the hands of Greek pension funds and Greek banks.
In other words, to reach the 90% participation we need to have almost half of the 22billion and almost all the Foreign law bonds maturing up to and including 2016 to hold out.
Thus the scenario of reaching 90% is something that can be achieved under some soft assumptions.

Retail holders
Would the Republic activate the CAC’s in this case? The CAC’s would only affect the Greek law bonds and therefore would push the assumed 10billion of hold outs to participate. Out of these 10billion around 5billion are in the hands of retail (Greek residents own around 2.5billion). Thus by activating the CAC’s you punish disproportionally retail investors and the Greek government has expressed its willingness to make good at least the losses to the Greek residents. Hence why activate the CAC’s if you are going to pay back the gains at least to some (around 2.5billion). The Republic’s gain is limited compared to the fuss and possible litigation that is going to create both from non-Greek retail and domestic.

The Foreign law bonds on the other hand are not subject to this CAC activation. Bondholders would be asked to vote in separate meeting that would take place between 24th and 29th March (after the famous March bond maturity). If CAC’s are used or if tomorrow ISDA determines that there has been a credit event (CDS pay) then some of the Foreign law bonds would become immediately payable. Would Greece also go into full blown default with failure to pay? We do not know the answer to this question and we will not risk a guess. 

Can a bondholder cause a credit event?
Here is another fun part of the process. Assume that the 90% is reached and the Hell.Republic decides to keep everything voluntary. It pays the hold outs on the March 12 (and the ECB which owns 4.6billion). Then it goes to the bondholder’s meeting on the 27th of March and someone has a majority of a particular Foreign law bond. This investor however, has a lot more in CDS and it decides to use his majority to pass the Republic’s proposal and thus cause the CDS to trigger even if there was no trigger by the Republic! In this case, only the bonds with Cross-default would be affected (New Greek PSI bonds do not have cross-default). Nevertheless the damage is done. Thus, there are many games that may be played in the next few days. 

Greece reserves the right to buy back
In the offering, it is explicitly stated that Greece reserves the right in the future to buy back some of the bonds or to initiate more restructuring offers. This to me points to another option; that of keeping the PSI voluntary if participation is high and trying to buy back some of the bonds left over afterwards in the open market. If you think about it, it is not such a bad idea. Most of the leftover would still trade at low prices (high yield) and buying them back may be the optimum solution. In fact buying back the debt at prices lower than 46.5% (haircut of 53.5%) reduces the nominal debt of Greece even more!

Prices of Greek Bonds

The majority of Greek bonds (Greek law) trade in the low 20’s with the March 12 trading at around 27. Are they cheap or expensive? How much would an investor loose or gain if he buys them now?

Assume that you buy a Greek bond at around 20%. Then, whether you tender it to the exchange or you are CACed into it you will get back (a) 15%, (b) the accrued interest you paid, (c) a new 30Y Greek bond, (d) a GDP warrant.

The GDP warrant is almost close to worthless, so assume zero (probably the correct price is close to 1%). Then the question is: Does the 30Y bond worth more than 5% or not.  What is the breakeven exit yield of Greece to get your money back? The answer is: you need an exit yield of lower than 22% in order to breakeven and/or make money. Thus, if you think that the Exit Yield of Greece would be lower than 22% then Greek bonds offer value even if they are forced to the exchange. On top of that you also have the probability of holding out and waiting to be bought later by the republic or being restructured and lose once more.

For the March 12 which is trading around 27%, you basically pay 7% premium for the chance to get back 100 on the day. This gives a probability of 10% (premium of 7 to get 73) for this to happen. Is this a reasonable number? Who knows? Maybe it is cheap maybe it is very expensive. We shall find out in the next 3 weeks.