Thursday 12 January 2012

GGB4.3% 20th March 2012, Pencil the Bond and the Date.

 The 20th of March is a rather unimpressive day for most of us. Few events of global significance have happened on that day, among them the start of the Iraqi war in 2003, and the publication of Einstein’s General Theory of Relativity (a personal favorite). Yet it tortures the minds of most traders and politicians in Europe for another reason. It is when Greece has to repay 14.4billion Euro to the holders of the 3Y bond with ISIN GR0110021236 (identification number). Out of the 33billion that Greece has to repay in 2012 the March12 represents the largest chunk and it is the first bond to be paid (or not) after the so-called PSI is being completed.
In this note we examine the reasons this bond has attain such significance and what are the possible scenarios.
  • In the original 110billion rescue of Greece, this bond was assumed to be repaid. The installments schedule provided a 15billion payment in March 12 to cover the redemption of this bond. It was thus seen by many traders as a safer bet than the long dated ones. 
  •  Many assumed that Greece would be safe till around 2013 when the ESM was to come into play. Events have proved them wrong however. 
  • According to traders hearsay the ECB in its SMP intervention was buying near maturities and many believe that the ECB is one of the biggest owner of March12 (some 8billion). 
  •  It was for this reason that up until the introduction of the PSI the bond was trading near the 60s level.
Risk perceptions changed with the PSI
 The March12 was in the list to be voluntarily PSI-ied even though the original Troika installments covered it. What is more important was the exclusion of the ECB (official sector) from the PSI restructuring. The letter that was send by the Greek PDMA on the 26th August 2011 asserted that Greece reserved the right not to proceed with the voluntary PSI if less than 90% of bonds maturing to 31 Aug 2014 . This created a rather surreal situation. Bondholders were asked to participate in a voluntary haircut knowing that the biggest owner (the ECB) was Free Riding and that the PSI allowed a further 10% to escape the haircut. Everybody wanted to be in that 10%!! It seemed that the PSI had more holes than the famous Swiss cheese.
No wonder that the PSI participation failed to reach critical levels. The best however was yet to come. At the end of October 2011, EU policy makers decided to change the PSI haircut from the original 21% in the NPV to a 50% in the nominal and kept the voluntary character of it and the exclusion of the official sector (ECB). They also demanded a high suicide rate-sorry I meant participation. You do not have to be an expert to figure out that the so-called “liability exercise” was doomed to fail.
Coercive PSI?
Faced with increasingly opposing odds the Greek side started to mumble the possibility of a coercive restructuring rather than a voluntary one.
Apparently the way it is going to be done is through the introduction of Collective Action Clauses retroactively once a certain majority of existing bondholders accept the PSI. Many believe that this is an empty threat and an imbecile behaviour. Others say it is the worst bluff ever. Let’s list their arguments:
  • Greece would have to find a significant majority in the first place to introduce the CAC. This is not certain. Would the ECB as bondholders vote? This would be fun to watch. 
  •  Introducing CAC’s according to some legal experts can be done without causing a credit event but applying them would for certain be a credit event. 
  •  Causing a Credit event simply to force some bondholders to participate is like using a nuclear bomb to take out a platoon. If you are going to cause havoc you might as well legislate that all Greek bonds become 100y zero coupon. 
  •  Collective Action Clauses are called “Collective” because the will of the majority is enforced to everybody and that includes the ECB! Excluding the official sector (ECB) from the Collective would present huge legal problems (Discrimination and Subordination). It would treat the official sector as senior (others subordinated) and would have repercussions to the rest of Europe. This is behavior usually associated with fringe sovereigns and not expected from an EU member. The Italian government bond market would suffer as they do not have CAC’s either and this renegade behavior can be replicated there. 
  •  If on the other hand they do not exclude the official sector then the ECB would have to take the losses. The ECB’s equity capital is 10.8billion and the losses from the 50% haircut would be greater than equity. Consequently, the ECB would have to raise capital from its shareholders the NCB (National Central Banks). Effectively, EU taxpayers would have to pay for the losses! Politically, this is not very appealing for Germany or other European countries that would have to foot the bill. 
  •  If Greece decides to cause a credit event then both the EU and Greece would need to be prepared financially for a bankruptcy. The Greek banks would immediately go bust and would need to be supported somehow (from the now bankrupt ECB). 
  •  Greece runs a current account deficit of around 8%. Getting things on credit would not be an option unless the EU or other party guarantees the payments. 
  •  Greece and the EU do not seem to be preparing either for an orderly or a disorderly default within the EZ. Financially it would probably cost a lot more to the EU to support Greece through the default rather than paying up now. 
  •  The IMF has come out saying that even if the PSI is successful the chances of Greece are slim. 
  •  Lastly whether the CDS is triggered and paid is irrelevant due to the insignificant low volume (3bl). Unless all the protection was sold by a Greek bank (counterparty risk) this is not an issue.
It is for these reasons that many are opening and others are adding on their March12 positions. Expert market participants do not assess a high probability to the threat and in any case if you are opening a position now at around 40% you will be in the money with the current PSI proposal (50% haircut).
Could this mean that the PSI may be postponed or even abandoned as Central Banker Orphanides said in an FT article? Maybe. Postponing the PSI for few more redemptions may limit the losses of the ECB. Abandoning it completely would be politically hard to achieve and save face. One thing is however clear; as long as the ECB is free riding the PSI is a futile exercise. Taking it out as suggested by ITC in a voluntary cash sell-back at cost together with a voluntary cash sell back at 30-35% for the private bondholders would save the PSI restructuring, save the trouble with the ECB and allow for a limited hard core risk-takers who wish to free ride on their own.
Finally, after a thorough analysis of the Mayan calendar I could not find any significant event on the 20th March 2012.