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During the second half of 2012 GGGBs had a vey nice rally, more than doubling in prices with the 10Y bond closing at 53.20 on Friday. The reasons had to do with the reduction of the Grexit risk,  commitment by official lenders on long-term financing (at very low rates) and a possible official haircut after the German elections. What I ‘d like to note is that, in my opinion, there isn’t much upside left on this trade unless there are serious rating upgrades of the Greek economy.

Looking at the ECB elidgible assets database, one can observe that the (ISIN:GR0128010676) 2023 bond carries a 57% valuation haircut.

ECB GGGB valuation haircut

That means that a bank can only finance 43% of a bond purchase through the ECB and will have to commit another 57% as capital or unsecured lending in order to settle the purchase, making it a very low leverage trade. Although the bond does pay higher coupons than current low-risk core bonds, the major source of income for a buyer is the capital gain from the difference between the current market value and the nominal amount payable at maturity which can be amortized during the remaining life of the instrument. As a result, one can make a very crude and simple calculation that investors will be willing to buy the bond as long as the future capital gain is more than the capital they ‘ll have to commit because of the high haircut (assuming that capital is expensive). In other words the higher price accepted would be:

PV(100) – market value = 57% * market value. If 100 is discounted with the current 10-year AAA yield of 2%, the actual PV is 82 and current market value 52.20.  Obviously, the above formula implies a 100% return on capital. Given the fact that the current 10Y bond YtM is 10.68%, this return is quite sensible. As a result, GGGBs are trading at a fair value for leveraged plays and do not provide an opportunity for further ‘easy profits’. Higher prices will be possible by the push-to-par effect for short maturities and future rating upgrades which will lower ECB haircuts.

Assuming a 2% annual return on capital (22% total), the highest price possible under current conditions would be close to 72.9.

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The Greek PDMA released the final results for the Greek bonds buyback. The total principal offered was €31.9bn for which €11.29bn in EFSF 6-month Bills will be needed (compared to the originally anticipated €10bn amount) while the weighted average purchase price was 33.8%.  The Annex contains a breakdown per bond series:

Greek bond buyback results

 

My initial comments:

  1. The purchase price achieved for every bond series is equal to the maximum price allowed in the auction. So it seems that the size of the auction allowed bondholders (which were at least 40% foreign) to achieve the best price offered.
  2. In the case of short-term series (2023-2025) only 40% of the principal held was offered. This percentage increased to 50% for 2026/2027 and to 55% for the longer dated series. Bondholders decided to mainly exchange long-term bonds (which would probably become illiquid anyway after the buyback) and hold on to shorter term ones which provide for push-to-par mechanics.
  3. Total principal write-off will be close to €20.6bn. Since each series pays €987mn till 2023 and EFSF interest will be deferred for the next 10 years, Greece will manage to avoid paying interest for €20.6bn principal completely and another €11.3bn till 2023. That’s around€ 6.5bn (for €20.6bn) and €3.5bn (for €11.3bn) for a total close to €30bn. As a result, outright debt reduction will be close to €27bn till 2023 plus another €3.5bn in deferred interest payments.
  4. Since domestic institutions seem to have offered almost 100% of their holdings and pension funds hold €7.9bn it will be almost impossible to enable the bond CAC’s in the future, especially since they can only be enabled for all series simultaneously and they require a 66% majority. In other words, remaining holders are now much more secure.
  5. Greek banks seem to be the main losers. Although they ‘ve probably calculated fair value around 21-25 (which means they ‘re making a small profit right now), they will lose on future interest payments and amortized principal. Their future outlook is much worse since they don’t have GGB profits to look into. How the Cypriot banks participated remains to be seen.

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Kostas Kalevras

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