€10bn Greek bond buy-back

On Monday, Greece announ­ced that it will be spending €10 billion to buy back its sovereign bonds. The objective is to reduce its soaring debt burden and unblock further financial aid from its bail-out programme. Bond prices were higher following the announcement, reflecting the generally positive reaction.

A bond buy-back that reduces the debt burden became essential- Karl Falzon

During recent weeks, expectations had been growing that Greece would need to buy-back a portion of its own debt as a measure to reduce outstanding obligations. This is viewed as a vital pillar of the effort to stabilise the country.

Greece has been relying on international aid for more than two years. The funds from eurozone countries and the IMF prevented bankruptcy and a euro exit. However, they are attached to severe austerity measures and reforms that made the recession deeper. In turn, this has made the nation’s debt increasingly unsustainable and the target of achieving a 124 per cent debt-to-GDP ratio in 2020 (190 per cent projected in 2014) very unlikely. Within this context, even after the €200 billion restructuring earlier this year, a bond buy-back that reduces the debt burden became essential.

The ongoing transaction is targeting around €62 billion of the new Greek government bonds from the previous restructuring. It will reduce outstanding debt because Greece will buy its own bonds from investors at prices that are close to current market levels, but considerably lower than nominal value.

The country’s Public Debt Management Agency set a price range of 32.1 per cent to 34.1 per cent on a series of 20 bonds across several maturities. Investors have the option to exchange their holdings for six-month zero-coupon European Financial Stability Facility notes amounting to a principal value around €10 billion. The process is being executed through a modified Dutch auction running until tomorrow. Investors have to show how low on their price they are willing to go before the price is set.

Given current prices, it is expected that around €30 billion of the ‘older’ bonds will be replaced by new bonds amounting to €10 billion. Basically, Greece is borrowing €10 billion to repurchase bonds that have a face value of €30 billion (but are worth around €10 billion in the market because of the heavily discounted prices). Therefore, the process is expected to result in a net decrease of the country’s obligations of around €20 billion, equivalent to 11 percentage points off debt-to-GDP according to analysts’ estimates.

Generally, the prices offered were above investor expectations and considered positive. In fact, the PDMA is offering prices that are higher than last week’s close and above the levels of November 23 (previously indicated as an upper limit). Interestingly, during recent weeks, expectations of the upcoming buy-back could have actually put its success at risk. Buying interest for the bonds increased, driven by hopes that Greece would bid at a higher level than the current market. For the same reason, it was also in the interest of bondholders to hold out for an improved offer. However, if prices were pushed too high, the buy-back could have become uneconomical.

While still considerably below par, some investors will be making a profit, having bought at even more depressed levels. Other bondholders will consider this buy-back as a liquidity opportunity to exit the investment before incurring further losses or may view it as an opportunity to simplify their holdings.

There are specific considerations to be made in relation to the different classes of bondholders. The buy-back is potentially targeting around €62 billion of bonds held by private investors. According to a draft report, Greek banks hold about €15 billion, the country’s pension funds hold around €8 billion, while the rest is held by foreign investors (mainly hedge funds).

In the long term, the banks have an incentive to accept the offer. A substantial portion of bail-out money (which, in turn, depends on a successful buy-back) will be directed towards their recapitalisation. Some critics have claimed that by selling at heavily discounted prices, banks will actually raise their capital shortfalls by ‘crystallising’ losses. However, it has been argued that banks’ bond holdings are already booked in their balance sheets at (post-haircut) depressed prices that are below what the PDMA is offering – some banks may even post a profit. Authorities have confirmed that pension funds will not be involved in the transaction.

The role of hedge funds in this situation is controversial. According to various reports, many funds were building stakes when the bonds traded at levels between 17-25 per cent until recently, and are set to make very attractive returns in a short period. Considering the accusation that this investor class is often responsible for amplifying financial crises, it is ironic that hedge funds are likely to be the major beneficiary from Greece’s offer.

Looking forward, while the country’s situation remains dire, it is hoped that the buy-back, in addition to other measures such as interest rate reductions and payment deferrals on official lending, will help Greece stabilise.

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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

Karl Falzon is a credit analyst at Curmi and Partners Ltd.