GGBs Soar As Buyback Backfires
Greece failed to persuade enough of its bondholders to complete the buyback that is so politically mandated by the Troika and so instead of admitting defeat, they have extended the deadline (til tomorrow at 12pm London). Current participation is around EUR26bn vs the EUR30bn target. It appears that more non-domestic investors have participated more than expected and given the buyback's success as a prerequisite for the bank recaps (and next aid tranche), we would expect the rest of the domestic banks to play along - though as JPM notes, they may prefer to hold on to shorter-dated GGBs (as opposed to taking the valuation hit). The bottom line is that the buyback has created an upsurge in price for long- and short-dated GGBs as the 'Greater Fool' theory comes fully into play. Of course, with the Troika making the GGB (and its buyback) now the fulcrum security for Europe's 'break-up' risk, holding out for bigger and better offers seems the game for hedgies at least - there is always the Greatest Fool of EU leaders ready to step in. The paradox, of course, is that the more bonds are being bought the longer the buyback lingers on hopes Greece will keep on bending and keep rising the repurchase price; culminating with these being bought at par and replacing 30bn in old debt with 30bn in new debt. The buyback process has driven prices up dramatically - backfiring considerably on any real gains for the Greek people - but that's hardly the point eh?
Media reports suggest the buyback is being extended because participation thus far is running around €26-27bn, short of the roughly €30bn notional target. However, this is not particularly alarming because non-Greek investors are reported to have tendered about €15-16bn, ahead of our estimated breakeven participation rate. Greek banks, on the other hand, have only tendered about €10-11bn and are estimated to retain another €6-7bn which they can tender if needed. Since buyback success is a prerequisite for planned bank recapitalization and a return to ECB repo rather than ELA, we expect Greek banks to tender enough to bring participation to the desired level (around another €3.5bn to get to €30bn notional overall). This will allow Greece and the Eurozone to declare the buyback a success and will unlock Greece’s next €34.4bn loan tranche.
Updated tender strategy
We now know two facts about the GGB buyback. First, participation is running on the low side, which will reduce Greece’s leeway as to accepting offers. Second, Greek banks want to retain some of their holdings, and will likely limit their offers to the minimum needed to meet the overall participation target. The Greek sovereign will likely tolerate this behaviour, since 1) Greece would likely rather fill non-domestic offers if possible, in order to preserve its sway over the GGB investor base, and 2) Greek banks appear to have marked new GGBs at somewhat above market values / exchange prices; tendering would likely cause some marginal writedowns. To be sure, we note that exchange terms do not appear to allow Greece to discriminate between investor type within a particular bond series (Greece will pick a series-clearing price and all offers up to that price will be accepted).1 However, there are 20 different bond series, each of which is a separate auction. Depending on how offers stack up across the series, Greece can discriminate in effect by how it allocates orders across series.
We see two ways that investors can benefit from the current situation.
First, investors who have not yet tendered should consider tendering long-end bonds at the maximum price. As shown in Exhibit 2, bonds with 15Y+ maturities were still trading well below the maximum exchange price as of Friday 7 December. As we discussed previously, longer-dated bonds (25Y+) continue to represent the best price returns.
Second, investors who have made partial offers should submit new, small, additional offers at the maximum price for each particular bond series. If this high-end offer is accepted, it will pull up the clearing price for the entire series (every offer must be filled at the series-clearing price). If this high-end offer is not accepted, old lower-priced offers will still be filled. Although Greece may choose not to hit offers at the maximum price, we view this as a costless option. Previous participation instructions cannot be changed, and one can submit bids in small increments (the minimum denomination to submit bids is €1000). One could also submit new bids at somewhat less than the maximum price to improve probability of acceptance (although with participation running low, we think Greece’s flexibility is limited).
Finally, investors who are bullish should retain shorter-dated GGBs (sub 15Y maturity) due to 1) due to strong pull-to-par profile, 2) likely better liquidity vs. longer-dated GGBs after the buyback, and 3) the prospect of eventual OSI in the long term (e.g. 2014). As shown in Exhibit 3, given estimated participation rates, post-buyback investor composition in Greek GGBs is likely to be heavily skewed towards non-domestic investors. This will increase bargaining power and make it more difficult to use collective action clauses (CACs) in future exchanges/restructurings. The voting threshold to use CACs in new GGBs is 75% for the first bondholder meeting and 67% by written resolution