Yes, you read that correctly! Greece killed its own banks. You see, many knew as far back as January (if not last year) that Greece would have a significant problem floating its debt. As a safeguard, they had their banks purchase a large amount of their debt offerings which gave the perception of much stronger demand than what I believe was actually in the market. So, what happens when these relatively small banks gobble up all of this debt that is summarily downgraded 15 ways from Idaho.
Reference (Bloomberg) Stocks Plunge as Dollar, Treasuries Gain After Greece, Portugal Rate Cuts and (the Wall Street Journal) S&P Downgrades Greece to Junk Status:
“S&P cut Greece’s ratings to junk status, saying the country’s policy options are narrowing as it tries to cut its large budget deficit. The news, combined with an S&P downgrade of Portugal, pushed down the euro to $1.3269, hit U.S. stocks and sent Treasury prices higher”.
- •Stocks Plunge, Asia Bond Risk Climbs on Greece, Portugal Default Concerns
- •Greece’s Junk Contagion Pressures EU to Broaden Bailout After Market Rout
- •Trichet Travels to Berlin on Diplomatic Mission as Merkel Nears Greek Vote
Bondholders May Lose $265 Billion in Default as S&P Sees 70%
- April 28 (Bloomberg) — Holders of Greek bonds may lose as much as
200 billion euros ($265 billion) should the government default,
according to Standard & Poor’s.
The ratings firm cut Greece three steps yesterday to BB+, or below investment grade, and said bondholders may recover only 30 percent and 50 percent for their investments if the nation fails to make debt payments. Europe’s most-indebted country relative to the size of its economy has about 296 billion euros of bonds outstanding, data compiled by Bloomberg show.
The downgrade to junk status led investors to dump Greece’s bonds, driving yields on two-year notes to as high as 19 percent from 4.6 percent a month ago as concern deepened the nation may delay or reduce debt payments. Prime Minister George Papandreou is grappling with a budget deficit of almost 14 percent of gross domestic product.
“It’s now not just market sentiment, but a top rating agency sees Greek paper as junk,” said Padhraic Garvey, head of investment-grade strategy at ING Groep NV in Amsterdam.
Before yesterday, Greece’s bonds had lost about 17 percent this year, according to Bloomberg/EFFAS indexes. The 4.3 percent security due March 2012 fell 6.54, or 65.4 euros per 1,000-euro face amount, to 78.32.
S&P indicated the cuts, which may force investors who are prevented from owning anything but investment-grade rated bonds to sell, may not be over, assigning Greece a “negative” outlook.
“The downgrade results from our updated assessment of the political, economic, and budgetary challenges that the Greek government faces in its efforts to put the public debt burden onto a sustained downward trajectory,” S&P credit analyst Marko Mrsnik said in a statement.
Traders of derivatives are betting on a greater chance that Greece fails to meet its debt payments.
Credit-default swaps on Greek government bonds climbed 111 basis points to 821 basis points yesterday, according to CMA DataVision. Only contracts tied to Venezuela and Argentina debt trade at higher levels, according to Bloomberg data. Venezuela is at about 846 basis points and Argentina is at about 844, Bloomberg data show.
Just minutes before lowering Greece’s ratings, S&P cut Portugal to A- from A+. Yields on Portugal’s two-year note yields jumped 112 basis points to 5.31 percent, while credit- default swaps on the nation’s debt rose 54 basis points to 365. The downgrades may force banks to boost the amount of capital they are required to hold against bets on sovereign debt, said Brian Yelvington, head of fixed-income strategy at broker-dealer Knight Libertas LLC in Greenwich, Connecticut.
While bank capital rules give a risk weighting of zero percent for government debt rated AA- or higher, it jumps to 50 percent for debt graded BBB+ to BBB- on the S&P scale and 100 percent for BB+ to B-.
“These downgrades are going to cause people to increase their risk weightings,” Yelvington said.
Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market rout of the 27th)…
The same hypothetical leveraged positions expressed as a percentage gain or loss…
When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can imagine, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:
- Leveraged European Entities from a
Sovereign Risk Perspective – retail
- Leveraged European Entities from a
Sovereign Risk Perspective – professional
To date, my work both free and particularly the subscription work, has shown signifcant returns. I am quite confident that the thesis behind the Pan-European Sovereign Debt Crisis research is still quite valid and has a very long run ahead of it. Let’s look at one of the main Greek bank shorts that we went bearish on in January: