Monday, 25 July 2011

Research Note: Is there value in Greek Restructured Bonds?

Research Note: Is there value in Greek Restructured Bonds?

25 July 2011
by Jacob H Schmidt

Last week’s announcement of a solution for the Greek debt problem involved private sector involvement (PSI), basically asking banks and other bondholders of Greek debt to participate in the restructuring of its debt burden via a range of options for new instruments. Greece’s total debt amounts to Euro 350 b, of which Euro 212 b is in GGB (Greek Government Bonds). For further details we refer to our Research Note: Greek Debt Profile and Solutions of 28 June 2010.  

The proposal on the table foresees three bond exchanges of existing bonds into new instruments: 

·         A new 30 year bond with an initial 4% coupon rising by 0.5%  to 5% in year 10, with a capital guarantee for the principal. We call this bond the new Greece Par Bond 2041.
·         A new 15 year bond with a 5.9% coupon, a 20% haircut and a capital guarantee for the principal. We call this bond the new Greece Discount Bond 2026.
·         A new 30 year bond with a 6.8% coupon, a 20% haircut and a capital guarantee for the principal. We call this bond the new Greece Discount Bond 2041.

We valued the coupon and principal as well as the collateral for all three options and find that at current prices (62 for the Greece 2014 and 59 for the Greece 2020) there is limited downside and some upside, provided that Greece can make the interest payments.

If we take an IRR of 14% for Greece and 4% for 30Y Bunds, we get values in the high 50s / low 60s range for the 30 Y Par and Discount Bonds, basically where the Greece 2020 is trading (62 on Friday). 15 Y Discount Bonds have a value of 71 at 14% Greece and 4% Bund IRR levels.

On the assumption that Greece can service theses instruments, they become liquid and new buyers come in, Greece bonds should trade at spread levels of 600-800 basispoints over bunds (10-13% yields) and the risk for the collateral could be lowered to 3.5%, resulting in prices in the high 70s / mid 80s. These bonds could be attractive due to their high fixed rate coupons and high current yields (6.4% for the par Bond, 8-10% for the Discount Bonds).

Hence we believe that these new bonds will attract high yield, distressed debt and emerging market bond buyers.

In the long run Greece’s bonds could trade much higher, provided that the risk premium investors require tightens to the 300-600 bp. range. At this point it is doubtful that Greece will indeed be able to cope with the still very high debt burden, reflected in the very high yields. It is possible that Greece needs another restructuring in 2-3 years. In such an event Greek bonds would suffer further haircuts and loss in value.

Appendix: Valuation of Par and Discount Bonds.

Schmidt Research Partners Limited is a London based investment advisory firm, providing global advisory, due diligence, rating and research.

In our investment approach we specialise in risk and risk factors: Quantitative and Qualitative Risks, quantifiable and non-quantifiable. The process ranges from understanding known and new risks, identifying them and managing them. Our research is based on in-depth qualitative, quantitative and structural analysis of financial markets, its participants and instruments, in particular alternative investment strategies, hedge funds, sovereign and distressed debt and investment opportunities.

Schmidt Research Partners’ principals have extensive experience in analysing , risk- managing, restructuring  and trading of distressed and defaulted debt. Available for high quality investment advisory, due diligence and consulting projects.

Jacob H Schmidt, international financial markets expert, researcher and hedge fund expert, Webster Finance Professor. CEO of Schmidt Research Partners Ltd, an investment advisory firm and MD of SFP-International Ltd, a consulting and training company. Jacob gained substantial experience in the restructuring and trading of LATAM, CEE, Russia and other EM debt in the 1990s. He is also the author of a book on credit risk entitled Credit Markets and Credit Derivatives” (2000).

This research note is for information only and for institutional and expert investors only. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision. It is not an invitation to buy, sell or subscribe and is by way of information only.

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