October 26, 2021
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So Maybe Greek CDS Will Be More Than Fine?

Gaaaaaaaaaaaaaaaah Greece. Okay so all systems appear to be go on the Greek debt exchange, which means its time to decide What This Means, and, I just. Really. Greece. Come on. All I want is to talk about 13D reporting requirements, and now I have to pay attention to Portugal? No. Just no.* Still here is arguably a fun factoid: On Wednesday, Swiss bank UBS AG started quoting a "gray market" in new Greek sovereign bonds ... using as a guide details of the debt swap Greece has put on the table for private investors to accept until Thursday evening. The "bid" price for a batch of future Greek bonds due in 2042, or the highest price the dealer was willing to pay, was around 15 cents on the dollar; the "offer" price, or the most the dealer was willing to sell at, was 17 cents on the dollar, the first person said. ... The prices quoted by UBS imply that losses private creditors to Greece will take are more like 79% of face value, not the original haircut of 70-75% many had expected. Yeah but. If you believe this horrible CDS mechanics stuff that various people including me have been yammering about for weeks - here is the best explanation - that means that if for some reason you had the foresight to be long Greek bonds and hold CDS against them you'd end up with a package worth (1) 21 on the bonds and (2) 83 on the CDS (assuming that the 17 offer for the 2042 bonds represents a real price for the cheapest-to-deliver new bond in the Greek auction) for (3) 104 total which is (4) more than par, so you win this particular game, yay. Which you were at risk of losing - a week ago one of our fearless commenters spotted the longest new bonds at 25ish vs. 24ish for the old-bond-y package, for a total of 99 for the hedged holder - losing 1 point versus par.**
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Gaaaaaaaaaaaaaaaah Greece.

Okay so all systems appear to be go on the Greek debt exchange, which means its time to decide What This Means, and, I just. Really. Greece. Come on. All I want is to talk about 13D reporting requirements, and now I have to pay attention to Portugal? No. Just no.*

Still here is arguably a fun factoid:

On Wednesday, Swiss bank UBS AG started quoting a "gray market" in new Greek sovereign bonds ... using as a guide details of the debt swap Greece has put on the table for private investors to accept until Thursday evening. The "bid" price for a batch of future Greek bonds due in 2042, or the highest price the dealer was willing to pay, was around 15 cents on the dollar; the "offer" price, or the most the dealer was willing to sell at, was 17 cents on the dollar, the first person said. ... The prices quoted by UBS imply that losses private creditors to Greece will take are more like 79% of face value, not the original haircut of 70-75% many had expected.

Yeah but. If you believe this horrible CDS mechanics stuff that various people including me have been yammering about for weeks - here is the best explanation - that means that if for some reason you had the foresight to be long Greek bonds and hold CDS against them you'd end up with a package worth (1) 21 on the bonds and (2) 83 on the CDS (assuming that the 17 offer for the 2042 bonds represents a real price for the cheapest-to-deliver new bond in the Greek auction) for (3) 104 total which is (4) more than par, so you win this particular game, yay. Which you were at risk of losing - a week ago one of our fearless commenters spotted the longest new bonds at 25ish vs. 24ish for the old-bond-y package, for a total of 99 for the hedged holder - losing 1 point versus par.**

The new numbers are perhaps a little dicey - I see CMA showing Greek CDS offered at at like 77-78, more in line with the 79 haircut than the 83 payout I get above - but whatever. At this point everything is within the margin of error (by which I mean the margin of bid/ask and/or the margin of nobody really wanting to hear your tale of woe or glee about how you got 99 or 104 for a package designed to pay out par) so I suppose this little sideshow is over.

But Let's Think About What This Means. Or, I mean, not really, but let me tell you an imaginary story.

There's a theory about "empty creditors" which runs that bondholders who hold $100 of a distressed company's bonds and $100 of CDS against those bonds have no incentive to reach a socially value-maximizing voluntary restructuring that avoids bankruptcy, because they get par in bankruptcy and less than par in a restructuring, and that's Bad. Here is some evidence, and some other evidence. Others disagree, but I have to say Greece seems confirmatory: there are some people who want to Do The Right Thing for the debtor, and some people who want to hold out so they get par, and those people are jerks but in the minority here - but maybe not everywhere.

We've talked before about how coercive restructurings can be designed to really really screw hedged bondholders. Again, it looks like whatever happens in Greece will be within margins of error, but you could have designed a restructuring with the same economic results for bondholders but where all the new bonds trade at "par," making CDS payouts zero. Greece seems to have reached rough justice by accident and/or the goodness of its heart.

The thing is, though, it's a two-way market, and those gray market numbers are a reminder that you could also structure things to really really benefit hedged bondholders (and screw CDS writers). Greece, for instance, could have offered the same package but instead of GDP warrants it could have thrown in a new hundred-year bond with a zero interest rate. If that bond trades at, I dunno, 1 cent on the dollar, then it's the cheapest to deliver and so sets the CDS price.*** Specifically a 99 recovery, instead of the 75-85 that we're looking at. Giving hedged holders an all-in recovery of something like 120, rather than 99-104.

In a restructuring more or less negotiated between European governments (which want to preserve their banks) and European banks (which want to preserve themselves), that would not happen. But in a restructuring negotiated between, say, a smaller European company**** and a few big bondholders who were hedged, you could imagine working a windfall: "we'll vote for a principal-reducing collective-action-claused forced restructuring if you'll give us some way-below-par bonds in the restructuring to goose our CDS payouts." So like you could exchange 100 of old 5-year bonds for 60 of new 5-year par bonds and 10 of new zero-coupon 100-year bonds which are worth 1 cent on the dollar. Giving creditors a recovery of 70 on the bonds and 99 on their CDS, for 169 total. And that surplus is maybe good for those companies and those creditors, who can split the surplus. Which surplus is provided by the big dealer banks who net write single-name CDS, who will be less happy.

I speculated groundlessly that maybe the CDS delivery thing would get fixed now that people see that it's broken; but the answer appears to be nope, not really. There are various kludgy fixes that might by accident fix this problem, and Greece appears to have alighted on one of the subtler ones, which is to just have the numbers line up by accident. But it sounds like if this problem resulted in banks paying out less than a "fair" amount on their CDS, ISDA would not be rushing to fix it.

If, on the other hand, all this publicity led to some corporate restructurings where banks paid out way more than the "fair" amount ...

* Though I can't really let this go unpunished. Apparently European 5-year nominal risk-free rates are below zero?

** WTF? aside. The idea here is that if as seems likely the Greek CDS auction runs after the exchange, then recovery on CDS is based not on what your package of bonds was worth before Greece, y'know, defaulted, but rather on what the cheapest-to-deliver new Greek bond is worth. That appears to be the 2042 bond allegedly trading at 15/17. So CDS pays out par (100) minus recovery (call it 17, the offer price of that new bond), or 83. And your package - which consists of a slice of 2042 bond, slices of various other shorter-dated new Greek bonds, some cash-like short-dated EFSF bonds, GDP warrants, and a good healthy amount of nothing (i.e. principal reduction) - is worth 21, or a 79 cent haircut. Which your CDS recovery more than makes up for. On these facts. If instead the Greek CDS auction runs before the exchange, or was based not on the new bonds but on the package received for old bonds, then I guess you'd deliver the cheapest to deliver of the old bonds and things would sort of work out - but it looks like that's not what happens under the rules. Though, I mean, what do you make of this?

*** I'm sure I'm being very juvenile about the interaction of cheapest-to-deliver and auctions. Sorry!

**** Because apparently there's no Restructuring in the US, who knew.

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