When S&P downgraded Greece to Default on Wednesday, I thought it was a bit silly. After all, here’s a chart of the benchmark 2042 bond, since issue: although it’s trading at just about 30 cents on the dollar, that represents an all-time high, and the price has trebled since the end of May. When an issuer’s bonds were trading at 10.65 in May and are 30.63 today, that’s not the kind of price action you expect from a defaulting entity.
When one of the big two ratings agencies says that an issuer is in default, that’s an important determination. But S&P doesn’t seem to be keen to own it: the stated reasons read a bit like “we’re only following rules, there’s nothing else we can do”. The logic goes like this: Greece is buying back its debt at a substantial discount to face value — and when investors “receive less value than the promise of the original securities”, that counts as a default, as far as S&P is concerned.
Now the analysts at S&P are human, so they’re allowed to make a reasonable determination as to what that means in practice. Specifically, what was “the promise of the original securities”, and are the investors who tender into the exchange getting less than that? One way to make that determination is to simply look at the face value of the bonds, but that’s silly. A long-dated zero-coupon bond, for instance, will always trade at a big discount to its face value, but that doesn’t mean it’s distressed, or delivering any less than was promised. And the 2042 bond I’m charting above, for instance, has a very low 2% coupon, so of course it’s going to trade well below par.
So instead, it’s worth looking at the yield on the bonds — in this case, it’s about 11.5%. That’s high, but I don’t think it necessarily enters into “distressed” territory. In any case, we know exactly what the promise of the original securities was: when they were fresh off the securities-creation machine, they were worth about 24% of face value, and now they’re worth about 30%. So investors are getting substantially more than the promise of the original securities, if you use the market as your measuring stick.
Judging by S&P’s own criteria, then, I’m not a huge fan of the decision to brand Greece as being in default. Certainly the credit default swaps aren’t going to be triggered, and on its face this deal doesn’t feel like a default: the tender offer is a voluntary one, it improves the value of the bonds rather than destroying value, and at the margin it means that the bonds are more likely, rather than less likely, to pay out in full and on time.
But then I saw this:
Banking sources told Kathimerini that Greece’s four main banks – National, Eurobank, Alpha and Piraeus – submitted all their bonds, with a nominal value of 11.5 billion euros, to the buyback process…
Sources said local banks are hopeful that investors’ take-up of the offer from the Greek government, which had set a price range of between 30.2 and 40.1 percent of the principal amount, was big enough to allow lenders to eventually hold on to some of the bonds they submitted.
Greek banks were hoping to keep 20 to 30 percent of their bond holdings to minimize their losses.
As far as Greece’s banks are concerned, then, this is not a voluntary deal after all. They don’t want to tender all their bonds, but they are tendering all of their bonds, and they’re hoping to be able to keep at least some of them. Why would they do something they don’t want to do? Because the alternative is that they risk Greece failing to get enough tenders, which would cause the offer to fail, which in turn would be disastrous for the economy. Technically, the banks have a choice here, but in practice they don’t. And when you’re being coerced to give up your bonds at 30 cents on the dollar, that feels like a default.
From the point of view of the Greek banks, then, I can see why this might be considered a default. On the other hand, from the point of view of any independent investor, including all the hedge funds who have made very good money on these instruments in recent months, the exchange isn’t a default at all. Independent investors really do have the voluntary choice of whether or not to tender into the exchange, and in fact they love the fact that the exchange is happening: it’s providing a healthy bid for their paper.
So, is Greece defaulting on its bonds again? My feeling is that the answer is no. You can make the argument that this is a coercive distressed exchange, and that coercive distressed exchanges are one way of defaulting. But default is a fraught word, and I don’t think it should be used lightly. In this case, when the exchange is genuinely voluntary for all but the Greek banks, it seems weird to call it a default. Especially when the bonds are trading at their all-time highs.