Bonds To Profit Amid Greece's Fallout

by: Zachary Latif

The burning question on Greece (will they or won't they) has been answered with Parliamentarians in Athens agreeing on a brutal round of cost cutting (two-thirds of Parliament agreeing) to appease the international paymasters holding the strings to a €130 billion bailout.

The choices available to the Greeks are unenviable in spite of the ominous rumblings on the street (34 buildings alight and further 150 looted). However, they must continue on this course since the alternative, a forced conversion into drachma, will be significantly more disruptive for Greek recovery. Furthermore, they could potentially be forced out of international markets for decades, though investors' collective memory is mercifully short.

Additionally, Greece remains less self sufficient than other eurozone countries by way of industry, relying heavily on tourism (indeed tourism and shipping contribute 70% of Greek GDP) to counter significant imports in manufacturing and fuel, Germany being their largest counterparty.

A weak drachma, in the aftermath of an exit of the euro, may then mean dire consequences for Greece, especially if it will be unable to afford vital imports, and furthermore, if domestic industry is unable to meet the demands of a rising population. Indeed Italy could theoretically leave the euro, and withstand the ramifications of pariah status amongst trading partners, given their strong manufacturing base. Self sufficiency means they could well dictate terms to the Eurozone about their participation but that is a discussion for another day.

The Greek technocrat leaders are aware of the examples of hyperinflation and a weak currency (Weimer Republic in Germany and, in modern times, Zimbabwe) and therefore have to live with the forced bill through and deal with the vexed public as well. Additionally, both Germany and France have probably chanced too much already on the survival of the eurozone and in particular with the recent Long-Term Refinancing Operation (LTRO), a Greek withdrawal will be a step backward they can ill afford.

With that in mind, I have been scouring through for Greek exposure within credit and in spite of the supposed binary nature of events (a forced redenomination back into Drachma, will render most of these euro-denominated notes useless), I do think if the base thesis is accepted and Greece remains in the euro, yield levels remain incredibly attractive.

If you start at ground zero -- Greek government debt -- this has to be tempered with expectation of PSI, which has still not been agreed upon. It does look likely that investors will eventually have to take a hit of half their bond value, so common sense dictates favoring maturities with pricing <50 cash price.

The 10-year and 20-year at m-h 20s pricing are therefore much more compelling and have decent convexity relative to the GGB 4.3 03/20/12, (GR0110021236) currently offered at 43. The latter will most likely be included in the PSI, so offers lower convexity in comparison to the more competitively priced GGB 0 04/17 (GR0528002315), currently offered at 24, and the 10-year, GGB 4.5.9 10/22 (GR0133002155) at 26 and 20 years, GGB 2.3 07/30 (GR0338002547) at 29.

However, the most interesting trade remains in Greek financials, and it's a slight surprise that not much discussion has been had on secondary levels in outstanding bank debt. Under the EU stress testing for European banks, perhaps surprisingly 4 out of the 6 Greek banks came above the 5% threshold (with EFG just under at 4.9%).

Unfortunately, National Bank of Greek, the strongest bank in the test, recently tendered its outstanding Tier 1 bonds and single outstanding covered bond (around 10-15 points against secondary levels), so is less interesting. My favorites are Alpha Tier 1 (DE000A0DX3M2 ALPHA 6 PERPs offered at 28) and Pireaus Tier 1 (TPEIRFloat 07/16 offered at 46).

Secured debt is more difficult to come by, but EFG has a covered bond: XS0438753294 ETEGA 3.875 '16 at cash price 70. The collateral suggests strong mortgage performance in their pools, furthermore with low delinquencies and having first lien on their residential pool. This should make these bonds reasonably attractive.

Interestingly, following a call with EFG investor relations, they pointed out an outstanding RMBS transaction, originated by them, THEMELION (THEME 4 A XS0305113523) with well over €1 billion issued. EFG report very strong underlying performance, with minimal amount of repossessions and losses in the securitized pool, with an indexed LTV of 65%. This seems less compelling, given the lack of pricing sources (Bloomberg generic suggests a price of 60), and with a FRN coupon, and at 4 year maturity, suggests a yield of around 10%. Given high unemployment, there is also doubt as to whether performance can remain this resilient over the course of the next few years.

Obviously, it is important to stress the binary nature of the trade (though I would argue the base case is Greece remaining within the eurozone). If Greece does find itself out of the euro, forced redenomination into drachma will means a lot of foreign investors will be left with useless paper. It is why we prefer the lower dollar- and euro-priced bonds. It is why we prefer the lower cash-priced bonds (GGB 10 and 20 year, as well as the Alpha tier 1, all offered under 30 cash price).

Another personal objection I have with the trade is perhaps more personal. One of my favorite movies, Inside Man, had a stereotypical British banker play the villain. His fortune was made through the dealing with the Nazis, and one of his lines stick: "When there is blood in the streets, there is money." Given the fact that these cuts will be particularly brutal on the Greek masses, and the riots will play out for months on our television channels, there is something discomfiting about profiting in this Greek tragedy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.