Greek bonds issued as part of the biggest ever sovereign debt restructuring signal sellers of default insurance will have to pay about $2.6 billion to holders of credit swaps.
Investors are using new Greek 30-year bonds that are trading at about 23 cents on the euro to calculate the payout, according to Teo Lasarte, a European credit strategist at Bank of America Merrill Lynch in London.
The credit-default swaps will be settled at an auction on March 19 after investors were forced to exchange their Greek debt holdings at a loss. Austria may have to inject 1 billion euros ($1.3 billion) into KA Finanz AG, the so-called bad bank of Kommunalkredit Austria AG, to help cover Greek swap payouts, the nationalized lender said.
“People are using the longest-dated new bond as an indication of recovery,” Lasarte said. “The important thing is that the payout will be reflective of the economic loss faced by most bondholders.”
In the exchange, investors agreed to write off more than 100 billion euros of debt in return for new Greek bonds worth 31.5 percent of their original investment.
The settlement auction will determine the amount that sellers of protection pay by setting an agreed price for Greek bonds. Sellers pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
The recovery value may fall at the auction to 20 cents on the euro, giving protection holders an 80 percent cash payout, because more investors will want to sell their securities, according to Saul Doctor, a credit strategist at JPMorgan Chase & Co.
“Investors with CDS and bonds will likely see this as a good opportunity to sell their holdings,” Doctor said. Buyers may be scarce unless prices fall to about 18 cents, he said.
There were 4,369 swaps contracts covering a net $3.18 billion of Greek debt outstanding as of March 9, according to the Depository Trust & Clearing Corp.
The vast majority of Greek contracts will be cash settled at auction, with a small minority of investors exchanging their bonds for the full face amount, according to Sherif Hamid, an analyst at Barclays Capital in London.
Investors that held equal amounts of bonds and insurance may now have an imbalance after the exchange, creating a so-called basis risk, according to Hamid.
“Investors were able to unwind their basis packages close to par in recent weeks if they so chose, and it appears that the remaining” cheapest-to-deliver “obligations are trading at similar levels to the economic recovery,” Hamid wrote in a note. “That said, this potential basis is an issue that we believe investors should remain mindful of.”
The International Swaps & Derivatives Association said it is expediting the auction to maximize the number of bonds that can be used to set payout amounts.
“Fears beforehand that the auction would have been delayed, thereby thwarting the value of CDS, are now gone,” according to Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in London. “ISDA’s decisions will go some way to ensuring that sovereign CDS in Europe survive and prosper as an instrument of cover.”