An Effective Buyback and Bondswap Strategy

The EU has given the EFSF power to both swap existing Greek bonds for new 30 year bonds as well as to buyback Greek bonds in the secondary market. These powers are complimentary and a smart debt manager may well be able to reduce the stock of Greek debt by more than expected under the bailout plan. How so?

Currently, the Greek yield curve determines whether the bondswap option is economic. The higher the yields, the less attractive the swap. But trading in the secondary Greek bond market is extremely thin at present, so small trades can move the yield curve a lot. Under these conditions, the EFSF could easily stand in the market and reduce yields across the curve to the region of 9-10%.

So what? My guess is that current bondholders would much rather sell their holdings for cash than take on new 30 year debt with the associated risk management issues this creates. Therefore, by making the price of the buyback slightly more attractive than the swap, the EFSF could easily smoke out a large quantity of stock that to date has had no liquid market to sell into. Offering say 80 cents for the 10 year that currently trades at 60 cents could easily entice 50% of the market to sell. This represents a 20% haircut relative to par and a 10% reduction in Greek debt outstanding, and yields would be sub-10%.

The EFSF will officially be empowered to trade in the secondary markets this month. Lets hope the bondswap option is not accelerated as the buyback solution is much preferred.

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