Friday, April 11, 2014

Greece Trusts Anonymous Capital Markets More Than Its Governmental Partners!

Financings can be differentiated by two different types: those financings where the borrower knows the lender and those where the borrower does not.

Where the borrower knows the lender (such as in the case of loans; like the bail-out loans), the borrower has someone to negotiate with. In case of trouble, the borrower can sit down with the lender to cure the problems; to cure defaults before they happen; to renegotiate the terms of the financing.

Where the borrower does not know the lender (such as in the case of capital market instruments; like bonds), the borrower does formally not know the lender. There is noone to negotiate with in case of trouble. A bond is a tradeable capital markets instrument which has an independent life of its own. That life is governed by the terms lined out in the bond prospectus. If those terms, for whatever reason, are not complied with, the bond goes into default and triggers all sorts of consequences such as cross-default. Even if one large bondholder were willing to renegotiate terms, he could not do so on his own.

I am surprised that this key difference between bond financing and loan financing has not at all been discussed in the case of Greece. In good times, bonds are a wonderful instrument: the borrower can raise large amounts of money in a rather simple way; there are no instalments of principal until the bullet maturity; one only has to pay interest annually during the life of the bond. Instead of a tough credit analysis, the borrower works out with the arranger of the bond a structure for which the arranger feels that there is 'investors' appetite'. They work out a 'story' which will 'sell'. The arranger has no credit risk responsibility other than the documentary responsibility (that the facts presented in the bond prospect are correct and, typically, one of the largest sections in a bond prospect is where the arranger spells out what he is NOT responsible for). The credit risk responsibility lies with the purchaser of the bond.

In bad times, investors' appetite goes out the window; bond prices go South and bonds cannot be refinanced upon maturity. In the worst case, it can lead to 'sudden stop' and NOONE can control that!

Hardly any country can 'repay' its bonds upon maturity these days. Virtually every country must refinance its bonds upon maturity. As long as there is investors' appetite, anonymous capital markets are a wonderful business partner. When investors' appetite goes out the window, capital markets are brutal because they can remain anonymous.

No investor of sound body and mind would buy the bond of a borrower who already has unsustainable debt, out of fear that, upon maturity in 5 years from now, the borrower might not be able to refinance. Unless...

Unless, of course, the investor has reason to believe that the implied support of a third party stands behind the bond. In the case of Greece, that third party is the EU. The most wonderful opportunities for investors are those where the real risk is much lower than the perceived risk. From the investors' standpoint, the perceived risk is that Greece might not be able to refinance in 5 years from now whereas the real risk, in the investors' estimation, is that of the Eurozone in toto. The investors get a return based on the perceived risk but only carry the real risk.

Greece has now opted to trust anonymous capital markets more than governmental partners (cynics could argue that Greece has opted to trust governmental partners that they will bail-out anonymous capital markets in case of need). If Greece were a stand-alone country with it own currency, a return to capital markets so early into the expected recovery would have to be considered as a sensational feat. It would indeed have reflected 'trust in the country's ability to exit the crisis' (Finance Minister Stournaras).

Trust is an elementary part of all financings. The only trouble is: one can only trust people whereas with anonymous capital markets there is noone on whom to bestow the trust. Greece has opted, at a cost of roughly 90 MEUR in excess interest expense annually, to trust anonymity.

PS: in reality, Greece has, of course, not totally trusted anonymity. Instead, it has trusted EU partners to bail-out anonymity in case it becomes necessary. The 3% interest premium goes to investors' P+L statements; it will be paid by Greek tax payers and, in the final analysis, by Eurozone tax payers.

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