Greece prepares to fly solo on bond markets

Once the outcast of European bond markets, Greece appears firmly on the road to redemption.

After years of austerity, the expiry of an 86 billion euro ($100 billion) bailout in August will mark the end of an era in which Greece defaulted, 10-year yields topped 40 percent and the country came perilously close to being kicked out of the euro.

Now, as Greece follows fellow financial crisis victims Ireland, Spain, Portugal and Cyprus back into the fold, it needs to lure long-term investors into its bond market so the country can fund itself independently once the bailout cash runs out.

That could happen with a new bond issue to tap into positive sentiment around the end of the country’s third bailout, inclusion in European Central Bank bond purchases or further credit upgrades for its debt which is still rated junk.

"The sun is shining on Greece. It is in a radically different place and ratings agencies are very likely to continue to upgrade the country," said Nick Gartside, international chief investment officer for fixed income at J.P. Morgan Asset Management, which manages $1.7 trillion of assets.

A significant milestone would be for the European Central Bank (ECB) to include Greek bonds in its massive quantitative easing (QE) stimulus scheme once the bailout ends.

As Greece is rated below investment grade, it has only had access to cheap central bank cash because it is part of a bailout programme. The ECB has made clear that once Greece leaves the program its waiver will be revoked.

To be included in QE, Greece would need to pass an ECB debt sustainability analysis and that is unlikely to happen until the country has implemented reforms agreed in June with Eurogroup creditors to ease its debt profile.

At almost 180 percent, Greece has the highest ratio of debt to gross domestic product in the eurozone.

Special case

Analysts at HSBC, however, noted that Greece was considered a special case by eurozone authorities, implying there could be some leniency on the conditions it needs to qualify for QE.

If the ECB is satisfied Greece’s debt is sustainable, this would pave the way for Greek bonds to be included in the final months of QE, or at least be included next year in the bank’s program to reinvest proceeds from maturing bonds.

"We believe that the June Eurogroup agreement has materially increased the chances that Greek bonds are included in ECB bond purchases," said Barclays economist Francois Cabau.

He estimates the ECB could buy about 3 billion euros of Greek debt before hitting the limit on how much of the country’s debt it can purchase.

Having received 260 billion euros in financial aid since 2010, Greece’s exit from the bailout program will be momentous for the eurozone too. It will be the last European Union member state to come off life support after Ireland in 2013, Spain and Portugal in 2014 and Cyprus in 2016.

Some long-term investors, such as J.P. Morgan’s Gartside say, the positive sentiment means they would "definitely" buy a new Greek bond, a departure from the situation now where most private sector bondholders are hedge funds or domestic banks.

The improving picture helped Greek bonds return more than 40 percent last year in dollar terms and they have performed strongly in 2018 too. Two-year yields have fallen 60 bps so far this year to 1.05 percent, well below 2-year US Treasury yields.

On a roll?

Besides its junk credit rating, the market’s small size and low traded volumes mean Greek bonds have been shunned by many big investors who prefer more liquid and accessible markets.

About 83 percent of Greece’s outstanding 332 billion euros of debt is held by official lenders, while the rest is with hedge funds, banks and domestic pension funds.

With only about 40 billion euros worth of bonds actually trading, the market is a fraction of the 2 trillion euros or so that trade in German, French and Italian markets.

Athens is under no immediate pressure to tap the bond markets. It is still due a final 15 billion euro instalment under the bailout package and will therefore have a cash buffer in excess of 24 billion euros, according to Swiss bank UBS.

That suggests Greece has enough funding to last through 2020 but a new bond would add liquidity to the Greek market.

"If you think that lots of corporates price off the government bond yield curve, building a benchmark makes a lot of sense," said Gartside at J.P. Morgan Asset Management.

Bond strategists reckon a new 10-year Greek issue could yield about 4 percent. That could prove attractive, given it would be 10 times what euro safe haven, Germany, pays for 10-year cash and well above the 2.5 percent paid by Italy.

There was strong demand for a sale of seven-year Greek bonds in February that was seen as a litmus test of private sector interest.

But investors have tended to be those with a strong stomach for risk – notably hedge funds – who have been buying Greek bonds throughout the crisis.

US-based Japonica Partners, for example, bought Greek debt at the height of the 2012 crisis and continued to buy in subsequent years.

"Our research team had discovered systemic misconceptions with a related massive under-valuation – at the core was a miscalculated and overstated debt number," said Japonica’s finance director Christopher Magarian.

Ratings watch 

Another significant boost for Greek bonds would come from better credit ratings.

While Greece’s sovereign ratings were upgraded by S&P Global and DBRS after the deal with lenders in June, the country’s debt is still rated B+/B3/B by the three main agencies – five to seven notches below investment grade.

Moody’s, for example, scores Greece on a par with Angola, Egypt and Ecuador. That leaves it outside major bond indexes that mainstream funds use as benchmarks.

"Greece is an asset that is not in a developed or an emerging market benchmark, which means it’s in a bit of financial no-man’s land," said Mark Dowding, a senior portfolio manager at BlueBay Asset Management.

To enter the Markit iBOXX EUR eurozone index, which has a market value of more than 6 trillion euros, Greece needs an average BBB rating at least. That could take a while, given Portugal spent five years climbing back to investment grade.

But for many investors, inclusion in benchmark bond indexes has become less important than the outright rating, so a higher score could be enough to increase their exposure to Greek bonds.

Dowding expects Greece will eventually follow Spain and Portugal, where 10-year borrowing costs have fallen 280 basis points and 200 basis points respectively since 2014 when they ended their bailouts.

"It’s been one of the stronger investment calls that we’ve been making and it is a constructive turnaround story," he said. [Reuters]