Short-term bond sale tempting for Greece but would bring risk forward

Tue Jul 8, 2014 6:29am EDT

* Greece plans to sell three- or seven-year bond in July

* Looming ECB cash injections make short-term debt attractive

* But short-term debt brings refinancing risks forward

By Marius Zaharia

LONDON, July 8 (Reuters) - Greece may be tempted to capitalise on increasing demand for short-term euro zone debt with a three-year bond sale in coming days, but in doing so it will give up its valuable status of having virtually no near-term refinancing risk.

Just two years after Greece defaulted and looked likely to crash out of a reeling euro zone, Athens returned to the market with a five-year bond in April, marking one of the fastest ever comebacks for a defaulted sovereign. This year it is expected to emerge at last from its six year recession, bringing an end to one the worst economic contractions in modern times.

Issuing shorter dated bonds would let Athens raise money more cheaply - it would be expected to pay only around 3 percent on a three-year bond, compared with yields around 6 percent for its 10-year debt and 4 percent for its five-year.

But shorter-term debt means it could also be on the hook for a big refinancing before its recovery is secure, and at a time when its unstable political situation has yet to settle.

A Greece official told Reuters last month that the country plans to sell 2 billion to 3 billion euros of bonds in July. While it has yet to announce whether they would be three-year or seven-year bonds, market watchers expect Athens to chose the shorter-dated option.

There would be huge potential demand for Greek short-term debt for banks to hold in a lucrative carry trade, with the European Central Bank promising to lend up to 1 trillion euros to banks from September at a rate as low as 0.25 percent.

Three-year Greek bonds would provide a windfall of extra profit to investors over other similar-dated euro zone bonds yielding 1.15 percent or less. But Athens would sacrifice one of the most appealing features of its debt: that it has no bond to repay for the next five years.

In comparison, almost half of Spain's and Italy's combined debt needs to be refinanced over that period, requirements that have kept those countries under constant pressure to meet tough financial targets.

"We are not talking about a country that's been completely fixed ...If anything happens in these next three years the first thing people will look at is this bond," said Gianluca Ziglio, executive director for fixed income research at Sunrise Brokers.

"Then they will start talking again about refinancing risk or a new aid package and more austerity, etc."

BY DESIGN

Greece has few repayments in the near term by design. Its debt restructuring in March 2012 imposed losses on bond holders by swapping its debt for bonds of lower value which mature between 2024 and 2034. The repayment dates of bailout loans it received from the European Union have also been pushed out.

A short-term debt sale would go against the euro zone's trend. The other borrowers emerging from the currency zone's debt crisis - Portugal, Italy, Spain and Ireland - have stepped up efforts this year to increase the average life of their debt.

Despite the expectation that the Greek recession is finally coming to an end, there are still significant risks of a U-turn in the next three years. Sky-high unemployment carries the risk of social unrest, if the recovery is not fast enough to make a difference for most Greek citizens.

And a shorter-term bond would lose protection from the vagaries of a political cycle that kept investors on edge throughout the euro zone crisis in 2011-2012.

The far-left Syriza party, which rejects Greece's euro zone bailout conditions, won strong support in European Parliament elections in May. It should remain popular ahead of the next elections, which are scheduled for 2016 and could come earlier if the fragile ruling coalition hits a rough patch.

"We have the highest level of anxiety about Greece because of the political timeline there," said Robert Tipp, chief investment strategist at Newark-based Prudential Fixed Income, a holder of Greek debt. "Things look good now, but the politics on the ground are up in the air so I think it's a better strategy to issue longer-term paper."

Against those risks, Athens has to weigh the savings of cheaper short-term debt, and also potential benefits that come from having a more diverse menu of terms of debt on offer.

If the issue meets good demand, the bond will rally in the market afterwards, which could bring down other Greek yields as well. That means Athens could potentially issue a seven-year bond later on at a lower cost than if it tried to sell it now.

It could also widen the investor base. Banks, for instance, usually prefer short-term debt. Local government bond holdings are just over 3 percent of the total assets of Greek banks, down from 14 percent 10 years ago, according to Reuters calculations based on data from the Greek central bank.

"I would rather do the 3-year if I were the head of the finance department," said Martin Wilhelm, founder of IfK, a bond boutique based in Kiel, Germany, which runs a bond fund with Acatis. The joint fund has invested in Greek debt.

"It's a big nice carry trade for a treasurer ... The bond will be oversubscribed, it will rally and bring the whole yield curve down and then they can do the seven year." (Reporting by Marius Zaharia; Editing by Peter Graff)

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