Hedge funds underestimating Europe’s will to force Greek losses

Hedge funds seeking to wring profits from a Greek debt restructuring are underestimating the will of policy makers to impose losses on them, according to investors who say trying to beat the politicians is too risky. “It’s hard for us to come up with an investment thesis that makes it interesting,” said Robert Rauch, a partner at New York-based Gramercy Advisors LLC, a $2.7 billion hedge fund that has avoided investments in Greek debt. “It’s not clear to us that out of this process you can make any money.” Greece’s talks with private creditors, led by the Institute of International Finance, have dragged on for more than two months as the nation’s European partners pressure creditors to accept lower interest rates on new debt to ensure a sustainable debt load for the Mediterranean nation. The agreement must be voluntary so as to avoid triggering credit-default swaps. Bruce Richards, who runs Marathon Asset Management LP, said two weeks ago that a swap would be struck that gives his firm and other investors new bonds paying an annual interest rate of as much as 5 percent. His view proved optimistic after European officials pushed for steeper losses of 70 percent or more, leading to average coupons of about 3.6 percent. European banks own most of the 200 billion euros ($263 billion) of Greek debt held by non-government investors. Hedge funds, pension funds, sovereign wealth funds and other “non- regulated investors,” own a further 60 billion euros, according to estimates by Pavan Wadhwa, JPMorgan Chase & Co.’s head of global interest-rate strategy.

The International Monetary Fund wants to get owners of about 88 percent of Greece’s bonds to take part in the swap to reduce the country’s debt-to-gross domestic product ratio to 120 percent by 2020, Wadhwa said. Because hedge funds and other holders could collectively keep the participation rate below that level, Greece has said it may approve legislation that imposes losses on investors who don’t support the voluntary swap by adding a retroactive collective action clause into its bond documentation. Such a provision would give a majority of bondholders the ability to force holdouts to accept the same terms as everyone else. Hedge funds that hold Greek debt include Och-Ziff Capital Management Group LLC, York Capital LP, Saba Capital Management LP, Greylock Capital Management and Vega Asset Management LLC. Vega resigned from the committee of creditors negotiating the Swap in December because the Madrid-based hedge fund refused to accept a net present value loss exceeding 50 percent, according to e-mail sent to other panel members, which obtained by Bloomberg News. Marathon, with $10 billion under management, is still on the credit committee of the Washington-based IIF.

Och-Ziff and York Capital, hedge funds that manage $42 billion in total, have said their investments in Greek debt aren’t significant and that they’ve had no involvement in restructuring talks. Greylock is on the IIF steering committee that negotiated the bond swap with officials from Greece, Europe and the International Monetary Fund.

“This is not the type of deal that the official sector likes to designate as ‘vulture funds making big windfalls’,” Greylock President Hans Humes said in an interview. “Hedge fund holdings aren’t significant and hedge funds that bought are clearly not going to endanger this deal.” It will be difficult for holdouts to assemble enough votes to block any collective action clause, because European banks have an incentive to support the provision, fund managers said. A lawsuit against a collective-action clause legislated by the Greek government may also be difficult to win, because it would probably have to be filed in Greece, said a hedge-fund executive whose firm holds the country’s debt and has examined the legal options. The executive declined to be identified because the firm’s holdings are private.

“It’s unlikely that there will be any group that can represent a blocking vote if they impose a retroactive” collective action clause, said Gramercy’s Rauch. “If you pursue a legal battle, it’s really a fight against the entire legal body of Europe.” Mark Cymrot, an attorney with Baker & Hostetler LLP in Washington who defended Peru in the 1990s against lawsuits brought by banks seeking repayment on sovereign debt, said hedge funds considering suing face a “very hard time.” “You have to have a long time horizon,” he said. “One of the biggest problems is even if you get a judgment in your favor, there’s still no guarantee you can actually collect.” A unit of Paul Singer’s Elliot Management Corp. has been in litigation with Argentina since declining to accept the country’s defaulted debt restructuring in 2005.

Meanwhile, creditors who agreed to Argentina’s offer of 30 cents on the dollar have received returns of about 90 percent, according to estimates by Morgan Stanley. (MS) Elliot won a lawsuit against the government of Peru in 2000, earning a 400 percent profit on the debt of two Peruvian banks it purchased four years earlier.

Greece has a 14.5 billion-euro bond payment due March 20. Hedge fund managers including Trung-Tin Nguyen of Zurich-based TTN AG have been buying debt maturing on that date, betting holders won’t have had to actually swap their bonds by then. As a result, Greece may be forced to redeem the bonds at face value with the 130 billion euros of rescue funds it will have secured from Europe by that time. Investors were buying these bonds last year, pushing the price up to 49 cents on the euro on Dec. 30, according to data compiled by Bloomberg. The debt now trades at about 39 cents. Risks include the possibility that March bonds will be rolled into the swap or that Greece won’t secure its latest rescue funds as tussles over the indebted nation’s austerity measures continue. Greece has struggled to meet targets set by EU officials for cutting its budget to secure the aid.

One way hedge funds may prevent losses on Greece’s debt exchange is if they insured their holdings with credit-default swaps. Activating a collective action clause would undermine the voluntary nature of the exchange, triggering a so-called credit event that allows hedge funds to demand payment on CDS positions. The losers of that scenario may be European banks.

“If you’re a European bank that holds a lot of Greek bonds and the financial side of your business wrote a lot of CDS then you get a double whammy,” said Gramercy’s Roach. [Bloomberg]