Distressed debt funds are buying Greek mortgage bonds after yields soared to a record, wagering the securities will rebound if Greece stays in the euro and with some priced so low they can still be profitable with an exit.
Bonds initially assigned top credit grades pay 22 percentage points more than benchmark rates, up from a premium of 9.25 percentage points last June when riots erupted in Athens over proposed austerity measures, according to data compiled by JPMorgan Chase & Co. The spread is more than triple Spanish home-loan bonds and about 15 times Dutch mortgage debt.
“The prices reflect concerns about a possible exit from the euro and the legal implications this may have,” said Apostolos Saflekos, a trader for Madrid-based investment firm Auriga Global Investors. Hedge funds and investors in distressed assets are buying as mutual funds and banks have to sell because of credit downgrades, said Saflekos, a native of the Greek city of Thessaloniki.
Greeks return to the polls this weekend after a May 6 election failed to produce a viable governing majority. Voters in the midst of the country’s worst recession since World War II face a choice between continuing with austerity that European partners are demanding in exchange for 240 billion euros ($303 billion) of aid from the European Union and International Monetary Fund, or voting for a party that’s pledged to reject the terms of a bailout, which may lead to an exit from the common currency.
The largest pro-European party is leading the anti-austerity force by 1 percentage point, according to an ANT1 TV poll on June 1. Under Greek law, there is a ban on publication of opinion polls two weeks before an election.
“We think that there is a very large chance that the Greek elections will produce a government that is committed to rejecting Greece’s obligations to its international creditors, said Michael Kurtz, Hong Kong-based head of global equity strategy at Nomura Holdings Inc. “If that happens, it will probably be forced out of the euro bloc,” said Kurtz. He says there’s a 50 percent chance the country will exit from the 17-member shared currency.
Returning to the drachma, would lead to a 65 percent drop in the value of the new currency in nominal terms, and “inevitably” defaulting on large portions of the country’s foreign debt, according to National Bank of Greece estimates.
Spreads on Greek home loan bonds have widened from 16 percentage points in May, JPMorgan data show, as speculation of an exit increased. Standard & Poor’s this week lowered its ratings on the debt, citing potential departure from the monetary union.
Leaving the shared currency and subsequent depreciation of the drachma would see per-capita income drop by at least 55 percent in euro terms, according to a May report by National Bank.
That would be problematic for Greeks who began taking out home loans in earnest after the country joined the common currency and for bond investors, according to a May 10 report by Deutsche Bank AG analysts Conor O’Toole and Rachit Prasad in London.
Thanos and Annetta Kappas, both schoolteachers, say they’re typical of Greeks who thought they had a guaranteed income. They bought a 270,000 euro apartment in an Athens suburb in 2009 with a 210,000 euro loan from the National Bank of Greece. At the time their combined monthly income of 2,700 euros meant they could comfortably meet their monthly installments of 900 euros.
Their pay has been cut by 32 percent to 1,840 euros a month by the state. The couple have sold their car and are relying on his 79-year-old mother for handouts.
The loan “was the product of an era where we believed that civil servants could never lose their jobs and that life would always be a straight path forward,” said Thanos, 50. “Today we are trapped.”
They plan on paying only what they can each month on their mortgage, after trying to renegotiate terms with the bank. Kappas said he hasn’t decided how he’ll vote in the June 17 election. He opposes the bailout conditions imposed on Greece.
Alexis Tsipras, leader of Greece’s Syriza party, has pledged to cancel the bailout and implementation laws and replace them with a national recovery plan. Antonis Samaras, head of the New Democracy party, has promised to extend unemployment benefits while honoring the country’s commitments to the European Union and the International Monetary Fund.
The Kappas couple are far from alone. Non-performing mortgage loans in Greece reached 15 percent of the total outstanding in the fourth quarter, up from 14 percent in the previous quarter, according to the Financial Stability department of the Bank of Greece. First-quarter data is due to be published in coming days, a spokesman for the regulator said.
“The country’s future is not bright and I do not know one single man who can now see light at the end of the tunnel, even with a possible left-wing government,” Kappas said.
The mortgage market had annual growth of 82 percent in the early 2000s as first-time buyers took advantage of increased financing and interest-rate reductions. Home loans expanded to 80.5 billion by the end of 2010 with about 3.5 billion euros packaged inside mortgage bonds outstanding. Home prices in Athens, meanwhile, soared 176 percent from 1997 through the end of 2008, according to data from the country’s central bank.
Home prices in the city, which have fallen about 20 percent from the peak in the second quarter of 2008, would plunge if Greece left the euro, according to Ioannis Kaligiannakis, a senior appraiser at Colliers International in Athens.
“Prices will fall significantly and the situation will be so liquid that it will be difficult to even give a range of reasonable values,” he said during an interview in the Greek capital on June 6. Properties would flood the market in “fire-sale mode” as companies and individuals struggle to obtain equity as bank funding dries up.
“Drachma devaluation, combined with high inflation, political instability, oversupply and the drop in house prices will force borrowers to stop paying their loans since their mortgages will be higher than the value of their homes,” said Kaligiannakis.
Investors with a view that a Greek euro-exit would materialize are “well-advised to avoid the Greek RMBS sector altogether,” the Deutsche Bank analysts wrote, referring to residential mortgage-backed securities. They estimate this could cause losses of 20 percent to 50 percent on certain senior bonds.
That’s not deterring some U.S. private-equity funds that are seeking returns they can’t find at home, according to Michael Bolton, managing director at Clayton Euro Risk, a provider of risk analysis for mortgages. There is “going to be value because the market had overreacted,” he said.
A pool of more than 27,400 mortgages called Grif 1 originated by state lender Consignments Deposits and Loans Fund for civil servants, is trading at about 35 cents on the euro from 52 cents in April, according to prices compiled by Bloomberg. About 2 percent of borrowers are more than 90 days delinquent. The trust can withhold up to 60 percent of the monthly salaries and pensions of borrowers, according to the prospectus.
At those prices, investors in the 650 million euro bond could still recover their investment if the currency was devalued and defaults increase.
If Greece doesn’t exit the euro, senior Greek mortgage bonds would “prove resilient, even under our most severe scenario,” Deutsche Bank’s O’Toole and Prasad wrote.