Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Tuesday, 19 March 2013

Cyprus June-13 Bonds - Buying Opportunity?



Cyprus June-13 bond price has fallen on fears of expropriation/default. However, the EMTN offering circular gives reasons to be greedy when the market is fearfully pricing the bonds around 92 (down about 3-3.5pts). Consider the following:

  1. The bonds are under English law: This makes it difficult to haircut bondholders through local law changes.
  2. A tax is very difficult to impose: As per the offering document (italics inserted) – “All payments in respect of the Notes and the Coupons will be made free and clear of, and without withholding or deduction for, or on account of, any taxes, duties, assessments or governmental charges (together, the “Taxes”) of whatever nature imposed, levied, collected, withheld or assessed by or within any jurisdiction in, from or through which such payments are made or any authority therein or thereof having power to tax, unless such withholding or deduction is required by law. In such event, the Republic shall pay such additional amounts as will result in receipt by the Noteholders or, as the case may be, the Couponholders of such amounts as would have been received by them had no such withholding or deduction been required…” There are exceptions but realistically there is little room for legal trickery within the scope of the document. An overarching European law is a different matter (see this FT Alphaville piece).
  3. The precedent of paying foreign investors to keep them in good humour: Along with EU's desire for haircuts to remain “unique” to Greece, a desire to ensure investors don’t take fright from the rest of the peripheral is presumably why depositors were raided. Moreover, the messiness and pain (eg. Argentina) involved in restructuring foreign law bonds means that Cyprus’ foreign law bonds are likely to paid out in full as well.
Of course there are risks in buying the June bonds. The three main ones are:

  1. Cy-exit or disorderly default: An irate citizenry and the prospect of years of austerity may yet cause politicians to reconsider their position in EU. The miffed Russian bear can easily provide the loose change required to prop up the system in return for burning bondholders instead of depositors (Although denied, Gazprom may have made such an overture earlier). Even if the Cypriots choose to stay in and rebuff Russia, the deal can fall apart due to political intransigence on all sides leading to disorderly default.
  2. Angry Russian response: The EU assumption that Russia would ease the terms of its bilateral loan is now likely to be belied. However in itself this will not pose a great burden as long as the EU is ready to pay a little extra. However there is also a hidden risk due to the bilateral loan between Cyprus and Russia. This is purely speculative but if there are provisions such as obligation acceleration in the loan contract and they are triggered then cross-default may occur. The EMTN documentation states that an event of default is triggered when: “Any present or future External Indebtedness becomes due and payable prior to the stated maturity thereof by reason of default…provided that the aggregate amount of all External Indebtedness in respect of which one or more of the events mentioned above in this paragraph (iii) have occurred equals or exceeds U.S.$25,000,000 or its equivalent in any other currency or currencies.” Again, this is unlikely otherwise the Russians would have threatened it already.
  3. EU grab: European leaders may tire of feeding “locusts” (in their view) and enact an EU-wide law to grab part of the principal repayment in guise of a “tax” or “special levy”. However the probability of this is low given the demonstrated desire to keep investors in good humour.
The main risk is of an exit but if one believes that Europe is Hotel California then buying these bonds maturing in less than 3-months makes sense.

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