Here are some useful calculations courtesy of Bank of America Merrill Lynch.
They’re to do with that idea of using loans from the European Financial Stability Facility (EFSF) to let troubled eurozone countries buy back their own bonds. That in turn, some think, might help lower the countries’ debt-to-GDP ratios, given that much of their debt now trades at a big discount to par. Et voila, debt sustainability.
So here’s BofAML’s Ralf Preusser with a list of potential buyback problems:
1. The financial incentive to engage in a debt buy-back is a simple function of the breakeven calculation whereby the (market value of debt * EFSF interest rate) << (weighted average coupon * notional of debt). In the case of Greece, the index trades at 73cts, with a weighted average coupon of just under 5%. On that basis it is worth buying back the debt up to the point where they pay the EFSF 6.8%, but for other countries the calculation will look much less favourable.
2. The debt maturity distribution would concentrate around the seven year point. This suggests there may be a bigger incentive to buy back shorter-debt rather than longer debt and thereby also extend maturity, but with shorter debt trading much closer to par there are less benefits. The 1-3Y index trades at around 90 cents, with a weighted average coupon of 4.5%, meaning that a buy-back would only make sense up to an interest rate of 5% which is less than the interest rates either Greece or Ireland currently pay.
3. Unless peripheral countries want to bid bonds all the way back to par in a drawn out repurchase programme – thereby subsidising the private sector – each country would effectively have to make a one-time exchange offer at current market prices for all or part of their debt, assuming condition 1) is satisfied and debt managers are not worried about 2).
4. To make a one-off exchange offer for all or part of their debt the EFSF has to have the cash in hand, i.e. has to pre-fund to the tune of roughly 1.5x the size of any exchange offer.
5. The EU would also end up being the sole creditor of the periphery bearing all the future risk of a restructuring alone.
Calculators out, European leaders.
Related links:
EU eyes bond buy-back for periphery - FT
What fresh basis the ECB hath wrought – yet again – FT Alphaville