Boring title, we know. But stick with us ’cause there’s all sorts of thematic points in here — from sovereign debt crises to the weakness of short-term financing to interest rate shocks.
After the financial crisis, governments sought to avert depression by bailing out their banks and upping their spending. Fast forward a couple years and now you’ve got all these heavily indebted countries — the UK, the US, Japan — who will be fighting to shrink their debt burdens in the near future (hopefully).
Enter, the debt maturity profile.
The below from Bank of America Merrill Lynch’s John Wraith:
While governments have some control over the speed at which they (try to) reduce the deficit, and while they would hope that making the right choices delivers a lower rate of interest, they have no ability to influence the redemption profile of their existing debt. As maturing bonds need to be refinanced, a heavily front-loaded distribution profile brings with it a high risk, as any big jump in interest rates will much more swiftly translate into a higher interest burden for short-term borrowers, than for longer-term borrowers.
Now Wraith has done something interesting here. He’s gone on to ask what if the UK’s debt maturity profile was like the US? Because believe it or not, at the moment, the UK has a much longer maturity.
So assuming a 100 basis point rise in yields along the curve, you get 32 per cent of outstanding UK gilts maturing by 2015. Fifty-nine per cent of outstanding US Treasuries will have done the same.
Now go back to that question — what if the UK were like the US? If you did that, you might get a better idea of just how much the maturity profile matters in calculating things like future interest costs.
Wraith crunches some numbers:
To isolate the impact of the redemption profile from all other considerations (actual yield moves, evolution of the underlying budget deficit, choice of maturity and stock-specific factors), we simply assume the redeeming debt is refinanced using the same sectoral split for conventional Gilts as fiscal 2011 (short 44.4%, medium 26.7%, long 28.9%) and use an average yield equal to the current weighted maturity yield for each sector plus 100bp (short 3.115%, medium 4.753%, long 5.364%).
Running this exercise first for the actual redemption profile of conventional Gilts and then under the hypothetical scenario where redemptions are in identical proportion to the profile for US Treasures, we find additional interest costs amount to £10.8bn per annum in the first instance (0.7% of GDP), and £20.0bn in the second (1.3% of GDP). In an environment that is sure to see immense stress persist for a wide range of government borrowers, the extent to which the UK benefits from its very long debt profile is striking, and will be a very strong and important positive factor in relative valuation considerations.
The price of short-termism (in this example) — an extra £9.2bn per year in interest costs.
Related links:
Europe’s shocking short-termism – FT Alphaville
From Fed run-offs to super-sized Treasury auctions – FT Alphaville
The sovereign debt premium - FT Alphaville