Not quite a Greek restructuring or re-profiling, but a big warning sign that we’re now very close.
First a little background…
The section of the International Capital Markets Association that looks after eurozone debt made an unusual request last month.
The Association des Marchés de Taux en Euro politely asked sovereigns to behave themselves when buying back their own government bonds. Here’s the request (click the image):
The ICMA basically noted these problems:
Issuers do not all have publicly disclosed policies for buying back their own debt securities in the international capital market. Where issuers do have buyback policies, objectives and the manner in which they are conducted differ. For example:
(a) Objectives: Issuers buy back their own debt as buyer of last resort (i.e. when there is no market) or on an ad hoc basis when they consider that the market is undervaluing their debt.
(b) Manner: Issuers conduct reverse auctions from time to time, which are pre-announced, or intervene in the secondary market without necessarily making a public announcement.
Issuers currently price buyback deals in different ways, for example:
• first, through reverse or exchange auctions, at a transparent price determined by the market;
• second, at a discretionary price negotiated by the issuer.
Just tell us what you’re up to, the ICMA asked.
Well, now they have a highly topical test case. Via Reuters:
Greece has bought back about 2.3 billion euros ($3.37 billion) of outstanding bonds and T-bills in the secondary market since the start of the year, government officials said on Thursday…
Another official said this was part of treasury cash management operations and that debt buybacks during the same period last year were much smaller.
It looks like Greece is really going to upset the ICMA. No public announcement, obviously. Nor any explanation of why the bonds were bought back. Which is a real shame. There are questions over why Greece is buying back now at a critical moment for its debt, and why so much more was purchased than normal.
We think we know why though.
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It’s all about the maturities
As it happens, the Greek debt office does detail policy on the triggers for buybacks, if not on how it buys back debt, under provisions on liability management.
FT Alphaville wishes to highlight the following triggers:
Reduction of total expected interest cost under risk constrains [sic]
- Appropriate risk measure: Cash Flow at Risk (i.e. predictability of interest expense in the budget)
Current Interest Rate Risk Control Parameters:
- Fixed to Floating ratio 80%/20% to 65%/35%
- Duration target around 4(±0.5) years
- Percentage of debt re-fixed or refinanced within 1 year: max 40%
- Percentage of debt maturing (refinanced) within the next 5 years: up to 55%
- Minimize foreign currency exposure, in order to stabilize the nominal value of debt
- Management of inflation-linked liabilities
In plain English, Greece buys back debt on which yields rise too sharply. It’ll also buy back bonds which reduce its average debt maturity below the above threshold, or which load its imminent refinancing burden too far. Naturally then, there is a particular incentive to buy back short-dated paper.
Now, consider the state of Greek debt in 2011, starting with its maturity profile. Greece is currently not refinancing debt apart from its T-bills, and is instead drawing down from EU and IMF loans. This means Greece doesn’t pay through the nose going to market, but any longer-term debt that matures in this period won’t be refinanced. Accordingly – its average debt maturity is being cannibalised from within, via simple run-off. Compounding the issue is the legacy of the short-dated debt Greece issued just before its bailout, the effects of which you can see in a December 2010 public debt bulletin:
Therefore, retiring short-dated bonds helps to rebalance the overall maturity. Not too controversial in principle. Except it obviously is absolutely quixotic for Greece to manage its debt refinancing risk via buybacks much further.
There is simply too much of it around, as was already clear in December 2010:
You can even see buybacks mentioned in a footnote to that chart above, as we’ve highlighted.
Ultimately, Thursday’s buyback revelation merely underlines the inevitability of a very particular type of Greek debt restructuring.
Greece will have to oblige holders of short-dated bonds to tender them for swapping into longer-dated issues. What’s really striking is how much of Greece’s outstanding debt is now dated five years and under — over half.
It’s such a big problem that it should really be seen as separate to haircuts as a trigger for a Greek default. Considering that there plausibly are ways to haircut without legal default, the maturity swap aspect of Greece needs more attention. It may turn out to trigger a default all by itself. More on this soon…
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It’s also about yields
The other thing worth mentioning with Greece’s short-dated outstanding debt is that the yields have gone bonkers in 2011.
The two-year bond has already achieved instant notoriety for yielding 25 per cent in recent days, for example:
This is a function of the imminent maturity swap, and the lack of information on what kind of maturities the bonds will be swapped into. (It could be five years or ten years added on to bonds, for all we know.)
However, we finally wish to point out how badly this yield spike has compromised whatever buybacks would have been carried out this year.
The whole point of buybacks is to take advantage of discounts on prices to realise savings on interest and principal. However, so fast have prices collapsed, that Greece would have massively overpaid by buying even in early April versus later in the month.
We’ll say it again therefore: the more Greece uses buybacks, the more the case for restructuring strengthens.
Related links:
A primer on sovereign debt buybacks and swaps – IMF (2007)
The buyback boondoggle -Rogoff and Bulow (1988)
Bond buyback irony in Europe - FT Alphaville