Monday, January 20, 2014

Bond yields tumble; should we refinance debt?

There was much talk over the weekend that the Moody’s upgrade of Irish government bonds on Friday was merely Moody’s catching up with the market.  If that was the case then it would have been reflected in little or no change on the yield on Irish government bonds this morning.  That has not been the case.  Yields have fallen considerably.  Here is a five-day chart of the five-year yield calculated here.

Bond Yields 5yr 20-01-14

The drop at 8am this morning is pretty apparent.  The reputation of ratings agencies has taken a deserved battering in the past few years but their significance in financial markets seems to have remained.

Any debate about the decision not to go with a Precautionary Credit Line now seems moot.  Although the yields now back the decision the reality is that the PCL was unlikely to be used if it was in place.  Here is chart from an interesting presentation on Portugal.

Debt Maturities 2014-15

Ireland’s debt financing needs over 2014 and 2015 was less than 5 percent of GDP which is much lower than Greece, Portugal, Spain and Italy.  At the end of 2013 Ireland had a cash reserve of around 12 percent of GDP which is enough to cover debt and deficit financing until the first half of 2015.  A PCL would have lasted 12 months before it would expire or require renewing.

Of the 5 percent of GDP debt financing needs for 2014 and 2015 about half has already been covered with the maturity of a bond on the 12th of January.  As shown here the only bond currently in issue that matures over the next two years is a €3.6 billion bond that will need to be paid in February 2015, while the one following that is a €10 billion bond that matures in April 2016.

The debt profile shown by the NTMA shows a large EFSM loan that is set to mature in 2015.

NTMA Debt Profile

The EFSM loans, however, will have their terms extended as agreed by the ECOFIN last June but the actual change will not be determined until closer to the original maturity debt.  As the NTMA note:

EFSM loans are also subject to a seven-year extension that will bring their weighted average maturity from 12.5 years to 19.5  years.  It is not expected that Ireland will have to refinance any of its EFSM loans before 2027. However, the revised maturity dates of individual EFSM loans will only be determined as they approach their original maturity dates.

Ireland’s low refinancing needs have undoubtedly been a factor in the relatively benign move out of the direct funding phase of the EU/IMF programme.  However, given the current level of borrowing rates, it might be better to have slightly more debt to refinance at the current lower rates.  As John Corrigan said on today’s Morning Ireland (reported here):

“each one tenth of one percent of a fall in the interest rate for every billion we borrow represents a saving of about a million per annum.”

Refinancing €10 billion of debt at a one percent lower interest rate would save around €100 million per annum.  The problem with this potential saving is that we don’t have debt to refinance.  We can’t just buy existing debt as that would have to be bought at the current lower yields, i.e. higher prices.  We need existing bonds to mature to benefit from the lower rates.  As we have seen we have less than €4 billion maturing over the next two years. Maybe we should give thought to repaying the EU/IMF loans early.

This seems particularly worthwhile for IMF loans.  These have an average interest rate of around 4.2 percent (almost one percentage point over the current ten-year yield).  Ireland has accessed €22.5 billion of loans from the IMF.  This will amortise in different tranches from 2015 to 2023.

So why not pay off the relatively higher cost IMF loans with the relatively cheaper funding now available from sovereign debt markets?  The problem with this is that one condition of the overall €67.5 billion funding package is that any early repayments must be split in proportion across all the lenders.  The IMF provided one-third of the overall funding.

So if we wished to repay €10 billion of IMF loans then a further €20 billion would have to be repaid to the EU lenders (EFSF, EFSM and UK, Danish and Swedish bilaterals).  Repaying the high-interest, relatively short maturity IMF loans makes financial sense.  Repaying the low-interest, very long maturity EU loans currently does not make financial sense.

Repaying IMF loans early is sometimes used as a positive indication for post-bailout countries. Iceland has done so.  Interest rates are now at levels that mean Ireland would gain financially and reputationally from doing so.  The structure of our EU/IMF funding package means it is unlikely to happen but if bond yields were to continue to tumble…

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