It's not quite a rags-to-riches story, but 2016 capped a remarkable three-year turnaround for the Republic of Slovenia – from ropey to robust, perhaps.
Between May and October, the treasury directorate at Slovenia's ministry of finance bought back $2.61 billion of the US dollar-denominated bonds issued between 2012 and 2014 as it struggled to contain a domestic banking crisis, replacing it with cheaper euro debt. That will deliver lifetime interest and savings of €66 million ($70.2 million) and a more forgiving refinancing schedule. Simultaneously unwinding a series of collateralised cross-currency swaps also cut the treasury's contingent liquidity needs.
"It has been such a long journey," says Marjan Divjak, the treasury's director general in Ljubljana. "I did not imagine a few years ago when there were all those downgrades and difficult discussions with investors that we would have achieved the debt profile you see today. Of course, I had a view that spreads would tighten – but it has been much better than I ever expected."
October's €1 billion tap issue of 24-year euro-denominated bonds was completed at a near-record low yield of 1.863%, for example.
Decisive reforms laid the foundation for a return to investment-grade status in 2015, but seizing the opportunity presented by diverging transatlantic monetary policy last year required quick and careful work.
I think they were visionary in embarking on this exercise
Maryam Khosrowshahi, Deutsche Bank
"They handled it great," says Maryam Khosrowshahi, a director in the public sector debt team at Deutsche Bank. "They picked their times so as well as having very successful outcomes they also had all the economic benefits with the transaction. It was extremely challenging – but each time they managed to get everything aligned. I think they were visionary in embarking on this exercise."
Lee Cumbes, a managing director at Barclays Capital says other debt management offices (DMOs) might have been put off by the many moving parts Slovenia had to manage: to satisfy national accounting regulations in each of the three buybacks, the DMO had to execute the swap unwinds, euro debt issuance and US dollar bond tenders on the same day.
"It's a very complex liability management exercise and hasn't been done many times before," says Cumbes. "It's a case of buying back multiple dollar issues, dealing with all the complex swaps on the back and reissuing in the euro market – all at the same time. If they were a less professional, dynamic DMO they might have decided to just let those bonds sit there and run down. There are plenty of others out there in this situation that are not going out and doing all this extra work."
Road to recovery
Slovenia's US dollar bonds were issued in 2012 and 2013 as the country struggled to contain a domestic banking crisis without calling on the European Union for a bail-out and submitting to the harsh economic stewardship imposed on Greece. As long as Slovenia could preserve access to the debt capital markets, its fate was in its own hands.
Concerned about the cost of borrowing in the euro-denominated markets, Slovenia decided to look further afield. In late 2012 it had raised $2.25 billion via three 10-year bonds paying a coupon of 5.5%. Another four US dollar issues followed over the course of the next two years.
To exchange the dollars it had borrowed back into local currency and manage its interest rate exposure, Slovenia entered into a series of interest rate and cross-currency swaps. The sovereign first exchanged a fixed for a floating rate of interest on the dollars, before swapping into euros linked to three-month Euribor. The underlying three-month Euribor rate was then swapped to six-month Euribor, and finally to a fixed rate in euros. The performance of these swaps as the markets shifted would later become a crucial factor in the sovereign's liability management plans for 2016.
Although the sovereign met its immediate financing requirements with the dollar bonds, it came with significant interest costs. Slovenia's dollar-denominated debt had also risen from zero to almost 30% of its total outstanding debt in a short space of time.
"It was at this point that we started to think about how it would be possible to buy back this expensive debt on the global market and fund it with issuance on the local market," says Divjak.
Timing it right
The stars began to align during 2015. First, Slovenia's banking and wider financial crisis had largely eased by this point. A series of reforms – including fiscal consolidation, privatisation, labour market and pension reform, and recapitalisation of banks – meant the sovereign's standing in the capital markets had improved. Reflecting its return to economic health, the sovereign was upgraded back into investment-grade territory by each of the three main ratings agencies during the course of the year.
Meanwhile, with monetary policy becoming more accommodative in the eurozone and the expectation of higher borrowing costs in the US, the euro became a more attractive currency in which to borrow. Crucially, the euro was also weakening against the US dollar. By the beginning of May 2016, with EUR/USD at 1.1451, Slovenia's cross-currency swaps were in the money. The liability management exercise Divjak had in mind was beginning to look feasible.
"The swap rate for US dollar and euro was already widening [in 2015], but our results were still not showing a positive net present value (NPV)," says Divjak. "We continued to monitor the situation and as monetary policies became more divergent we started to observe positive NPV for the possible liability management transactions. It was at this point that we started to prepare everything so we could execute the transactions."
Matching it is tricky. You need to be more careful with the timing, especially because there are three transactions where the movements are uncorrelated
Marjan Divjak, Republic of Slovenia
There was a lot to prepare. On top of determining precisely how much of the existing US dollar debt to buy back, and how much euro debt to issue, the treasury was presented with an additional complication. In order for the planned transactions to meet Slovenian accounting standards, national deficit figures would need to be immediately adjusted and reflected in the national budget. Beyond asking the government to submit a supplementary budget to parliament after buyback, it was unclear – initially at least – how this requirement could be met.
After consulting on their plans with the Slovenian Court of Audit, the treasury was eventually able to devise a workable solution. The bond issue, swap unwind and buyback were to be executed near simultaneously. Supported by specially customised documentation, proceeds from the euro bonds and the swap unwind would be delivered straight from clearing and settlement depositories to the US bondholders participating in the tender. Only the residual value would flow to the national account, eliminating the need for a supplementary budget.
Using this approach, three liability management exercises were completed over the year. The first was May 11. On this occasion, Slovenia bought back three US dollar bonds maturing in 2022, 2023 and 2024, before completing a tap issue of a 2025 €1.25 billion bond and a 2032 €1.5 billion euro-denominated bond issued on the sovereign's return to the euro market in 2015. In August 2016, the country bought back the same dollar bonds, tapping an existing 2035 €1 billion bond.
Behind the unwind
Satisfying the accounting requirement made the transactions harder to pull off.
"It was more difficult to plan; it was heavier to execute," says Divjak. "Matching it is tricky. You need to be more careful with the timing especially because there are three transactions where the movements are uncorrelated. It means the Republic of Slovenia is exposed to many different risks during execution."
The risks posed by the swap unwind required particular attention – for example, the need to manage differences in the collateral agreements between the DMO and each of its counterparties. With Eonia falling to –34 basis points in May 2016, the treatment of negative interest rates was one source of difference – some counterparties apply a zero-rate floor in their agreements, meaning a collateral poster would not have to pay interest, and this can produce significant valuation differences between banks for the same trade.
Divjak and his team sought to minimise unwind charges through a competitive bidding process.
"We asked all the banks with which we had entered into agreements to provide us with swap unwind charges," says Divjak. "It was important to us to get the lowest possible cost for the republic."
The approach paid off. Overall, €39 million was saved on debt service and lifetime swap costs with the first liability management exercise the sovereign conducted in May 2016. A further €7 million and €20 million was saved on the August and October 2016 exercises respectively.
The exercise had a host of risk management benefits as well. By restructuring the redemption profile of its debt, the weighted average time to maturity of Slovenia's portfolio rose from 5.7 years at the end of 2015 to 8.1 years in late 2016. Modified duration, meanwhile, moved up from 4.5 to 7. "The redemption profile is very robust now," says Divjak, "and that is important from a refinancing risk perspective. The republic has only moderate financing needs now for the next decade."
By unwinding the cross-currency swaps which – unusually for a sovereign – were collateralised, Slovenia was also able to manage down its contingent liquidity needs.
"The liquidity risk created by the swap mark-to-market operations we do weekly is now significantly reduced," he says. "We were actually getting a lot of additional liquidity back in 2016. Although we don't expect that monetary policies will be less divergent soon with implications for liquidity risk, it is still beneficial to us from a risk management perspective."
The week on Risk.net, September 8-14, 2018Receive this by email