For the past eight years, Greece has been shorthand for financial mismanagement. The Greek economy contracted by nearly 30% between 2008 and 2016. Unemployment levels climbed to nearly 30% in 2013, and Greece’s debt-to-GDP level reached an all-time high of 181% in 2016.
But what is not well known is that quietly, and through a well thought-out, methodical process, the country’s Public Debt Management Agency has been righting the ship.
First, it managed to negotiate maturity extensions for its €204 billion ($231 billion) of bailout loans with the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM). A large amount of floating-rate loans were converted to fixed rate to protect against future rises, locking in historic lows in euro interest rates and providing the B+ rated issuer with an effective rate that is on a par with AA-rated France.
And second, it quietly managed to corral 18 initially unwilling dealers to provide €35 billion notional of euro interest rate swaps to hedge a large proportion of a separate bilateral loan portfolio. In all, the PDMA’s work over the past year has taken its proportion of floating-rate debt from 34.6% in June 2017 to what Dimitros Tsakonas, alternate director general of the agency, believes will be around 10% by the end of 2018.
“We have faced death between his eyes,” Tsakonas says. “We’re a small group of people here and have faced so many difficulties in the past. We’re not afraid of anything now.”
The first step was to tackle the floating-rate bailout loans provided by the two European institutions. The EFSF loans totalled €131 billion, due between 2023 and 2056, and the ESM loans totalled €62 billion, due between 2034 and 2060.
Interest on those loans was based on the EFSF and ESM’s cost of funds over the lifetime of the loans, which was calculated to be 3.2%. But in 2016, with euro interest rates at around 1.6%, the PDMA suggested to the institutions a range of measures that could reduce the cost of servicing Greece’s debt without affecting the cost of other eurozone countries’ borrowings. The institutions agreed, announcing a package of short-term measures in 2017, which achieved a number of goals.
First, the weighted average maturity of the EFSF loans, which had fallen to 28.3 years due to some bond swap activity in 2015, was extended to 32.5 years. Second, around €31 billion of the EFSF and ESM funding, provided during 2012 and 2015 in floating-rate note form to prop up the country’s banks, was swapped for fixed-rate notes.
The PDMA then looked at the liability portfolio of the EFSF and noted that 90% of its funding came from fixed-rate notes. As the EFSF was supposed to pass on its cost of funding, the PDMA incorporated this liability profile into its own debt portfolio. It converted €90 billion of the remaining floating portion of the EFSF loans into fixed rate at a stroke.
Then came the interest rate reduction. The ESM used interest rate swaps to lock in a fixed rate of around 1.6% on a portion of its loans, which it passed on to Greece as its lending rate – halving the sovereign’s interest payments on those liabilities.
We’re a small group of people here and have faced so many difficulties in the past. We’re not afraid of anything nowDimitros Tsakonas, PDMA
The size of this swap programme is not public, but the ESM’s 2017 annual report, released in June 2018, shows it had €36.5 billion of interest rate swaps notional on its books by the end of 2017. The annual report states it only started trading interest rate swaps that year and that it had otherwise done minimal trading due to market conditions – suggesting the bulk of notionals were linked to the Greece trade. This implies the ESM swapped around 59% of its total Greek loans to fixed through 2017.
Following this, in June 2018 the Eurogroup agreed a package of medium-term measures which saw a 10-year extension of the grace period the PDMA has before paying principal and interest on the EFSF loans, from 2023 to 2033. The weighted average maturity of the EFSF loans was also extended by a further 10 years.
As a result of this activity, Greece has seen a total reduction in its debt-to-GDP level in 2060 of 50 percentage points – from 140% to 90%. Of this reduction, 25 points each came from the short- and medium-term measures. Given the size of debt and the interest rates it is now paying, Greece’s credit costs are lower than many AAA-rated sovereigns.
“By extending the maturity and fixing the interest rates, we effectively locked our interest rate exposure, in terms of credit, with the credit of an AAA issuer instead of a CCC or B issuer – which Greece was up until a couple of months ago,” says Tsakonas. “That’s why we have this massive reduction of debt-to-GDP levels in 2060.”
Living on the hedge
After addressing the EFSF and ESM loans, there was another unhedged liability to tackle – €52.9 billion of bilateral loans from eurozone member states back in 2010, known as the Greek loan facility (GLF). Those loans carried an interest rate of three-month Euribor plus 50 basis points.
With rates set to rise in the eurozone in the near future, Greece faced an additional €500 million per annum interest payment if rates rose by 1% – close to 0.25–0.30% of Greece’s GDP. For a 2% rise, it would be €1 billion.
“This is an unknown factor for us as far as the future is concerned and we didn’t want, and still don’t want, to jeopardise the efforts of the Greek taxpayers by leaving this risk and not hedging it,” says Tsakonas.
An interest rate swap programme would be the ideal route, but Greece was a B-minus rated credit at rating agency Standard & Poor’s at the time, which would force banks to add on charges for counterparty credit risk and funding costs that would make it uneconomical.
The PDMA took another route. It conducted a long-planned liability management exercise in November 2017, where the agency offered to exchange a strip of 20 government bonds issued after the 2012 debt restructuring for five new benchmark issues. This €30 billion debt swap had the effect of cutting the liquidity premium on Greek debt, which also resulted in a reduction of the country’s credit spread of 150–170bp across the curve.
With tighter credit spreads, the PDMA saw an opportunity to approach banks about swapping the GLF debt to fixed rate. At first, the banks were reluctant to consider even something as simple as a 10-year interest rate swap. But the PDMA used its improving situation in the markets to its advantage.
[We] don’t want to jeopardise the efforts of the Greek taxpayers by leaving this risk and not hedging itDimitros Tsakonas, PDMA
“We incentivised by incorporating in our eligibility criteria that to be part of our primary dealers group – that if they wanted to be part of the new story of Greece – then you should fill some gaps. We want you to participate in the auctions, to provide liquidity and be present in the secondary market, and to open credit lines for the Hellenic Republic and the PDMA for plain-vanilla interest rate swaps,” he says.
A number of banks were in-the-money in existing swaps with Greece, but as the sovereign was uncollateralised, they were not receiving any margin. But the hedge of the position was likely to be in the collateralised interdealer market. In all, this ate up potential credit lines with Greece and created large funding and counterparty credit risk costs.
The PDMA said it would allow banks to novate positions to other counterparties that had negative mark-to-market positions against Greece, cutting costs across the Street. In exchange, banks would have to use these now freed-up credit lines to provide the PDMA with the swaps it needed.
The agency started the trading programme with three or four counterparties in January and grew from there. The PDMA also offered some “cashflow incentives” help the programme continue. In all, out of a primary dealer group of 21 banks, 18 have engaged in such interest rate swaps with the PDMA – 14 foreign banks, and four Greek systemic banks. They were done in clips of €250 million or €500 million for a total of €35 billion notional, or 66% of the total amount of GLF loans, and with an average weighted maturity of 10.5 years.
“Soon, we will have another one or two newcomers in this exercise. Almost all of the primary dealers will be part of our exercise,” Tsakonas says.
The PDMA’s efforts resulted in a two-thirds fall in derivatives valuation adjustments compared to those available immediately after the liability management exercise. The agency managed to change its funding costs from floating at three-month Euribor plus 50 basis points, to around 95bp plus 50bp all-in.
“We are going to continue with this hedging programme as soon as markets give us the opportunity,” says Tsakonas.
A taste of things to come
Thanks to the PDMA’s hard work, Greece now has cash reserves close to €34 billion – enough to cover its interest payments for the next four years. Assuming Greece will have a continued presence in the capital markets, it will be able to generate excess liquidity. The question is what to do with it.
Tsakonas says the country will look to buy back expensive short-dated, floating-rate debt – in particular, the International Monetary Fund loans, which have an outstanding amount of around €10 billion and weighted average maturity of around 3.5 years. Half of that is charged at 4.9% due to a step-up feature of the loan.
The floating element of the 4.9% is linked to the price of the IMF’s three-month special drawing rights rate, which is not only expensive but includes foreign exchange risk that is tricky to hedge.
Despite the hard work of his team, Tsakonas insists they don’t have the luxury of basking in their success.
“What we have achieved so far is just the first step for our future. It’s not the end of the story, it’s just the beginning. We are proud of what we have achieved but we feel this responsibility and it is our duty not to have the same problems that we’ve faced in the past,” he says.
“Now, we need to very carefully design our future steps, especially as far as access to the capital markets is concerned – that’s one of our main targets.”