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Sunday, June 25, 2017

Greek Mytilineos Group A Better Risk Than Greece?

The announcement that the Mytilineos Group successfully placed a 300 MEUR 5-year bond at a 3,1% yield caught my attention for a number of reasons.

For starters, Mytilineos' yield of 3,1% is substantially below the current yield on Greek sovereign bonds in the secondary market (5%+). That is the first time in my experience that I see a national borrower issuing debt in international markets at a lower yield than that of the sovereign. One of the general rules about country lending which I had learned over the years was that no national borrower, private or public, could raise debt at lower yields than the sovereign. The reason for that is the so-called 'country risk'. Country risk is the sum of many components, one of which is that within the national borders, it is the national jurisdiction which counts. Theoretically, a sovereign could any time of the day declare a moratorium on all foreign payments. If that happened, even a AAA-rated borrower in that country, flush with liquidity, could not service his foreign debt.

After browsing Mytilineos' website (the first time ever; I had not been familiar with this group), I saw that this group is internationally diverse with operations in several foreign countries. That could be part of the explanation. If the bond is secured by foreign assets or foreign revenues or whatever else is outside the jurisdiction of Greece, that could explain the below-sovereign yield. But then a couple of other observations came up (which I have to hedge by emphasizing that they are based on a very cursory review only and without any other knowledge about the Mytilineos Group).

This is not a large group by international standards with group sales just below 1,3 BEUR. Certainly not the kind of group which one could expect to be an important player in international capital markets attracting the very best conditions. A cursory glance at the group's P+L and balance sheet suggests the following:

* the most obvious financial strengths of the group are (a) very high cash flows (roughly 20% of sales); (b) a rather decent profitability (ROS of 5%+); and (c) almost 200 MEUR in cash on hand.
* with current assets exceeding current liabilities, the group's liquidity would appear fine.
* with equity representing about 40% of total assets, the balance sheet structure would appear to be stable.

However, there are some items which, at first glance and in the absence of more information about the group, could be considered 'scary':

* consolidated total assets include (a) 209 MEUR goodwill; (b) 243 MEUR intangible assets; and (c) 257 MEUR in own stock, or a combined total of 709 MEUR. This means that about 60% of the group's equity of 1.284 MEUR are invested in what cynical credit risk officers would call 'hot-air-assets'.
* the group has almost 800 MEUR in trade and other receivables. That reflects extremely unfavorable trading terms and possibly includes substantial risk.
* total group debt of 650 MEUR appears rather high even for a capital intensive industry.

In summary, the 3,1% yield raises more questions in my mind than it provides answers. Obviously, the immediate reaction is that the low yield (for Greek risk) is due to the group's outstanding creditworthiness and reflects investors' belief that Greece as a country is on the rebound.

Or it could be, as mentioned at the outset, that the bond is secured with foreign revenues or assets.

Or - one could be a bit suspicious. A very important element is not known in this matter, namely: who purchased the 300 MEUR bonds? Suppose it were the Mytilineos family itself. 3,1% on 300 MEUR is close to 10 MEUR per year. If the Mytilineos family had purchased these bonds, they would have arranged for an annual transfer out of Greece of close to 10 MEUR, and that in the presence of capital controls which would normally impede such a thing. Shamed be he who thinks such a thing!

Wednesday, June 21, 2017

A New Narrative For Greece. Again?

The article from the Ekathimerini about building a fresh narrative for Greece made me wonder what the old narrative was/is. Since I couldn't remember any, I thought what kind of a narrative I would like to see. These are some of the thoughts which came to mind.

The first question I asked myself was what exactly is it that I would like to see achieved? And here is the answer I came up with: "We will seek to build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos."

As I pondered this statement, my first reaction was that it basically says everything there is to say. But, of course: stating a goal alone will not do the trick. There has to be a discussion about how this goal can be achieved.

"We will create an obsession with exports!" This proclamation will have to be heard in all walls and halls of Greece. What is it that we could possibly export? Where do we have comparative advantages? Where would be good export markets? How can we move our products up the value chain before they leave Greece? How can we get assistance in pursuing this objective? And why, exactly, should we do all that? Well, because through exports we achieve financial inflows which we can then use to pay for imports, i. e. to increase our living standard. Not to mention the fact that many new jobs will be created.

"We will create an obsession with import substitution!" Now why would we want to do that? Because with imports, all the jobs along the production chain (product development, manufacturing, marketing, selling) are in other countries. We want to 'steal' those jobs from other countries by no longer importing products which could just as well be produced in Greece. Questions are: Which products which we are importing now could be just as well produced in Greece? Can we get any foreign manufacturers to manufacture in Greece? Where should we import from? (presumably from those countries which can reciprocate in one way or another). Import substitution is a job creation program!

"We will create an obsession with tourism!" Tourism is actually another form of exports and through tourism we achieve financial inflows which we can then use to pay for imports, i. e. to increase our living standard. We are first class in the luxury segment but in the rest of the industry we leave quite a bit of money on the table. Either because we have cheap tourists from cheap countries or because rich tourists from rich countries pay cheap all-inclusive prices. We will put the focus on improving quality. Quality of the infrastructure and quality of the service.

"We will create an obsession with foreign investment!" Every Greek will have to understand that there are only 3 options to get out of our economic crisis: foreign investment, foreign investment and foreign investment, again! We will pursue very aggressively foreign investors who take a long-term view with their investments. Who plan to add value to the Greece. And we will de-emphasize any kind of financial investors because such investors are principally interested in short-term financial gain. The key question will always be: Does the foreign investor promise know-how transfer, further investment and expansion. Put differently: Does the foreign investor accomplish something which we could not accomplish by ourselves. Or: Does the foreign investor contribute to the increase in exports, in import substitution and in improving the tourism infrastructure and quality of service?

And, finally -

"We will turn the Greek state into an efficient administration with a strong public service ethos!" Meritocracy will the the buzzword reverberating in the halls and walls of our public administration buildings! In the future, it will be very difficult to get a job in the public sector because the required qualifications will be very high. Patronage or nepotism will no longer be qualifications!

Our guiding policy will be that anything which hinders the above described measures or even makes them impossible will be reformed with great speed. We invite our critics to remind us forcefully should we deviate from this policy.

Friday, June 9, 2017

Debt Relief For Greece - A New Proposal

This article proposes an approach to Greece's debt relief which has not been discussed by authorities. At the heart of the proposal lies the following premise:

'Debt burden' is the amount of government revenues which has to be allocated to debt service (i. e. interest). Populists would argue that 'this is the amount of government revenues which we have to give to banks instead of building new schools and hospitals'.

In consequence, 'debt relief' can only mean reducing the 'debt burden'. If one considers the percentage of the debt burden (i. e. percentage of government revenues allocated to debt service) as the 'Borrower's Sacrifice', the premise of 'debt relief' must be to reduce the 'Borrower's Sacrifice'.

The table below shows the 'Borrower's Sacrifice' for all Eurozone countries. I have made the arbitrary decision to consider countries whose annual debt service exceeds 5 BEUR as 'significant countries'. The 'significant countries' are marked in blue and sorted by 'Borrower's Sacrifice' top-down.

Year 2016
Ordinary Interest "Borrower's
Government Expense Sacrifice"
Portugal  76.613 7.836 10,2%
Ireland 73.029 6.178 8,5%
Italy 788.502 66.272 8,4%
Spain 421.672 31.358 7,4%
Greece 87.473 5.649 6,5%
Belgium 214.063 12.074 5,6%
Austria 173.077 7.347 4,2%
France 1.181.278 41.983 3,6%
Germany 1.411.381 43.372 3,1%
Netherlands 307.004 7.551 2,5%
Finland 116.047 2.277 2,0%
Slovakia 32.345 1.339 4,1%
Slovenia 17.352 1.275 7,3%
Lithuania 13.315 523 3,9%
Cyprus 7.019 465 6,6%
Latvia 9.097 282 3,1%
Malta 3.871 218 5,6%
Luxembourg 23.147 183 0,8%
Estonia 8.507 16 0,2%

Portugal has the highest 'Borrower's Sacrifice' (10,2%) and the Netherlands have the lowest (2,5%). Greece ranks in the middle with 6,5%. However, it must be noted that Greece's 'Borrower's Sacrifice' is highly subsidized by the fact that the bulk of its debt carries below-market interest rates. That is 'debt relief' right there.

Under normal circumstances, the 'Borrower's Sacrifice' of a country is determined by the markets. Not so with Greece because Greece is bankrupt and kept afloat by the Eurozone. Thus, in the case of Greece, the 'Borrower's Sacrifice' can (and must be) steered by its creditors. The balancing act is to make the sacrifice as large as possible for the creditors' benefit without making it so large that it becomes politically unsustainable in Greece (and/or slows the growth potential).

In short, the 'Borrower's Sacrifice' for Greece should be somewhere between 2,5% (the lowest of the 'significant countries') and 10,2% (the highest). My point is: it does not matter so much where the 'Borrower's Sacrifice' is set at the outset. What really matters is that (a) it is made variable; that (b) it is tied to the correct base; and that (c) it has the right adjustment mechanism when the situation changes.

Suppose the 'Borrower's Sacrifice' had been agreed at 2,5% for Greece. In that case, Greece would have been expected to set aside 1.750 MEUR for interest in 2016 (2,5% of 87.473 MEUR). Put differently, Greece would have had to pay 3.899 BEUR LESS in interest than it actually did. That would have been real 'debt relief'.

Once Greece has made its 'Borrower's Sacrifice' (i. e. paid the 1.750 MEUR), Greece's part would have been done. Now it would be up to the creditors to negotiate an agreement among themselves who gets what of the cake. As long as Greece needs to be subsidized, it is clear that none of the creditors can get everything they want. The trick will be to make all creditors equally unhappy.

Why should the 'Borrower's Sacrifice' be tied to government revenues? (instead of, perhaps, to GDP?). The answer is quite simple: interest is paid out of government revenues and not out of GDP.

What should be the right adjustment mechanism? That's the tough part. The adjustment mechanism must assure that as Greece's economic strength increases, the 'Borrower's Sacrifice' increases accordingly. At some point in the future, the 'Borrower's Sacrifice' will reach levels which are acceptable to the markets and, at that point, and only at that point, Greece can truly return to markets.

In summary: the negotiation with Greece should be about the initial 'Borrower's Sacrifice' and the adjustment mechanism, and the negotiation among the creditors should be about allocating the 'Borrower's Sacrifice' amongst themselves. No more, no less.

Monday, June 5, 2017

Greece's Creditors Waiting For 123 BEUR!

The story has been making the media rounds that if Greece's Eurozone creditors agreed to a debt relief in the form of interest deferral until 2048, they would be waiting until 2048 to receive 123 BEUR. This is allegedly based on a forecast by the German Finance Ministry. No details as to how that calculation was made were given.

After having recovered from the shock of this piece of news, one can justifiably ask the question: "What else is new?"

Interest deferral does not mean that interest is forgiven. Its payment continues to be due but, as the name suggests, instead of paying interest every year, all interest is deferred until payment at a later date in the future. Until 2048, for example. And, normally, interest on interest deferred is also added to the bill.

Suppose Greece owed 200 BEUR out of its total debt of about 320 BEUR to Eurozone creditors. At a rate of 2%, the annual interest amount to be deferred would be 4 BEUR. Multiply that by 26 (from 2022-2048), you come to 104 BEUR. Given the difference with the above 123 BEUR, the German Finance Ministry's forecast calculates either with a higher level of debt or a higher interest rate or high interest on deferred interest, or a combination of these.

So there isn't really any news in this shocking news because we are talking about 'debt reprofiling' and not 'debt relief'. Debt reprofiling means to reprofile the existing debt and interest maturities in such a way that they become more amenable to the borrower's cash flow. That's all. There is no relief in that whatsoever.

To express shock about having to wait until 2048 for payment would only be justified if one felt that the payment can eventually be made. I don't believe that there is any person in the world who still believes that Greece can service its debt (i. e. pay interest at market rates), today or in 2048. Thus, to calculate interest at market rates (which cannot be paid), defer it out to 2048 so that a huge bullet payment results and then clamor that 123 BEUR have to be written off, well, that reminds a bit of Paul Kazarian's accounting tricks.

The only thing which will work for Greece is a debt reprofiling combined with a reasonable debt relief. To avoid that governments of lending countries have to tell their tax payers that they had to forgive Greece debt, the relief should be played via the interest rate.

The simplest way would be to set the interest rate at zero percent and to build in certain 'kickers' stipulating that interest could be charged in the future under certain unforeseen developments. For example, if Greece were to discover the world's largest oil reserves and became very rich, that could be a situation where the 'kicker' kicks in.

In the present interest rate environment, this debt relief would not be too costly for the lending countries. They could fix their funding cost until 2048 at rather low rates and the resulting 'loss on Greece' would become an opportunity loss (not collecting interest) whose bookkeeping entry no outsider could find in the published fiscal statements (because there is no bookkeeping entry for opportunity losses).

Everything else is a bit of a farce.

Saturday, June 3, 2017

America First! Germany First! Greece Perhaps last?

The Germans are all upset about President Trump not living up to global responsibilities. The President tells people to 'buy American' and to 'employ Americans'; he withdraws from the Paris Agreement because it would enrich other countries at the expense of Americans and then he even has the nerve to say it loud and clear: "America First!" President Trump blasted that message to the whole world in his inauguration speech.

That is indeed bad behavior. The Germans (and many other European countries) would never say that out loud. But a closer look merits the observation that there are indeed some parallels between Germans within the Eurozone and Trump within the global world community. Germany does not want to enrich other Eurozone countries (or rather: make them less poor) at the expense of German tax payers. Nevermind that it would be good for the Eurozone overall. Germany does not purse rogue companies like VW as forcefully as they pursue rogue (because profligate) states like Greece. The German Chancellor criticizes the American President for tweeting an unintelligible word but she does so in a sentence without true content. And one doesn't have to be a linguist to hear behind every statement of the German Finance Minister the unspoken appeal: "Germany First!"

Well, well, well. This doesn't look good for Greece. If everyone else aims at being first, someone has got to come out last. No point in pondering that. Better to have an ouzo!

PS: this obviously was written with tongue in cheek!