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Liability management: A step too far

Mexico’s exchange calls into question the point of recent liability management trades.

In January, Mexico launched yet another of its liability management transactions. It was, predictably, a blowout. This one was designed to create a liquid 30-year benchmark by reopening the existing 2034 bonds, and that’s exactly what it did: there were $1.5 billion of the 2034s outstanding before the exchange, which meant they were liquid; there’s now $3.7 billion outstanding, which means they are very liquid.

But what price liquidity? Mexico bought back its non-benchmark long-dated bonds at the market offer price, and sold back its new benchmark long-dated bonds at the market bid price. The majority of the bonds that were tendered into the exchange were 2031s and 2033s, and more than one observer wondered what exactly the point was of spending vast amounts of money on lawyers and bankers just for the sake of swapping 2033s into 2034s.

Indeed, a simple swap of 2031s or 2033s into 2034s would have been so meaningless, from a bondholder perspective, that the US tax authorities wouldn’t even have considered the swap to be a taxable event.

In most bond swaps the swapper is liable for any capital gains on the bonds he’s swapping out of. But in this one, the bonds were so similar that the US would simply carry the tax basis of the 2031s and the 2033s over onto the new 2034s.

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