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COUNTRY RISK ANALYSIS (PowerPoint)

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					COUNTRY RISK ASSESSMENT


      External Debt Crisis
  Investment & Opportunities
              -II-
              April 2008
          MH BOUCHET/CERAM (c)
   Various approaches to country risk
              assessment
 Qualitative analysis
 Quantitative approach : rating and scoring
 Econometric approach and modelization
 Analytical approach: crisis typology (Indosuez)
 Principal Component Analysis (CDC)
 Logit Analysis
 Non-linear conditional analysis (threshold levels
  & breaking points)
 External debt analysis

                  MH BOUCHET/CERAM (c)
US banks cut lending to EMCs... while improving capital ratios!

400 US$ billion

350                                                                            Tier 1 capital
300

250
               US Banks’ loans to
200                 EMCs

150

100
                        BAKER PLAN
 50                                          BRADY PLAN

     0
 81
         82
              83
                   84
                        85
                             86
                                  87
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                                                                                                                                 07
19
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          19
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                    19
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                                                      BOUCHET/CERAM                                                     3
        US Banks cross-border claims on
               EMCs end-2007
   Total US banks’ claims= US$189 billion
   O/w on India = US$28319 million
   O/w US foreign office claims on India= US$25162
   O/w claims on India’s banking sector= US$10097
   O:W claims on India’s public sector= US$6785

   O/w Citibank’s claims on India= US$17470 million
   O/w <1 year= 82%
   (>1% of total assets or >20% of capital)

    Source: USFFIEC
                      MH BOUCHET/CERAM (c)
The Brady Plan = Menu-based debt
     restructuring workouts




           MH BOUCHET/CERAM (c)
               The 1989-2000
          Brady Debt Reduction Plan
                         Debtor countries:
1.   Tough macroeconomic adjustment programs under the
     monitoring of the IMF/WB (SALs)
2.   Cofinance LT debt repayment guarantees with purchase
     of zero-coupon bonds
                     London Club banks:
1.   Provide deep discounts through interest or debt stock
     reduction
2.   Get accounting and regulatory incentives
3.   Shift to specific purpose financing and voluntary
     lending (2003-2007)
                       MH BOUCHET/CERAM (c)
              The Brady Plan
 Objective: defaulted sovereign London Club bank
  loans would be exchanged for collateralized, easily
  tradeable 30-year bonds, with bullet repayment
 London Club banks would grant some amount of debt
  relief to debtor nations, in some proportion of
  secondary market discounts.
 The new Brady bonds would be guaranteed by zero-
  coupon US Treasury bonds which the defaulting
  nation would purchase with financing support from
  the IMF/World Bank.


                    MH BOUCHET/CERAM (c)
                 Brady Bonds
 Brady Bonds are named after former U.S. Treasury
  Secretary Nicholas Brady.
 Brady bonds have their principal guaranteed as
  well as x semi-annual interest payments, whose
  guarantee is rolled over.
 Bullet repayment is collateralized by 30-year zero
  coupon bonds, with a specific-purpose issue of the
  US Treasury, the Banque de France or the BIS.
 Cross-default clause




                    MH BOUCHET/CERAM (c)
     The Brady plan in action

                                                Debt cancellation backed up
                                                by commercial banks’
                                                reserves for loan-losses
                                                with regulatory incentives
                                       35%


            65%

           SENIOR DEBT

New debt with long-term maturity,
principal collateralization, rolling interest
guarantee, and cross-default clause

                         MH BOUCHET/CERAM (c)
                         Brady Bonds

     Default on interest payments would trigger exercise of interest guarantee
     and of principal collateral guarantee
                                                     Bullet Payment
                                                     at maturity




                                    Prime rate or LIBOR + Spread of 13/16




     ZCB
t0                 t10                t20                   t30
                             MH BOUCHET/CERAM (c)
      How to assess and calculate the market value
           of a collateralized Brady Bond?

 Brady    bonds comprise defaulted London Club
    debt, repackaged and backed by 30-year US
    Treasury bonds as collateral, often including a
    rolling 18-month interest guarantee.
 1. Strip the bond by separating the risk from the no-risk
  elements (interest and principal): risk-free discount rate
 2. Calculate the risk-adjusted NPV of the guaranteed and
  non-guaranteed streams of interest payments and the
  principal payment at maturity
                       MH BOUCHET/CERAM (c)
                 Brady Bonds
 In February 1990, Mexico became the first country
  to issue Bradys, converting $48.1 billion of its
  eligible foreign debt to commercial banks.
 US$200 bn of Bradys from 18 countries in Asia,
  Africa, Eastern Europe and Latin America
 Mexico, Brazil, Venezuela & Argentina
  accounteed for more than 2/3 of Brady Bonds
  issued.


                   MH BOUCHET/CERAM (c)
       Market-driven menu of options:
 new money loans + discounted buybacks
+ exit bonds + debt conversion + debt
restructuring bonds

   Official Support: up to US$ 25 billion to
  support the Brady initiative from the IMF +
    World Bank + RDB + OECD creditors:




                   BOUCHET/CERAM           13
              Financial components of a Menu:
I. Buying back debt at a discount, either formally or informally, enables
   developing countries to reduce debt by exploiting the discount on
   commercial bank loans in the secondary market.

The effectiveness of a buyback depends on how it is financed whether it be by a
  loan or donation and on its impact on the future debt servicing profile. For
  highly indebted countries, one aim of buying back debt is to enable small
  banks to exit before a restructuring plan.

For low income countries with little debt, the purchase can be used to eliminate
   commercial bank debt in its entirety. However, the purchase of debt raises
   legal and legislative issues. Restructuring agreements require the legal waiver
   of restrictive clauses prohibiting buybacks or conversions.



                               MH BOUCHET/CERAM (c)
      Financial components of a Menu:


II. Debt Exchange consists of converting old claims for
more favorable instruments both for the creditor and the
debtor country:
Brady bonds (discount bonds, par bonds, and FLIRBs)
Debt/Equity conversion
Debt restructuring with new coupon and longer term
maturity
(Pakistan, Russia, Ukraine in mid-1999)




                      BOUCHET/CERAM                   15
              Types of Brady Bond Instruments

   Par Bonds Maturity: Registered 30 year bullet issued at par
    Coupon: Fixed rate semi-annual below market coupon Guarantee:
    Rolling interest guarantees from 12 to 18 months Principal is
    collaterallized by U.S. Treasury zero-coupon bonds
   Discount Bonds (DB) Maturity: Registered 30 year bullet
    amortization issued at discount Coupon: Floating rate semi-
    annual LIBOR Guarantee: Rolling interest guarantees from 12 to
    18 months.
   Front Loaded Interest Reduction Bonds (FLIRB)
    Maturity: Bearer 15 to 20 year semi-annual bond. Bond has
    amortization feature in which a set proportion of bonds are
    redeemed semi-annually. Coupon: LIBOR market rate until
    maturity. Guarantee: Rolling interest guarantees generally of 12
    months available only the first 5 or 6 years.


                          MH BOUCHET/CERAM (c)
                        Brady Bonds
   Debt Conversion Bonds (DCB) Maturity: Bearer bonds
    maturing between 15-20 years. Bonds issued at par. Coupon:
    Amortizing semi-annual LIBOR market rate. Guarantee: No
    collateral is provided
   New Money Bonds (NMB) Maturity: Bearer bonds
    maturing 15-20 years. Coupon: Amortizing semi-annual LIBOR.
    No collateral
   Past Due Interest (PDI) Maturity: Bearer bonds maturing
    10-20 years. Coupon: Amortizing semi-annual LIBOR. No
    collateral
   Capitalization Bonds (C-Bonds) Issued in 1994 by Brazil
    in the Brady plan. Maturity: Registered 20 year amortizing bonds
    initially offered at par. Coupon: Fixed below market coupon rate
    stepping up to 8% during the first 6 years and holding until
    maturity. Both capitalized interest and principal payments are
    made after a 10 year grace period.
                          MH BOUCHET/CERAM (c)
                  Par, Discount and FLIRB bonds:

1.   may have principal collateralization, usually 30 year U.S. Treasury
     zero-coupon bonds, and/or rolling interest collateralization (usually 12-
     18 months);

2.   may be excluded from further new money requests of the bond issuer in
     order to maintain the implicit seniority of the new debt;

3.   may be eligible for debt-equity conversions in the developing country.

4.   bonds with recapture clause (Argentina, Nigeria, RCI…): In some
     cases, the bonds carry rights to receive additional payments that are
     triggered by an increase in the price of the country's major exportable
     goods. The value recovery clause can be linked to the evolution of
     GDP, an index of terms of trade, or export receipts.

                               BOUCHET/CERAM                          18
                          Bank Options in Debt Restructuring Menus

BANKS                            MEXICO                     PHILIPPINES
              Par Bonds       Discount Bonds New Money Buybacks New Money
Canada             48%              52%          0%      100%         0%
France             79%               9%         12%        4%        96%
Germany            80%              20%          0%       81%        19%
Japan              18%              81%          0%       41%        59%
United Kingdom 48%                  45%          6%       54%        46%
United States      58%              24%         19%       18%        82%
                                  BOUCHET/CERAM                      19
The market-based menu of debt restructuring instruments

                Bank Menu Choices in Brady Agreements

                  Par Bonds        Discount Bonds   Buybacks
Argentina               66                 34
Bolivia                 19                 35            46
Brazil                  32                 35
Bulgaria                                   60            13
Costa Rica                                               63
Dom. Republic                                 65         35
Ecuador                 42                    58


                              BOUCHET/CERAM                20
                Brady Bonds
   Arg Par   48.000         50.000
   Arg FRB   41.000         42.000
   Arg '27   31.000         33.000
   Brz C     75.250         75.437
   Brz '27   72.750         73.000
   Bul IAB   85.000         85.500
   Mex Par   93.000         93.250
   Pol Par   75.250         76.250
   Rus '28   107.750        108.000
   Ven DCB   78.250         78.750
   Vie Par   44.000         45.000

                   MH BOUCHET/CERAM (c)
        Market-based menu approach: the importance of
         the tax, accounting and regulatory framework
   In June of 1999, the BIS launched a revision of the capital
    adequacy guidelines, known as the 1988 Cooke ratio. The BIS’
    12 banking comptrollers were to edict new regulations to be
    applied by 2002, in consultation with the EU’s commission.
   The Cooke solvency ratio imposes an 8% proportion between
    risk-weighted assets and capital.
   There are four risk categories, between 0 (OECD countries, IFIs)
    and 100% (EMCs risk).
   In 1995, the BIS adopted a reformed Capital Adequacy ratio to
    account for investment and transaction financial instruments. The
    ratio also distinguishes between market risk and counterpart risks.



                           MH BOUCHET/CERAM (c)
        Market-based menu approach: the importance of
         the tax, accounting and regulatory framework
   The Capital Adequacy ratio stipulates that various exposures to
    risk must be considered, including interest, counterpart, volatility,
    currency risks…) and that capital requirements must be assessed
    by Value at Risk methods.
   Capital comprises two categories:
   1. Tier 1: capital, reserves, benefits, and “FRBG”
   2. Tier 2: reevaluation reserves, guarantees, public subsidies,
    subordinated debts under specific conditions.
   The 2000 BIS reform aimed at adjusting the risk weighted assets
    to take into account (i) not the legal nature of risk but rather the
    underlying risk quality, (ii) risk mitigating tools (guarantees,
    collaterals) and (iii) risk ratings.

                            MH BOUCHET/CERAM (c)
        International banks’ reserves against LDCs claims in the mid-1990s


OCDE COUNTRY       RESERVE LEVELS      TAX REDUCTION   CAPITALISATION   NUMBER OF COUNTRIES


FRANCE             58%                 Yes Maxi 60%    Yes              42


BELGIUM            60% mini            No              No               50


CANADA             35% mini            Yes Maxi 45%    No               43


GERMANY            70%                 Yes             No               AD-HOC


JAPAN              30%                 1% only         29%              38


NETHERLAND         45%                 Yes             No


SWITZERLAND        70%                 Yes             No               90


UNITED-KINGDOM     65%                 Yes 50%         No               Matrix


UNITED6STATES      58% money-center    No              Yes              AD-HOC




                                      BOUCHET/CERAM                                           24
        Basles II regulatory guidelines
 Came     in operation in 2007: the new guidelines
    force banks to allocate more capital against loans
    to countries (and companies) that are lower –rated
    or not rated at all.
   In addition to credit and market risk, the operational risk
    capital charge rests on a basic indicator approach, a
    standardised approach and an advanced risk-sensitive
    measurement approach. This risk stems from inadequate
    or failed internal processes.


                         MH BOUCHET/CERAM (c)
    Basles 2= Tax, accounting and regulatory framework
   Impact of new capital adequacy guidelines on EMCs ‘ capital
    market access?
   Negative impact on OECD countries with ratings < AA- = higher
    capital requirements (Mexico, Turkey, Korea…) = 100%
   Non OECD countries with ratings < B- = 150% capital backing
   Non OECD countries with ratings > BB+ = lower capital backing
    = from 100% to 50% or even 20% and 0% (Taiwan and
    Singapore)
   Growing risk of procyclicality of banks’ internal risk rating
    systems




                         MH BOUCHET/CERAM (c)
    Tax, accounting and regulatory framework

Ratings      AAA<R>A BBB<R<B BB+<R<B- R<B-
             A-      BB-


Sovereigns   0%       50%           100%   150%

Banks        20%      100%          100%   150%




                   MH BOUCHET/CERAM (c)
 Commercial banks which include general reserves in capital
  (France and the United States) might be reluctant to enter
  debt reduction schemes owing to the related upfront capital
  loss. Buybacks and discount bonds will probably meet strong
  opposition from the creditor banks. These banks will tend to
  prefer par bonds with temporary reduced interest rates in
  order to stretch the accounting loss in the income statement
  over the life of the loan.

 Commercial     banks which must reserve against new money
  credits (e.g., France) face an additional cost compared to
  banks which have the discretion of increasing or maintaining
  reserves at existing levels. Finally, banks which benefit from
  very limited tax deduction on loan-loss reserves (e.g., in
  Japan) prefer selling discounted LDC claims in order to
  shrink their new money base and improve asset/capital
  ratios.
                        BOUCHET/CERAM                         28
The Secondary Market
 of Emerging Markets
        Debt



      MH BOUCHET/CERAM (c)
 The Secondary Market of Emerging Markets Debt

The    secondary market for commercial bank claims is the
 market where buyers and sellers trade sovereign debt. Since
 the late 1980s, the debt of many developing countries sells at
 below its face value on the secondary market, the discount
 reflecting the risk associated with holding such debt.
 An active secondary market in LDC debt began to emerge in
 1983-84 in which banks traded their portfolios on an inter-
 bank loan swap basis in order to consolidate or diversify their
 claims or to take advantage of accounting and tax benefits.
 The market expanded significantly in 1987-88 owing to the
 rise in reserves and a growing number of debt-equity
 conversion programs and portfolio rebalancing strategies.

                         BOUCHET/CERAM                   30
Secondary market trading has been dominated by Latin
 American country debt, in particular debt from Brazil,
 Mexico, Argentina and Venezuela, accounting for close to
 70% of volume. Many investors consider the Mexican
 par bond as a benchmark as it is one of the most liquid
 markets in the world after the US Treasury market,
 reportedly.
Outside Latin America, the debt of Nigeria, Russia,
 Morocco, the Philippines, Bulgaria and Poland is traded
 in a market which is considered reasonably liquid.
 Privatization programs and conversion schemes which
 are active in several countries such as Argentina,
 Venezuela, and Brazil have stimulated trading of
 sovereign country debt.

                       BOUCHET/CERAM               31
Asset Trading:        Definition and purposes
Asset trading is the exchange of claims on
emerging market countries between creditors and
investors, for book rebalancing purposes. The
claims are mostly in the form of syndicated loans,
promissory notes, bonds, restructured debt, etc.,
which are traded at a discount from their nominal
value.
The discount (i.e, 1 minus market price) is the key
characteristic of the asset trading market.
Holders of claims sell their assets for enhancing
their liquidity, for restructuring their portfolio,
for benefiting from upward pressure on prices.
                     BOUCHET/CERAM            32
How Does Asset Trading Work?
Trading is typically conducted by specialists in commercial and
investment banks, and in specialized institutions. Trades might
be priced outside the available quoted price range. Occasionally,
the market anticipates the possibility of debt restructuring
negotiations or of government buybacks.
Trading has often a speculative element. Moreover, buybacks
can occur on a formal or an informal basis, i.e. outside the
framework of officially sponsored debt reduction workouts.

Often, they are also concluded by third parties working on
behalf of the government, which are typically investment banks.
The most active market makers in developing country debt are:
ING Bank, FH International, JP Morgan, Santander, Bankers
Trust-Deutsche Bank, BNP/Paribas, SocGen., Citibank and
Salomon Brothers.

                          BOUCHET/CERAM                   33
           EMC debt traders
Phase  1 (1980s): short-term speculation
Phase 2 (1990s): highly active, short-term
 traders, and investors for debt swap
 transactions
Phase 3 (2005-08): More stable buy-and-
 hold investors, life insurance companies,
 central banks, pension funds, retail
 investors, private investors
                MH BOUCHET/CERAM (c)
                          The EMTA
EMTA was formed in 1990 by the financial community in response to the many
new trading opportunities created by the Mexico and Venezuela debt
reschedulings under the Brady Plan

In an effort to develop market mechanisms to trade nearly U.S. $50 billion face
amount of newly issued debt securities, a small group of debt traders from major
international financial institutions formed the LDC Debt Traders Association
(changed to the Emerging Markets Traders Association in May 1992).

 EMTA is the principal trade group for the Emerging Markets trading and
investment community and is dedicated to promoting the orderly development of
fair, efficient and transparent trading markets for Emerging Markets instruments
and to helping integrate the Emerging Markets into the global capital markets.
EMTA also provides a forum that enables market participants to identify issues
of importance to the trading and investment community.
.
.
                              MH BOUCHET/CERAM (c)
Volume Increase and change in product structure:
Following an initial phase of bank portfolio re-balancing
  transactions, secondary market activities have diversified toward
  discounted debt repurchases, new money bond issues, and large-
  scale securitization. The overall size of the market rose to about
  US$ 225 billion at end-1991 --more than 25 times the trading
  volume in 1986. Volumes increased to US$500 billion in 1992
  about US$3000 billion in 1997, and to US$6500 billion in 2007.
Market growth has been concentrated in Brady bonds, i.e., LDC
  bank loans repackaged as loans with IFIs-financed enhancements
  and guarantees, until the late 1990s.
Trading in Brady bonds rose sharply in 1993-94, representing about
  61% of overall turnover. In 1997, Brady bonds shared dropped to
  about 40% of total trading volume and to a mere 2% in 2007.


                            BOUCHET/CERAM                    36
           Emerging Market Debt Trading
             1989-2007 (US$ billion)
 7000
               Total EMC Debt
 6000          Brady
               Corporate
 5000          Eurobond

 4000

 3000

 2000

 1000

    0
        1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: EMTA-London                   MH BOUCHET/CERAM (c)
        The evolving structure in the
          secondary debt market




Source: EMTA 2006
                    MH BOUCHET/CERAM (c)
Trading Volume by instrument in 2007 turnover
Bradys transactions which accounted for 50% of debt trading
   in the mid-1990s have shrunk due to early redemption,
             exchange offers and debt buybacks
                       2%
                 10%
                            21%
                                                    Brady
                                                    Eurobonds
                                                    Local
                                                    Corporate
                    66%




                    MH BOUCHET/CERAM (c)
     Share of Securities in Total External Debt %
80
                                                    Hungary
                                                    Argentina
70
                                                    Venezuela
                                                    Bulgaria
60
                                                    Lebanon
                                                    Mexico
50
                                                    Uruguay
                                                    Brzil
40
                                                    Ecuador
                                                    Malaysia
30
                                                    Korea
                                                    Colombia
20
                                                    Turkey
                                                    Ukraine
10
                                                    RCI
                                                    Philippines
 0
                                                    Poland
                      MH BOUCHET/CERAM (c)
Trading Volume by Region



                                 LAC
    12%                          Europe
                                 Africa
                                 Asia
               69%               MidEast




          MH BOUCHET/CERAM (c)
Trading Volume by Country (EMTA)


                    21%
                                     Mexico
                                     Brazil
                                     South Africa
                                     Turkey
                        17%          Russia
        6%                           Argentina
                                     Other

         7%
              9% 4%



              MH BOUCHET/CERAM (c)
                           Weak Liquidity:
Angola, Nicaragua, Cameroon, Albania, Congo, Tanzania, Zaire (Rep.
Democr.), Zambia, Iraq, North Korea

                       Limited Liquidity:
Algeria, Cuba, Egypt, Madagascar, Panama, Jamaica, Ivory Coast,
Sénégal

                         Moderate Liquidity:
Nigeria, Morocco, Costa Rica, Bulgaria, Peru, Jordan, Vietnam

                           Good Liquidity
Brady Bonds= Argentina, Brazil, Russia, Ecuador, Mexico, Philippines,
Poland, Venezuela. South Africa, Turkey


                            BOUCHET/CERAM                       43
    EMBI+ spread evolution 1997-2007

                 Average spread weighted by debt volume




Source: CBONDS       MH BOUCHET/CERAM (c)
Argentina’s and Russia’s shrinking spreads 1997-2007
     ARGENTINA




              Bond crisis
                                     RUSSIA


                                            Oil price surge




                     MH BOUCHET/CERAM (c)
Secondary Market Price of RCI ’s London Club Debt 1986-2008
90
     % of face value
80                     Debt servicing suspension
70

60                                            Weighted average LDC debt price


50
                                                                  Soro-Gbagbo alliance
40                             CFA devaluation
30

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                                 MH BOUCHET/CERAM (c)
                       01
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                                        0
                                            10
                                                 20
                                                      30
                                                           40
                                                                   50
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                            3
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MH BOUCHET/CERAM (c)
                       01 /199
                         /0
                            3 6
                       01 /199
                         /0
                            7 7
                       01 /199
                         /1
                            1 7
                                                                                  (1990-2008- in percent of face value)




                       01 /199
                         /0
                            2/1 7
                       01       9
                         /0 98
                                                           Cuba (DM)




                            6
                                                           Cuba (Yen)
                                                           LDCs index




                       01 /199
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                            0/1 8
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                                                                                                                          Secondary Market Prices of Cuba’s London Club Debt




                               c-
                                  06
Hyper-exotic Debt prices end-2007
   Myanmar 20%                     Irak Bonds 60%
   Cambodia 20%                    Libya 65%
   Mongolia 28%                    Syria 10%
   North Korea 28%                 Yemen 30%

   Cuba 14%                        Angola 60%
   Albania 38%                     Ethiopia 10%
   Bosnia 50%                      Senegal 15%
                                    Sudan 13%
                                    Uganda 15%
                                    Zimbabwe 5%


                      MH BOUCHET/CERAM (c)
                 Instrument Diversification
The market has become more diverse in the variety of instruments
available as well as the type of investors. For instance, the Venezuela
Brady Plan included a complex menu of options, such as Debt
Conversion Bonds (DCB) and Front-Loaded Interest Reduction Bonds
(FLIRBs). The debt conversion bonds are bearer in form and as such
they are more easily tradable and likely to be held by non-bank
investors.
The investor base has widened over the past years. One estimates that
more than US$10 billion face value of sovereign debt is held by
institutional investors. In addition, the fast-growing market in
developing country debt has expanded in terms of region and in terms
of instruments. Thus, Salomon Brothers issued two tranches of
warrants on Poland's debt for about US$100 million in August of 1992.
Chase, likewise, issued a US$15 million two-year CD for a
Venezuelan bank guaranteed by Brady bonds (par bonds and FLIRBs).
The face value of the collateral is more than 200% of the value of the
CDs.
                             BOUCHET/CERAM                           49
Various debt funds have emerged.

In December 1989, Banque de l'Union Européenne set up a
Financial Investment Portfolio Company. The objective of the
fund was to offer investors the opportunity to take advantage of
the potential yields available on LDC debt.

In October 1991, SG Warburg set up a Latin America Extra Yield
Fund, which has been described as the first fund targeted
exclusively at Latin American debt securities.

In November of 1991, Citicorp Investment Bank launched an
Argentine Debt Fund that invests at least 60% and up to 80% of
its assets in Argentine debt.


                          BOUCHET/CERAM                       50
ING Bank has also set up a similar LDC debt fund, the LFM
Emerging Markets Capital Fund. It is an open-ended
investment fund incorporated in Luxembourg.
The fund initially focused on the major Latin America
economies of Mexico, Argentina, Chile, Brazil and Venezuela.
Some investments are being made in Hungary, the Philippines
and in other regions when appropriate.
The investor has a choice between capital growth and dividend
distribution shares.

FH International launched in July 1992 the First African Asset
Fund Limited under the laws of Jersey. The fund is managed
by FH Carlson Investment Management. It had a life of two
years, with the possibility of one further one-year investment
program.


                         BOUCHET/CERAM                       51
            Institutional Developments:

The combination of Brady debt restructuring agreements and
officially supported privatization programs has strengthened
the secondary markets in the mid-1990s.
New instruments have emerged such as new money bonds, exit
bonds and interest reduction bonds. With the securitization of
the LDC debt market, liquidity has improved. For example,
Mexican and Venezuelan Brady bond transactions are
processed through the Eurobond clearing institutions, and
CEDEL.

In addition the major credit rating agencies have formalized
ratings of LDC debt such as giving ratings to Brady bonds, both
the floating rate (discount bond) and the fixed-rate (par bond).

                         BOUCHET/CERAM                        52
                           Price Trends

Secondary market prices have kept fluctuating strongly over the last 20
years. The weighted average of prices dropped from 71 cents per US$ at
end-1985 to about 35 cents per US$ in the beginning of 1991, reflecting
deepening doubts regarding normalization of debtor-creditor relationships
and further desire to reduce or eliminate country risk exposure.

An accentuation in declining trend can be observed following the
announcement of the March 1989 Brady initiative. Secondary market
prices, however, showed an upward trend since the year 1991. The market
price index averaged 55 during the the year 1997 despite the impact of the
Mexican peso crisis. Average prices dropped sharply since mid-1998 and
the overall emerging markets crisis.
Gradual price increase over the period 2003-2007 due to large global
liquidity, IMF programs, large current account surpluses, FDI flows, and
strong reserve assets.
                              BOUCHET/CERAM                       53
                    Factor Affecting Prices
1. Interest rate volatility
   In 1993, the continuing decrease in US Treasury 30-year bond rate
   has been a driving force behind the increase in fixed rate Brady par
   bonds. In late 1994, however, the upward trend in US Treasury
   bonds led to a decrease in Brady bond prices. In late 1998, the spill-
   over effect of the Asian and Russian crisis has severely hit the
   market with sharp drops in prices for all LDC’s debts. In 2002-2004,
   the decline in US rates enhanced the value of fixed-rate discount
   bonds.

2. Macro-economic situation
   Factors such as reserves, balance of payments, privatization
   programs tend to affect price volatility. In addition, signing of an
   economic adjustment program with the IMF is also a positive factor
   behind price changes (Argentina in 2003). Likewise, a Paris Club
   rescheduling agreement is considered as a positive element towards a
   normalization of relationships with foreign creditors.
                              BOUCHET/CERAM                      54
3. Rating by S&P and Moody's
   A credit rating by credible international rating agencies is likely to
   lead investors to consider LDC debt as a meaningful investment
  opportunity: S&Ps increase Argentine rating to B in 2006 and Moody’s
  upgrading of Peru to investment grade in 04/2008
4. Securitization
   The exchange of bank loans into long-term bonds with guarantees
   funded by international institutions enhances the quality of claims.
   In addition, Brady bonds can be traded on a fairly liquid market,
   thereby leading to the emergence of arbitrage opportunities as well
   as derivatives instruments.

5. Deal-driven transactions
   A debt-equity program will open the way for swap transactions
   adding liquidity to the market as well as investment opportunities in
   the domestic economy.

                              BOUCHET/CERAM                      55
    September-October 1999: The debt default of
          Ecuador occupies the limelight
 Ecuador: Brady bonds account for US$6.1 billion in
  Ecuador’s overall external indebtedness of US$13
  billion. The Brady bonds have been subject to a lot of
  financial engineering, including the stripping of the
  collateral out of the bonds.
 IMF’s position: Ecuador needs to find out some
  US$500 million to cover its balance of payments
  shortfall until the end of next year, and about US$1
  billion to cover its budget shortfall, and probably more
  since Ecuador has foreign currency denominated
  domestic debt.... For the first time in 55 years, the IMF
  is acquiescing in a country’s decision to default on its
  debts to the international bond markets.
                     MH BOUCHET/CERAM (c)
Mexico whittles down its Bradys
 September 2002: Mexico issues US$1.75 billion
  with a 20-year global bond exchange with Brady
  par bons (JP Morgan: Lead manager with
  CSFB)
 Mexico exchanged US$1.3 billion for Bradys
  and raised US$450 million in new money bonds.
  The exchange released US$651 million in
  collateral and produced NPV savings of US$59
  million.
 January 2003: Mexico buys back US$500
  million of Bradys
                 MH BOUCHET/CERAM (c)
        COTE d ’IVOIRE-Debt Restructuring
                  US $ 7.2 billion o/w 4.4 int. Arrears. Redenomination in
  Debt Stock
                                          FF/US$
Upfront costs &    NPV Debt reduction = about 78.5%. Costs about =
 Enhancements            US $ 287 million incl. US $ 60 m. from RCI.
                    No, menu includes discounted debt buyback, par
  New Money
                           and discount bonds and conversion.
                     30% of principal at 24 cents mandatory minimum
   Buyback          cancellation of past due interest payments. Cost=
                                        US$190 million
                      Discount= 35%. 30 year bond in FF and US $
                        denominations Collateral on Principal only.
Discount bonds       Agents: US Fed, Bdf, BIS. During first ten years,
                   rates to rise from 2.5% in 98 to 4% in 2008. Cost of
                                  collateral= US$90 million
                  20 year bond with low int. rates (2% in Y1) until year
                         13 and L+13/16 thereafter in FF and US $
  Par Bonds        denominations. Rolling interest guarantee until end
                       of year 13. Repayments due in 2006-2016. No
                                   collateral on principal.
                       MH BOUCHET/CERAM (c)
      COTE d ’IVOIRE-Debt Restructuring (end)

                         Base=First generation only with L-200 bp (US$955 m).
                        US $ 30 million cash payment at closing. Rising rates from
      PDI bonds
                           2% to L+13/16% on Y 16. 20 year notes with value
                                                recovery.
Debt Conversion Bonds             bonds eligible for debt conversion
    Rescheduling                                  No
       Waivers                                    Yes
 Bank Legal Advisor                        White and Case
   Country Advisor                  Lazard/SBC Warburg/Cleary

Steering Com. Chair                BNP (Citibank, Crédit Lyonnais)




                          MH BOUCHET/CERAM (c)
Market-Based debt exchange offers
           2000-2006
       Argentina(2001 & 2005)
              Mexico
               Brazil
             Venezuela
               Peru




            MH BOUCHET/CERAM (c)
              Argentina’s Bonds
 Total  amount: US$94 billion 3/4% -$ denominated
 Dollar bonds are traded at default discounts
 All rating agencies have downgraded Argentina’s
  bonds
 Fitch downgraded Argentinean government bonds
  to a high risk “CC” rating, in effect making them
  junk bonds
 Global Committee of Argentina Bondholders ($55
  billion claims)
 2005 Request: 75% write off of bonds’ nominal
  value
                   MH BOUCHET/CERAM (c)
Argentina’s Bonds




   MH BOUCHET/CERAM (c)
Voluntary Debt Restructuring - Swaps
   May 2001 Argentina offered  $30 bn debt swap
    – in exchange for old securities it issues four NEW GLOBAL
      BONDS and a NEW PAGARE




                          MH BOUCHET/CERAM (c)
 Voluntary Debt Restructuring -
            Swaps
 Argentina’s   local banks, insurance
  companies and pension funds (that hold at
  least a third of Argentina’s $95bn bonds)
  have already swapped more than $55bn in
  federal government debt for new
  obligations that carry lower interest rate
  over a longer period
 The operation has reduced Argentina’s
  debt service cost by $3.5bn per year
                MH BOUCHET/CERAM (c)
Voluntary Debt Restructuring - Swaps
 Dec.  3 Argentina offered to swap another $60bn in
  locally owned bonds; the new bonds are backed by
  futures tax revenues and will pay a maximum of 7%
 Argentina hoped that voluntary exchange of local debt
  will be followed by similar foreign debt exchange =>
  reduced pressure on its budget




                     MH BOUCHET/CERAM (c)
            Trading of Official Bilateral Debt

 During    1990, the Paris Club agreed on the principle of
reducing debt through clauses stipulating the conversion of part
of the obligations into local currency.

The Paris Club does not set a limit for conversions applied to
development aid. However, a limit of 10% is applied to officially
guaranteed commercial loans (for example those covered by
COFACE, ECGD and Hermes).

Conversion is a voluntary option and should be ratified by each
creditor government in Paris Club bilateral agreements.


                          BOUCHET/CERAM                   66
 The French Treasury started auctioning developing
countries' debts with US$20 millions of claims on the
Philippines in September of 1992.

The sales' objective is to fund viable and productive local
projects in the tourism, infrastructure and industry sectors,
with either French, foreign or local private investors.

A few large debtor countries are excluded from the list: Russia,
Mexico, Brazil, Argentina and Venezuela. The Treasury
followed with Tanzania in November of 1992, and with
Honduras during the first quarter of 1993.




                         BOUCHET/CERAM                        67
The debt conversion operation for Tanzania was to be
implemented by November 30, 1992. It involved FF 120 million
of French government's claims.

The offer has reportedly not met with much investor interest.
Accordingly, the Treasury contemplates offering claims in a less
formal framework thereby negotiating discrete sales on a case-
by-case basis.

In the case of Honduras, conversion involved about FF 55
million of claims by way of bids to COFACE with minimum
offers of FF 5 million.




                         BOUCHET/CERAM                        68
 In March of 1993, COFACE started auctioning about FF 550 million of
claims on Egypt through the Treasury. Successful bidders were Egyptian
investors reportedly.

In November of 1993, the French Treasury and COFACE announced a
further offer of FF1 billion of claims on Egypt.

In April of 1994, COFACE auctioned off FF1.5 billion of export credits. In
September of 1994, France’s Credit National auctioned FF1.5 billion of
official development debt.

Such claims were consolidated in the agreement dated September 12, 1991.
The banks acted on behalf of local investors for pre-authorized projects
Potential investors were to be represented by a banking intermediary and
must have obtained an investment permit from Egypt's authorities.
Successful bidders paid about 47.2% of face value with the Paris-based
bank UBAF purchasing nearly FF700 millions of Egyptian claims
reportedly. CCF and BNP purchased the remaining claims.


                             BOUCHET/CERAM                             69
 In  September 1992, the United Kingdom export credit agency
(ECGD) announced a fairly ambitious program of selling Paris
Club debt.

In a period of around six months, the ECGD was very successful
with such sales, selling around £100 million (face value) of debt.
The debts concerned are those which have been rescheduled under
certain Paris Club and related bilateral agreements.

Although quoted in US dollars, both sterling and US dollar
denominated debts are available in almost all cases. The ECGD
will only sell debt if the price it will receive implies a higher level of
income than the net present value of the expected recovery of the
debt, within the framework of the Paris Club agreement and given
the projections of the country studies department of the ECGD.



                               BOUCHET/CERAM                            70
The demand for ECGD paper has come from banks (who wish to
act as an intermediary), and increasingly from end-users. The latter
option reportedly allows for greater speed and a somewhat higher
prices for the ECGD.

In January of 1993, ECGD auctioned off £48 million of Egyptian
Paris Club debt. The proposal did not include capitalized
moratorium interest, which remains as debt within the bilateral
arrangements.

In March of 2000, the French government and Morocco signed an
agreement of debt conversion.
In July of 2000, Algeria and the Algerian government signed a debt
swap scheme for the equivalent of some FF400 million. Algeria will
have to set up a regulatory framework to implement the
transactions within an adequate macroeconomic and legal
framework.


                             BOUCHET/CERAM                        71
                       Part III
             Debt Conversion Transactions
   Debt conversion constitutes the transformation of the legal and financial
    nature of a country's liability from a hard currency debt into some form of a
    domestic currency obligation. In other words, a debt conversion is a
    prepayment of debt at a discount in local currency.

   The vehicle for such debt conversions is often the secondary market of
    commercial bank claims where bank and nonbank creditors can sell or swap
    their LDC assets, investors can obtain bank loans at a discount for subsequent
    conversion into domestic currency assets, and debtor countries can
    repurchase their own discounted debt.

   Altogether, cumulative debt conversion volumes have reached about US$45
    billion, with an annual peak of US$10 billion in 1990, owing to large-scale
    debt-equity conversion programs in Argentina and Chile.




                                 BOUCHET/CERAM                              72
    Debt Conversion: a positive sum game?
                                  Face value= $1000

                                   DISCO UNT O N DEBT = 80%

                                               800




          Price of Debt                  Debt Redemption P rice                  Debt Face
                                                                                  Value

0            200                               400                        1000               $




       200                  200                                   600
    Incentive to          Incentive to           Debtor Country's Share of Discount
    Claim Holder            Investor



                                  MH BOUCHET/CERAM (c)
            Positive Sum Game!
 Debtor: debt cancellation with local currency
  payments while stimulating foreign direct
  investment and enhancing the role of private sector
  activity in the local economy (privatization)
 Creditor: cleaning up of portfolio with upfront cash
  payment while accounting losses get absorbed by
  loan-loss reserves
 Investor: access to local currency at a discounted
  exchange rate that boils down to an investment
  subsidy, thereby mitigating the overall country risk
  and the specific project risk


                     MH BOUCHET/CERAM (c)
Corporate debt swap transactions
 04/2001: South Korea’s largest builder
 HEC (Hyundai Engineering & Constr.)
 makes a debt swap with its creditors to
 reduce debt ratios from 1240 % to 250%,
 by issuing new shares and bonds to
 creditors as a part of the rescue package
 after Hyundai reported losses >US$2.2
 billion that wiped out its equity capital!


               MH BOUCHET/CERAM (c)
               Debt Conversion Mechanism

                                 Funds/Grants
                   SECONDARY
                   M ARKET OR
                    AUCTIONS
                                      $
 CREDITOR
   BANK or               $
 BILATERAL                          Investor
GOVERNMENT
                    Discounted
                      Claims

                                           CLAIMS



                LOCAL
             CURRENCY             CENTRAL
              BONDS or             BANK
               ASSETS

                      MH BOUCHET/CERAM (c)
                          Debt-Equity Swaps
                          * Shares in privatized companies
                          (Argentina, Chile, Côte d'Ivoire...)

                          * Shares in private sector entities
                          (Philippines, Tanzania, Madagascar,
                          Egypt, Chile...)

                          Debt for Nature Swaps
   TYPES of               (Costa Rica, Bolivia, Madagascar,
                          Ecuador, Philippines...)
   DEBT
  CONVERSION              Debt for Export Swaps
                          (Peru, Vietnam...)


                          Debt for LT Bond Swaps
                          (Costa Rica, Guatemala...)


                          Debt for Development Swaps
                          (Sénégal, Mexico, Madagascar...)


                          Debt for Local Currency Swaps
                          (Tanzania, Madagascar...)


Source: OSF
               MH BOUCHET/CERAM (c)
     EXCHANGE OF DEBT CANCELLATION

   There are various forms of local currency payouts in debt
    conversion transactions:
i) local currency for local cost component of investment or
    operating costs (salaries)
ii) transfer of ownership of equity in a public company
    (privatization programs)
iii) local currency and/or financial instruments to fund
    humanitarian or environmental projects
iv) non-traditional exports or other domestic assets
v) tax vouchers, customs duties, oil exploration bonuses...
vi) monetary stabilization bonds

                  Michel Henry BOUCHET; Professeur CERAM
Enabling legislation: What are the various parameters of a
  conversion regulatory program ?

   A key prerequisite in debt conversion and buyback
    transactions is the formulation of enabling legislation so as to
    waive various legal clauses which prohibit a debtor country
    from inequitable treatment of its debt obligations. In
    addition, restrictions on permissible assignees must be
    waived if creditor banks are to be able to sell debt to private
    investors. In particular, mandatory prepayment and
    "sharing" clauses in loan and refinancing agreements must
    be waived in order to open the door to debt conversion
    transactions.

   A second prerequisite is the formulation of a regulatory
    framework in the debtor country. One can distinguish a
    number of critical variables of a debt conversion program:
                           BOUCHET/CERAM                          79
1.    Amount and Pace of Conversion: the Central Bank must monitor
     debt conversion owing to its potential impact on monetary and
     budget policy. The domestic monetary implications result from the
     release of local currency at the time external debt is redeemed.
     This may create inflationary pressure, hence an impact on the
     IMF's performance criteria. When the monetary effect is mitigated
     by the issue of local-currency bonds, the creation of additional
     domestic debt affects credit and budget policy. Sound macro-
     economic policy is thus a prerequisite for any lasting debt
     conversion program.

2.     Exchange rate (official or market rate) applicable for debt
     conversion. The exchange rate determined for the conversion has a
     direct impact on the actual discount that is obtained by the
     investor. The gap between the official and parallel market rates
     could be so large that it wipes out the discount the investor
     obtained in the secondary market transaction, thereby eliminating
     the implicit "subsidy" inherent in the conversion.


                                BOUCHET/CERAM                       80
3.   The eligibility criteria applicable to the type of debt: The
     Central Bank has the following range of choices regarding
     the origin of the debtor's or guarantor's liabilities to be used
     for conversion:

     i) public sector external debt
     ii) external debt of national government
     iii) external debt guaranteed by a public sector entity
     iv) private sector external debt with or without a public
     sector guarantee
     v) original claims or secondary market debt


     4. Legal nature of debt: Short term/Long-term, promissory
     notes, trade and suppliers credits, bank loans, official
     bilateral debt...

                            BOUCHET/CERAM                          81
5. Quotas or ceiling on the annual (or quarterly) amount of debt to be
     swapped. The quota is to be determined in close relation the macro-
     economic policy objectives. Annual ceilings have been implemented in
     Tanzania, Argentina, Chile, Ecuador, the Philippines, and Mexico.

6.     Redemption rate: Debt conversion boils down to discounted
     repurchase. The redemption fee represents a "second" internal
     discount. It helps the central bank "capturing" a portion of the
     discount, thereby sharing with the investor the benefit of the
     transaction. Indeed, by purchasing the debt directly in the market, the
     country could take the full market discount for itself instead of the
     redemption fee only, and in the process avoid problems of creating a
     preferential exchange rate. In an auction based situation, the
     redemption rate is determined by a market-based system: potential
     investors bid by offering competitive discounts from the face value of
     the debt. The relationship between the discount rate and the
     redemption rate gives rise to the investor's pay-out ratio.


                                 BOUCHET/CERAM                        82
7.     Fees taken by the local authorities and/or by the local
     intermediaries for the right to participate in a conversion.

8. Degree of transparency in the program:     The issue of transparency
     (the disclosure of complete information) is important from the
     investor's standpoint, since the regulatory framework is officially
     defined and applicable to all investors.

9.     Specified parties eligible for use of the debt conversion
     mechanisms: for instance, allowing the local nationals/residents to
     take part in the program (allowing residents to bid for local
     currency can be a way of encouraging capital flight repatriation).

10. Procedure to be employed in assigning the right to convert debt:
     the procedure can be quarterly ceilings of local currency, regular
     auctions of local-currency assets, case-by-case allocation with
     regard to sectoral priorities...

                                 BOUCHET/CERAM                        83
11. The form of the conversion proceeds: Very few
  programs provide for an upfront cash, due to monetary
  implications. In most cases LDC governments create
  some sort of deposit account or alternative local
  currency denominated term debt. The Central Bank
  might also provide protection to the investors against
  inflation and/or currency depreciation. If conversion
  leads to the issue of local-currency assets, two ways are
  possible: the investor can gradually redeem the
  "stabilization bonds" in local currency for investing the
  proceeds, or the investor has only access to the interest
  payment flow on the bond. This latter case is often use
  for NGOs involved in debt-for-nature swap.


                          BOUCHET/CERAM                  84
12.  Eligibility of local currency investment (or Additionality): Debt
  equity conversion could be used as a vehicle for mobilizing new
  foreign investment in priority sectors of the economy and for
  stimulating privatization. The program could also be designed (with
  appropriate restrictions on the sector eligibility) to promote export
  generation and import substitution. One of the objectives of the
  government is to prevent "round tripping", that is, access to local
  currency through the use of discounted bank claims without investing
  at home the local currency proceeds.


13. Requirement of "matching funds": Most LDC governments prefer
  not to allow debt conversion proceeds to be used for any imported
  inputs. Hence, there is an implicit requirement of new money to cover
  imports. In the case of Argentina, debt conversion coupled with
  privatization required a combination of debt and new money.


                               BOUCHET/CERAM                         85
14. The schedule of capital and dividend remittance:
  Restrictions on capital repatriation and profit remittance
  vary widely across different programs. The repatriation
  guidelines are generally not on terms more flexible than
  those of the underlying debt.

15. Restriction (if any) on the percentage of shares held in
  a company through debt equity conversion: In general,
  investors must agree with the broader framework of the
  foreign investment legislation of the host country.




                         BOUCHET/CERAM                    86

				
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