The Restructuring Process
General Considerations
Following the emergence of widespread debt-servicing difficulties in 1982–83, a framework was developed to negotiate bank debt relief which, during the early years, worked fairly expeditiously. During 1986, however, the time needed to finalize bank financial packages increased significantly. On the basis of ten bank financial arrangements concluded during 1982–87 with four major debtor countries (Argentina, Brazil, Chile, and Mexico), the average time that elapsed from when the debtor country first approached the banks until the first disbursement under a new money loan rose to eight months in 1986 from five months in 1982–84. In Mexico, the process of assembling the bank financial package until the first disbursement took 10 months; for Nigeria, the process took even longer—12 months between the agreement in principle and the final agreement, although it remained unclear at the time of the final agreement when the new money committed under the restructuring agreement would actually be disbursed.
These delays have prompted proposals from banks to improve the working of the advisory committee process to reduce the time and cost involved. Regional U.S. banks and Japanese banks have felt under-represented at times on advisory committees. For this reason, efforts have emerged from time to time to increase the size of advisory committees so as to include these banks. However, other banks worry that the advisory committees could become too large and unwieldy to function effectively or that one nationality of banks could become overrepresented. Moreover, greater involvement in the advisory committee process may not successfully address smaller banks’ concerns or may co-opt them into the process.
One approach that has proven useful—for example, in getting the menu approach explicitly adopted for Argentina—is to have discussions among senior officers of leading financial institutions to resolve basic problems and maintain momentum in the restructuring process. Commercial bank representatives also stressed that the information flow between Fund and World Bank staff and commercial banks could be improved; in particular, banks wanted to be consulted at an earlier stage about the size of a financing gap and the distribution of its financing. Finally, it was widely believed that the development of financing options in recent restructuring agreements (see below) could help facilitate the participation of banks with differing interests. Many banks noted that the Institute of International Finance might provide a suitable forum to review such issues affecting the restructuring process.
The Argentine new money package, where more than 90 percent of banks’ commitments were received within two months of the 1987 agreement in principle, contrasts strongly with the difficulties in assembling the new package for Mexico. Bankers have cited a number of reasons for this rapid commitment. One, the commercial banks’ contribution to the Argentine package was smaller, both in absolute terms and as a percentage increase in their exposure, than the Mexican package ($1.95 billion, or 9 percent in Argentina, compared with $7.7 billion, or 12 percent for Mexico). Two, banks also felt that communication in Argentina’s case had been better concerning the size and structure of the package. Three, the early participation fee of ⅜ of 1 percent for commitments made before a specified date may have quickened the decision-making process in a number of banks. Four, the composition of creditor banks was more favorable; fewer recalcitrant banks, particularly U.S. regional banks, were creditors of Argentina than of Mexico. Also, more generally, banks became worried by late February 1987 about the debt-restructuring process, because the three largest debtor countries were in a situation where either financing packages had not been completed (Mexico, Argentina) or arrears were accumulating (Brazil).
Association with Policy Reform
Financing Assurances for Fund Arrangements
The appropriate degree of confirmation on bank financing reflects a variety of considerations: whether new money is required and, if so, its scale; the actual or likely progress of negotiations with creditor banks; the extent to which assurances place appropriate pressure for rapid progress; and prior relations between the country and its creditor banks.
Fund practices with respect to assurances on bank financing have varied. During 1982–87, 30 Fund arrangements were approved in connection with concerted new bank financing; in two of these cases new money was negotiated without a bank rescheduling. A “critical mass” of bank commitments was obtained prior to Executive Board approval in about half of the cases (14), while in five additional cases Fund arrangements were approved in principle but did not become effective until a critical mass had been secured from banks.1 In six more cases, Executive Board approval, apart from the usual requirements to be met by the member, was granted on the basis of an agreement in principle with the bank advisory committee; in two of these cases the Executive Board approval was only in principle. In the remaining five cases the Executive Board approved the Fund arrangements while discussions between the countries concerned and the banks were still in progress.
This approach has reflected the varied circumstances of member countries. Stand-by arrangements for Mexico and Nigeria were both approved in principle in 1986, on the basis of agreements with their respective advisory committees, and had one-month deadlines for securing a critical mass of commitments from creditor banks. In both cases, the deadline was not met and the Executive Board approvals lapsed, although for only a few days in Nigeria. Subsequently, the critical mass was secured and the stand-by arrangements were approved once again and then became effective. For Nigeria, the new money package was finalized in November 1987, although the Board already approved the Fund arrangement on January 30, 1987. It should be remembered, however, that the Nigerian authorities had previously announced their intention not to purchase under the Fund arrangement.
In Chile, the review under the extended arrangement was concluded in February 1987 and a purchase was effected on the basis of observance of end-1986 performance criteria and the completion of the review. The review was completed without financing assurances from banks, although a future review, as a performance criterion, required that satisfactory arrangements with respect to external financing had to be in place by mid-May 1987. On June 17, 1987, an agreement was signed with banks on a financial package without a concerted loan, as retiming of interest payments provided the needed financial support from banks. In other recent instances where reschedulings, but no new money, were required, such as the Philippines and Morocco, Executive Board approval was granted outright and reviews early in the program had to assess progress in obtaining external financing. In Argentina a program was approved in principle in February 1987, pending the attainment of the critical mass of bank financing. An agreement in principle was reached with the steering committee of banks in April 1987, and by mid-July sufficient funds had been committed to allow the arrangement to become effective.
The Executive Board approved a Fund arrangement for Bolivia even though relations between Bolivia and its creditor banks remained unresolved at that time. For purposes of the program, arrears to banks were excluded from the definition of arrears until the end of 1986; this deadline was subsequently extended, in order to give additional time for a negotiated agreement to be reached. In July 1987, agreement was reached on an arrangement to regularize relations with bank creditors.
Linkage
Banks have responded to pressure for financial assurances by seeking, in turn, to obtain safeguards from debtor countries concerning the implementation of sound economic policies and to influence the scale of contributions by the official community. Banks have generally phased their disbursements under new concerted lending packages in line with purchases under a Fund arrangement, thus linking their financial contribution to the implementation of appropriate macroeconomic policies by the debtor countries. Linkages to World Bank disbursements have also become more common as banks sought assurances concerning the implementation of structural reforms by debtor countries. In addition, virtually all recent agreements between debtor countries and commercial banks have included clauses concerning minimum amounts of debt relief from Paris Club creditors or financing from bilateral official sources.
These developments have further increased the complexity of financial packages, particularly as official creditors may have different views on what constitutes equitable burden sharing and because the flow of export credits reflects also the magnitude and composition of import demand. By contrast, in some cases where countries do not need concerted financing but still require a rescheduling of maturities, banks have accepted “delinking” from the use of Fund resources but not from Fund involvement, by insisting on provisions under which the member requests the initiation of enhanced surveillance procedures after the expiration of a Fund-supported program.
Recourse to linkages in loan agreements frequently takes the form of conditions precedent to the effective date of the agreements, to the availability dates under new money agreements, to the effective dates of the restructuring timetable, and in the form of events of default. In some instances such linkages have been unduly rigid and prevented the swift mobilization and disbursement of financial assistance. In other instances problems of a different nature may arise in areas such as cross-conditionality between World Bank and Fund disbursements, the precommitment of Fund resources, and requirements preventing members from repaying the Fund when their external position strengthens, contrary to what is stipulated in the Fund’s Articles of Agreement. The most recent restructuring agreements between commercial banks and Argentina, Chile, Mexico, Nigeria, and the Philippines all have links to Fund programs or enhanced surveillance (see section below) and the World Bank and official creditors.
Enhanced Surveillance
In 1984–85 it became evident that some countries, which had achieved a significant degree of adjustment and were seen not to need immediate additional concerted financing, were still confronted with an excessive bunching of amortization obligations that appeared to present an obstacle to the restoration of normal financial market relations. Multiyear restructuring agreements (MYRAs) were developed to reach a more realistic debt-servicing profile. To facilitate agreement on MYRAs, a new form of Fund monitoring—enhanced surveillance—was introduced. Enhanced surveillance is requested by the Fund member country.
In March 1987, the Fund’s Executive Board endorsed continuation of the enhanced surveillance procedure in appropriate cases as a useful means of facilitating a return to more normal market relations. It was emphasized, however, that close attention in approving enhanced surveillance both to the criterion that the member had a strong record of adjustment and to the continued willingness of creditors to exercise appropriate influence were essential if the procedure was to be effective. The issues of influence on debtor countries’ policies and whether enhanced surveillance should continue in case of inadequate cooperation by the member were also raised.
Enhanced surveillance has been approved by the Fund’s Executive Board in the cases of Mexico, Ecuador, Venezuela, Yugoslavia, and, in July 1987, Uruguay. But only for Venezuela and Yugoslavia have enhanced surveillance procedures actually been implemented so far. Venezuela’s request for enhanced surveillance was approved by the Fund’s Executive Board in May 1985 to support a bank MYRA that covers 1983–88 maturities. Four reports under enhanced surveillance have been prepared, and the most recent two (July 1986 and March 1987) were distributed to the banks.
In Yugoslavia, the first report under enhanced surveillance was discussed by the Fund’s Executive Board in August 1986 and subsequent Executive Board discussions for the 1986 Article IV consultation and the mid-year 1987 consultation took place in March and August 1987. In all instances staff reports were made available to commercial banks.
On September 27, 1985 the Fund’s Executive Board approved Uruguay’s request for an 18-month standby arrangement. Subsequent to the expiration of that arrangement, the authorities requested from the Fund enhanced Article IV surveillance through 1989, which would correspond to the consolidation period under Uruguay’s bank MYRA. The authorities adopted a quantified economic program for 1987–88, with quarterly targets for the main macroeconomic policies. The Fund’s Executive Board approved the request for enhanced surveillance on July 29, 1987.
Deferments and Other Arrangements
As an immediate, temporary response to a marked deterioration in their ability to service external debt as scheduled, several countries have announced moratoria or agreed to standstills with their creditor banks. These arrangements are generally for a transitional period until a medium-term financial package can be negotiated. Mexico and Venezuela, for example, agreed with banks to defer amortization payments while negotiating recent restructuring packages. In some cases, deferment agreements, which usually postpone principal payments for 6 to 12 months at the originally contracted terms, have been rolled over repeatedly (e.g., Bolivia, Guyana, Nicaragua, and Zaïre) without a medium-term agreement, lapsing into arrears over time with a consequent deterioration in creditor-debtor relations.
Some debtor countries, as a possible alternative to deferment agreements and new financing packages, have announced unilateral actions on debt service payments. In general, countries that have announced unilateral restrictions acknowledge their full contractual obligations; but they either announce a moratorium on debt service payments until relations with creditor banks are regularized or they propose to base actual debt service payments on a selected measure of “ability to pay,” such as a percentage of exports, variously defined, or as a percentage of gross domestic product (GDP). Of the countries that have announced such limitations most have not actually restricted debt service payments in exact accordance with their announced policies.
Banks, in general, have been reluctant to reschedule interest arrears, which have arisen as a result of unilateral actions, and relatively few restructuring agreements provide for the rescheduling of interest in arrears. Bolivia’s normalization plan of 1983 included a payment schedule for interest arrears, while the 1983 restructuring agreement with Costa Rica rescheduled interest arrears or certificates of deposit held by banks accumulated prior to that year. Three restructuring agreements with Nicaragua (1980–82), two with Sudan (1982, 1985), and one with Togo (1980) provided for the rescheduling of interest arrears. More recently, banks have discussed ways to regularize or refinance accumulated interest arrears in the cases of Brazil, Costa Rica, Côte d’Ivoire, and Mozambique; Ecuador reached an agreement in principle with the advisory committee in November 1987 that, inter alia, provides concerted lending that will eliminate the accumulated interest arrears.
Bridge Financing
Debtor countries often approach the Fund and their major creditors to request financial support for their economic programs when their international reserves are at very low levels, commercial and official arrears are substantial, and their access to spontaneous commercial financing has been virtually exhausted. From that time until the first disbursement under any new financing arrangement, several months may elapse. Under these circumstances short-term bridge finance may enable a country to regularize its arrears and to remain current on its external obligations.
Bridge financing arrangements have often been put together at the initiative of the monetary authorities of industrial countries, who in turn may request the participation of other central banks, governments, and bank creditors. The BIS has also played an important role both as creditor and as coordinator. Commercial banks—particularly those banks on the advisory committee—have gradually taken a more active role in providing bridge finance. The early participation of a selected group of banks has sometimes been seen as a positive, concrete signal to other creditor banks of their commitment to the package. As a general principle, lenders—whether official or commercial—have requested and obtained repayment from the first disbursement from a specific medium-term loan (i.e., a Fund arrangement, World Bank loans, or new money from commercial banks).
At the height of the debt-servicing difficulties in 1982–83, use of bridge loans reached an unprecedented scale. Eight bridge loans were arranged for major borrowers in an amount of about $10 billion during 1982–83 (Table 10). The largest arrangements were for Brazil, Mexico, and Argentina. Argentina, Chile, Hungary, and Yugoslavia also had arrangements for smaller amounts during this period. By the end of 1983, most of these loans had been repaid. During 1984–85, only four bridge loans were arranged (Argentina, Costa Rica, Dominican Republic, and Zambia) for $1.2 billion, although only $224 million was utilized. Some of the unpaid amounts to banks under these operations were subsequently restructured.
Selected Bridge-Financing Arrangements, 1982–Third Quarter 19871
(In millions of U.S. dollars)
Maximum gross amounts. Unless otherwise stated, loans were disbursed and repaid within indicated period.
Loan was not disbursed.
The amounts shown for 1982 and 1983 correspond to total gross disbursements; $1,480 million of the U.S. Treasury, $1,450 million by the BIS including $250 million of Saudi Arabia, and $2,646 million from commercial banks. All loans were repaid by mid-1983.
Provided by the BIS. Loan was only partly disbursed by the end of June.
Support for this facility was provided by the Central Bank of Mexico. There was only a partial repayment and the remainder was subsequently restructured.
Support for this facility was provided by the Central Bank of Mexico.
Support provided by commercial banks only. Loan fully repaid by the end of February 1987.
Includes lines of credit and swap operations made available to Mexico during the period March–December 1982. It includes swaps with Spain and France for $450 million, and the U.S. Federal Reserve Board for $1,300 million. It also includes facilities supported by the BIS ($925 million), the U.S. Treasury ($600 million), and the U.S. Federal Reserve Board ($325 million). At the end of 1982, the combined outstanding balance on all these facilities amounted to $1,953 million. By mid-1983, however, all these loans had been fully repaid.
Official sources supported $1,100 million and commercial banks supported $500 million. All loans were repaid by April 1987.
Support provided by the central banks of France, Japan, the United Kingdom, and the United States plus the Kreditanstalt für Wiederaufbau in the Federal Republic of Germany. Only $150 million was used. Loan was repaid before the end of 1986.
Facility was supported by commercial banks only and was provided together with a medium-term loan of about $30 million.
Fully repaid by the end of 1986.
Bank financing only. Bridge to the first purchase under Fund-supported program.
Bank financing only. Bridge to the first purchase under the structural adjustment facility and compensatory financing facility.
As of the end of May 1987, there was an outstanding amount equivalent to about $8 million. The proceeds of the loan were used to bridge the first purchase under a Fund-supported program for 1986. Subsequently, the repayment was postponed to bridge the second purchase under the program, but this never materialized.
Selected Bridge-Financing Arrangements, 1982–Third Quarter 19871
(In millions of U.S. dollars)
| 1987 | ||||||
|---|---|---|---|---|---|---|
| 1982 | 1983 | 1984 | 1985 | 1986 | January– September |
|
| Argentina | 500 | 1,100 | 1,0002 | — | — | — |
| Brazil | 3,9073 | 1,2953 | — | — | — | — |
| Chile | — | 4502 | — | — | — | 2254 |
| Costa Rica | — | — | 505 | — | — | — |
| Dominican Republic | — | — | — | 246 | — | — |
| Hungary | 510 | — | — | — | — | — |
| Jamaica | — | — | — | — | — | 407 |
| Mexico | 3,6008 | — | — | — | 1,6009 | — |
| Nigeria | — | — | — | — | 25010 | — |
| Sierra Leone | — | — | — | — | 611 | — |
| Somalia | — | — | — | — | 1712 | 2213 |
| Uganda | — | — | — | — | — | 4514 |
| Yugoslavia | 500 | — | — | — | — | — |
| Zambia | — | — | — | 14515 | — | — |
| Maximum available | 9,017 | 2,845 | 1,050 | 169 | 1,873 | 332 |
Maximum gross amounts. Unless otherwise stated, loans were disbursed and repaid within indicated period.
Loan was not disbursed.
The amounts shown for 1982 and 1983 correspond to total gross disbursements; $1,480 million of the U.S. Treasury, $1,450 million by the BIS including $250 million of Saudi Arabia, and $2,646 million from commercial banks. All loans were repaid by mid-1983.
Provided by the BIS. Loan was only partly disbursed by the end of June.
Support for this facility was provided by the Central Bank of Mexico. There was only a partial repayment and the remainder was subsequently restructured.
Support for this facility was provided by the Central Bank of Mexico.
Support provided by commercial banks only. Loan fully repaid by the end of February 1987.
Includes lines of credit and swap operations made available to Mexico during the period March–December 1982. It includes swaps with Spain and France for $450 million, and the U.S. Federal Reserve Board for $1,300 million. It also includes facilities supported by the BIS ($925 million), the U.S. Treasury ($600 million), and the U.S. Federal Reserve Board ($325 million). At the end of 1982, the combined outstanding balance on all these facilities amounted to $1,953 million. By mid-1983, however, all these loans had been fully repaid.
Official sources supported $1,100 million and commercial banks supported $500 million. All loans were repaid by April 1987.
Support provided by the central banks of France, Japan, the United Kingdom, and the United States plus the Kreditanstalt für Wiederaufbau in the Federal Republic of Germany. Only $150 million was used. Loan was repaid before the end of 1986.
Facility was supported by commercial banks only and was provided together with a medium-term loan of about $30 million.
Fully repaid by the end of 1986.
Bank financing only. Bridge to the first purchase under Fund-supported program.
Bank financing only. Bridge to the first purchase under the structural adjustment facility and compensatory financing facility.
As of the end of May 1987, there was an outstanding amount equivalent to about $8 million. The proceeds of the loan were used to bridge the first purchase under a Fund-supported program for 1986. Subsequently, the repayment was postponed to bridge the second purchase under the program, but this never materialized.
Selected Bridge-Financing Arrangements, 1982–Third Quarter 19871
(In millions of U.S. dollars)
| 1987 | ||||||
|---|---|---|---|---|---|---|
| 1982 | 1983 | 1984 | 1985 | 1986 | January– September |
|
| Argentina | 500 | 1,100 | 1,0002 | — | — | — |
| Brazil | 3,9073 | 1,2953 | — | — | — | — |
| Chile | — | 4502 | — | — | — | 2254 |
| Costa Rica | — | — | 505 | — | — | — |
| Dominican Republic | — | — | — | 246 | — | — |
| Hungary | 510 | — | — | — | — | — |
| Jamaica | — | — | — | — | — | 407 |
| Mexico | 3,6008 | — | — | — | 1,6009 | — |
| Nigeria | — | — | — | — | 25010 | — |
| Sierra Leone | — | — | — | — | 611 | — |
| Somalia | — | — | — | — | 1712 | 2213 |
| Uganda | — | — | — | — | — | 4514 |
| Yugoslavia | 500 | — | — | — | — | — |
| Zambia | — | — | — | 14515 | — | — |
| Maximum available | 9,017 | 2,845 | 1,050 | 169 | 1,873 | 332 |
Maximum gross amounts. Unless otherwise stated, loans were disbursed and repaid within indicated period.
Loan was not disbursed.
The amounts shown for 1982 and 1983 correspond to total gross disbursements; $1,480 million of the U.S. Treasury, $1,450 million by the BIS including $250 million of Saudi Arabia, and $2,646 million from commercial banks. All loans were repaid by mid-1983.
Provided by the BIS. Loan was only partly disbursed by the end of June.
Support for this facility was provided by the Central Bank of Mexico. There was only a partial repayment and the remainder was subsequently restructured.
Support for this facility was provided by the Central Bank of Mexico.
Support provided by commercial banks only. Loan fully repaid by the end of February 1987.
Includes lines of credit and swap operations made available to Mexico during the period March–December 1982. It includes swaps with Spain and France for $450 million, and the U.S. Federal Reserve Board for $1,300 million. It also includes facilities supported by the BIS ($925 million), the U.S. Treasury ($600 million), and the U.S. Federal Reserve Board ($325 million). At the end of 1982, the combined outstanding balance on all these facilities amounted to $1,953 million. By mid-1983, however, all these loans had been fully repaid.
Official sources supported $1,100 million and commercial banks supported $500 million. All loans were repaid by April 1987.
Support provided by the central banks of France, Japan, the United Kingdom, and the United States plus the Kreditanstalt für Wiederaufbau in the Federal Republic of Germany. Only $150 million was used. Loan was repaid before the end of 1986.
Facility was supported by commercial banks only and was provided together with a medium-term loan of about $30 million.
Fully repaid by the end of 1986.
Bank financing only. Bridge to the first purchase under Fund-supported program.
Bank financing only. Bridge to the first purchase under the structural adjustment facility and compensatory financing facility.
As of the end of May 1987, there was an outstanding amount equivalent to about $8 million. The proceeds of the loan were used to bridge the first purchase under a Fund-supported program for 1986. Subsequently, the repayment was postponed to bridge the second purchase under the program, but this never materialized.
The resurgence of external payments difficulties in 1986–87 increased the use of bridge loans. During 1986 to mid-1987, bridge loans totaled about $2.2 billion. As in the past, the official sector provided the bulk—60 percent—of the bridge finance, although this represented a smaller share than during 1982–85 when official creditors provided 80 percent of the total. A bridge loan for Mexico in an amount of $1.6 billion was agreed in mid-1986, with $1.1 billion from official creditors and $500 million from commercial banks. Official sources provided about $850 million in August 1986, prior to the approval in principle of the Fund arrangement. The remaining $250 million from official sources, together with the commercial bank portion was drawn in December 1986 when the commercial bank financing commitments reached the critical mass. The commercial bank portion of the bridge loan was fully repaid at the end of April 1987, when the first tranche under the concerted bank loan was disbursed. At that time, bridge financing provided by official creditors had already been fully repaid.
In February 1987, the BIS authorized a bridge loan of $225 million for Chile. This loan was expected to help Chile cover a temporary shortfall in its external financing during 1987 that results from the delayed impact on Chile’s cash flow of the interest retiming in the restructuring agreement; by mid-1988, the interest retiming would provide sufficient cash relief to repay the bridge loan. Official creditors provided a bridge loan of about $0.5 billion for Argentina in November 1987. Smaller amounts of bridge financing were arranged for African countries during 1986–87 on several occasions.
Financing Modalities
Financing modalities in bank financial packages have evolved considerably since 1982 (Table 11). The initial 1982–83 round of bank financial packages was largely undifferentiated financing for the central government, with restructuring agreements that transformed private sector debt, often publicly guaranteed, into direct public sector debt. The terms on these loans reflected the perceived temporary nature of debtor country’s debt-servicing difficulties. Consolidation periods covered only one or two years, maturities ranged up to ten years, and spreads were typically increased to about 2–2¼ percent above the London interbank offered rate (LIBOR).
Financing Instruments and Options in New Money Packages (NM) and Restructurings of Bank Debt (R) of Selected Developing Countries, 1983–871
Classified by year of agreement in principle.
London interbank offered rate (LIBOR) and domestic floating rate options or fixed rate options.
Parallel financing.
Guarantees.
Revolving short-term trade facility.
Financing Instruments and Options in New Money Packages (NM) and Restructurings of Bank Debt (R) of Selected Developing Countries, 1983–871
| Country | Currency (Re)denomination | Interest Rate Options2 | Onlending/Relending | New Trade Facilities | Debt Conversions | World Bank Cofinancing/Parallel Financing | Retiming | Securitization | Alternative Participation Instruments | |
|---|---|---|---|---|---|---|---|---|---|---|
| 1987 | ||||||||||
| Argentina | NM,R | NM,R | NM,R | NM | NM,R | NM3 | R | NM | R | |
| Chile | R | R | R | R | R | |||||
| Philippines | R | R | R | R | ||||||
| Venezuela | R | R | R | R | ||||||
| 1986 | ||||||||||
| Brazil | R | R | R | R | ||||||
| Mexico | NM,R | NM,R | NM | NM,R | NM4 | |||||
| Nigeria | NM,R | NM,R | R | |||||||
| 1985 | ||||||||||
| Chile | NM,R | NM,R | NM,R | NM,R | NM4 | R | ||||
| 1984 | ||||||||||
| Argentina | NM,R | NM,R | NM | NM | ||||||
| Brazil | NM,R | NM,R | NM,R | |||||||
| Chile | NM | NM | ||||||||
| Mexico | NM | NM | ||||||||
| Philippines | NM,R | NM,R | NM5 | NM | ||||||
| Venezuela | R | R | R | |||||||
| 1983 | ||||||||||
| Argentina | NM | NM | ||||||||
| Brazil | NM,R | NM,R | NM,R | |||||||
| Chile | NM,R | NM,R | ||||||||
| Mexico | NM,R | NM,R | ||||||||
Classified by year of agreement in principle.
London interbank offered rate (LIBOR) and domestic floating rate options or fixed rate options.
Parallel financing.
Guarantees.
Revolving short-term trade facility.
Financing Instruments and Options in New Money Packages (NM) and Restructurings of Bank Debt (R) of Selected Developing Countries, 1983–871
| Country | Currency (Re)denomination | Interest Rate Options2 | Onlending/Relending | New Trade Facilities | Debt Conversions | World Bank Cofinancing/Parallel Financing | Retiming | Securitization | Alternative Participation Instruments | |
|---|---|---|---|---|---|---|---|---|---|---|
| 1987 | ||||||||||
| Argentina | NM,R | NM,R | NM,R | NM | NM,R | NM3 | R | NM | R | |
| Chile | R | R | R | R | R | |||||
| Philippines | R | R | R | R | ||||||
| Venezuela | R | R | R | R | ||||||
| 1986 | ||||||||||
| Brazil | R | R | R | R | ||||||
| Mexico | NM,R | NM,R | NM | NM,R | NM4 | |||||
| Nigeria | NM,R | NM,R | R | |||||||
| 1985 | ||||||||||
| Chile | NM,R | NM,R | NM,R | NM,R | NM4 | R | ||||
| 1984 | ||||||||||
| Argentina | NM,R | NM,R | NM | NM | ||||||
| Brazil | NM,R | NM,R | NM,R | |||||||
| Chile | NM | NM | ||||||||
| Mexico | NM | NM | ||||||||
| Philippines | NM,R | NM,R | NM5 | NM | ||||||
| Venezuela | R | R | R | |||||||
| 1983 | ||||||||||
| Argentina | NM | NM | ||||||||
| Brazil | NM,R | NM,R | NM,R | |||||||
| Chile | NM,R | NM,R | ||||||||
| Mexico | NM,R | NM,R | ||||||||
Classified by year of agreement in principle.
London interbank offered rate (LIBOR) and domestic floating rate options or fixed rate options.
Parallel financing.
Guarantees.
Revolving short-term trade facility.
The next financing round in 1984–85 saw the use of certain financial modalities—currency redenomination, interest retiming, onlending/relending, trade facilities, cofinancing, debt conversions—and modifications in terms. These adaptations reflected a desire to tune these packages more closely to the needs of both the creditors and debtor. On the creditor side, these new modalities were seen as a technique to facilitate participation in financial packages by shaping these packages to the business interests of banks, and to their regulatory, tax, and accounting environments.2
On the debtor side, an improvement of terms—lower spreads, reduction or elimination of fees, multiyear consolidation periods, and extension of maturities—has provided additional debt relief, while utilizing financial modalities that are prevalent on international capital markets.
These modalities were described in last year’s capital market report. An update of the use of “traditional” financing modalities is contained in the first section below; the second section describes more recent developments and further innovations in bank financing modalities under the menu approach.
Traditional Modalities
Most recent new money packages and restructuring agreements include a currency (re)denomination option, under which banks may denominate new loans and redenominate existing loans in their domestic currencies, if eligible, or the ECU. This exists in new money packages and restructuring agreements concluded during 1986–87 with ten countries (Argentina, Brazil, Chile, Ecuador, Mexico, Mozambique, Nigeria, the Philippines, Uruguay, and Venezuela). In general, bank creditors whose domestic currency is internationally convertible are eligible to (re)denominate their claims in that currency but limits on the amount exist in some cases. Banks of member countries of the European Community (EC) also have the option to (re)denominate in ECUs. Creditors whose domestic currency is ineligible often may (re)denominate in U.S. dollars, ECUs, or a specified convertible currency. Election of the (re)denomination option for all or part of any bank’s claims normally is a one-time choice that must be exercised either on or before the date the debt becomes subject to the refinancing agreement.
The 1987 package for Argentina includes procedures for the conversion over time, at the option of the lender, of a substantial portion of outstanding claims. Eligible is up to 75 percent of debt with maturities originally falling due on or after January 1986, and up to 40 percent of previously rescheduled maturities. Election of this option must be made within six months of the date on which the agreement becomes effective. The redenominations are scheduled for implementation over a 2½ year period.
Chile’s 1987 bank debt-restructuring agreement allows any bank to redenominate claims into its home currency, if eligible; banks for whom no 12-month interest rate exists in their home currency may switch to U.S. dollars. Election of this option must be made 60 days prior to the first retiming date.3 The exercise of redenomination options in Chile’s 1983 and 1984 restructuring agreements resulted in a reduction of U.S. dollar-denominated claims from 96 percent to 88 percent of the restructured debt. Banks switched primarily to deutsche mark, Japanese yen, Swiss francs and Canadian dollars. The currency denomination of the 1983–85 new money contributions also shifted away from U.S. dollars, as well as Swiss francs, into Japanese yen and deutsche mark.
Ecuador’s restructuring package, agreed in principle in November 1987, allows banks to denominate their contribution to the new money facilities in an eligible home currency or in dollars; it also gives banks a onetime option to redenominate restructured maturities in the lender’s eligible home currency or in dollars. Mexico’s 1987 bank debt restructuring amendment allowed any bank to redenominate claims in its home currency for any credit eligible for conversion up to 45 calendar days after the closing day of the agreement.
The MYRA for Uruguay permits banks to redenominate the principal restructured at each annual advance. This selection can be changed prior to each annual advance date during the consolidation period. So far, Japanese, German, and Swiss banks have redenominated only a small amount of eligible debt into their domestic currencies. The 1987 agreement with the Philippines permits the denomination or redenomination of original public sector debt with maturities falling due during 1987–92.
As a counterpart to currency (re)denomination options, many recent new money packages and restructuring agreements provide banks with alternative interest rate bases to which the spread is added for some eligible currencies. Such provisions allow banks to choose LIBOR, a domestic rate (typically a market-determined cost-of-funds rate adjusted for reserve requirements and deposit insurance premiums), the prime rate, or a fixed rate. All interest rate options are not necessarily available for each currency. Most recent agreements have excluded the prime rate option as a U.S. dollar interest rate base. Borrowers may benefit from lower intermediation costs, and from lower financing costs to the extent interest charges are more market related. Debtor countries’ vulnerability to future increases in interest rates may be reduced when their external debt is converted to a fixed interest rate.
Interest base options exist in restructuring agreements (or agreements in principle) concluded during 1986–87 with Argentina, Chile, Ecuador, Mexico, Mozambique, Nigeria, the Philippines, Uruguay, and Venezuela. Overall, in the countries where this option, together with the currency redenomination option, exists, most of the bank debt was switched from a variable to a fixed rate basis and was converted into low-interest currencies, such as the Japanese yen, the deutsche mark, and the Swiss franc. In the medium term, if the present trend continues, more than one fourth of bank debt could be denominated in low-interest currencies at fixed rates.
Interest retiming essentially extends the interval between interest payments, permitting a country to defer one or more interest payments. The interest base option is usually adjusted to reflect the extended interest periods. For example, associated with a switch from quarterly to semiannual interest payments would be a change from a three- to a six-month LIBOR interest base. Retiming thus enables banks to extend finance without committing new money.
Experience with retiming is confined to three bank agreements (Chile in 1985 and in 1987 and Argentina in 1987). The 1985 restructuring agreement and new money package with Chile extended the interest period from three months to six months. The 1987 package for Chile further extended the interest period from six months to one year; retiming is scheduled to commence in the second half of 1988. Interest payments originally scheduled for that semester, amounting to an estimated $447 million, would be postponed until the first half of 1989. Under the agreement, interest payments would revert to a six-month schedule between 1991 and 1993. The 1987 agreement in principle with Argentina extends the interest payment period for the 1983 and 1985 term credit agreement from three months to six months.
Onlending and relending allow banks to reallocate credit to different debtors in the same country without increasing their overall exposure. Onlending occurs when the lenders and original borrower, usually a public sector entity, agree that the proceeds of a new money loan will be transferred to a new obligor who assumes the responsibility to repay from the original borrower. The lender usually assumes the credit risk that stems from transfer to a new borrower. Relending involves the repayment of an outstanding debt by the original borrower; the lender then relends those proceeds to other borrowers in the country. Both relending and onlending enable banks to develop business relationships with clients in developing countries, to support the export activities of their customers in industrial countries, and, more generally, to reallocate credit risks among different borrowers within a particular country.
Provisions for onlending and relending exist in the 1986–87 restructuring and new money agreements with Argentina, Brazil, Chile, Ecuador, Mexico, Morocco, the Philippines, and Venezuela. While the principal features of these provisions have been described in previous reports on international capital markets, two aspects merit particular emphasis. First, to the extent onlending and relending induce a more rapid and unpredictable expansion of domestic credit to the private sector, these provisions will affect monetary developments and the design of Fund programs. Second, onlending and relending expand the role of international banks in the domestic capital markets of developing countries. To mitigate these effects, many agreements include restrictions on the scale of on-lending and relending operations.
The 1987 restructuring agreement with Argentina increases the amount of onlending permitted under the 1983 term credit agreements by $500 million. In addition, all onlending under the 1983 and 1985 new money agreements is subject to a combined quota of $600 million over five years and to monthly limits on the rate at which onlending transactions can take place. During 1986, $422 million was onlent in Argentina, while an additional $75 million was onlent during the first four months of 1987. The 1986 restructuring agreement with Brazil provides for the possibility of relending at least $1.2 billion of the rescheduled principal that was due in 1985. Moreover, relending is permitted under the 1983 and 1984 restructuring agreements. During 1986 $1 billion was relent, and about $260 million during the first quarter of 1987. The Central Bank’s policy is to allow for an increase in relending in 1987 compared with 1986.
Chile’s 1987 financial package provides for an increase in the amount of relending permitted under the 1985 term credit agreement and the 1985–87 restructuring agreement. Under the former, the maximum relending amount will be increased from $80 million to $105 million after January 1988. Under the latter, the maximum relending amount will be increased from $130 million to $200 million after January 1988. Relending and onlending operations totaled $28 million in 1986 and $106 million during the first eight months of 1987.
The 1987 restructuring agreement with the Philippines extends the debt eligible for relending to include all central bank obligations covered by the agreement. Previously, only private sector debt assumed by the Central Bank and not assigned or transferred by creditors was eligible for relending.
To reduce the size of general purpose bank finance and to facilitate the assembly of the financed packages, new trade credit facilities have been incorporated in these packages. Such facilities enable banks to maintain closer ties with customers in both the debtor country and in industrial countries, while providing additional finance for a country’s imports. Moreover, some banks view debtor countries as assigning a higher priority to servicing trade-related debt; thus such lending could have reduced risks for banks.
New money in the form of trade credit facilities has been extended to Argentina and Costa Rica. The 1985 Argentina financing package included a $500 million medium-term trade credit facility, while the 1987 agreement in principle includes a $400 million trade credit facility with a maturity of four years. The 1985 restructuring agreement with Costa Rica included a $75 million increase in an existing revolving trade credit facility. The 1982 financing agreement with Poland restructured certain interest due as a $355 million short-term revolving trade credit facility. Subsequent agreements in 1983 and 1984 ultimately increased the facility to $800 million.
Commercial banks have been interested in linking their loans to developing countries to lending from multilateral institutions. Banks participating in co-financing arrangements with multilateral institutions benefit from these institutions’ analysis of projects, supervision of implementation, in some cases the administration of loans until their full repayments, and varying degrees of financial protection.
The World Bank began cofinancing operations with commercial lenders in 1983, and currently uses three techniques: (1) direct participation in the longer maturity portion of a commercial loan, which is intended to encourage banks to extend their own maturities and to achieve a lengthening of maturities beyond the point to which the commercial banks would normally commit themselves; (2) a guarantee by the World Bank of the later maturities of a loan made by commercial banks, which provides an incentive for the co-lenders to finance longer maturities than would otherwise be the case; and (3) the assumption by the World Bank of a contingent obligation to increase its participation in the loan in the event of interest rate increases for commercial loans designed with fixed repayment installments, but combining floating interest rate and variable principal components.
Although cofinancing normally involves direct World Bank lending as well, the World Bank also has been willing to consider the selective use of guarantees and other cofinancing instruments in heavily indebted countries on a case-by-case basis. The World Bank has recently made use of such guarantees for Mexico and Uruguay, both of which involved some innovative features. For Uruguay, the guarantee was extended in the context of a bank financing package arranged in connection with the 1986 MYRA (although the commercial bank loan was not disbursed until March 1987). For Mexico, a guarantee was granted for up to 50 percent of commercial bank disbursements under the growth contingency cofinancing facility. In the concerted lending package for Argentina arranged in April 1987, there is no formal cofinancing arrangement with the World Bank but the disbursement of $500 million of the commercial bank loan is conditioned on the disbursement of a $500 million Trade Policy and Export Diversification loan from the World Bank (“parallel financing”). Out of the $350 million in concerted lending to Ecuador agreed in principle in November 1987, $150 million represents parallel cofinancing with the Bank under which interest payments are to be concurrent with interest payments due to the Bank under specified loans.
The Inter-American Development Bank and the Asian Development Bank have also entered into co-financing arrangements (and complementary financing programs) with commercial banks, but the number of arrangements and their size are relatively small.4
Debt conversion schemes have been established in several debtor countries (e.g., Argentina, Brazil, Chile, Costa Rica, Ecuador, Mexico, the Philippines, and Venezuela), as a means of benefiting from the prevailing discounts on sovereign debt in secondary markets. Such schemes are also under active consideration in a number of other developing countries (e.g., Guatemala, Honduras, Jamaica, Morocco, and Nigeria). During the period 1984–September 1987, an estimated $6 billion in bank debt was converted under officially recognized schemes (Table 12). This amount represents about 3 percent of outstanding bank debt to those debtor countries with active conversion schemes, although in some cases a substantially larger share of bank debt has been retired (e.g., in Chile 16 percent of medium- and long-term bank debt has been converted). In addition to debt converted under officially recognized schemes, significant amounts of private sector debt have been bought back by debtors in some countries; in the case of Mexico, for example, such transactions are estimated to have amounted to more than $1 billion in 1987.
Debt Conversions, 1984–Third Quarter 19871
(In millions of U.S. dollars)
Face value of debt converted under officially recognized schemes.
The annual breakdown of conversions is estimated.
January–June 1987.
Of the total conversions 1985–87, an estimated $156 million was capitalized under the Foreign Investment Law (DL 600); $576 million was converted into equity with remittance rights under Chapter XIX; $914 million was converted without remittance rights under Chapter XVIII, and the remainder involved portfolio swaps and write-offs agreed between foreign creditors and domestic debtors mainly in the private sector.
January to mid-October 1987.
Debt Conversions, 1984–Third Quarter 19871
(In millions of U.S. dollars)
| 1987 | |||||
|---|---|---|---|---|---|
| 1984 | 1985 | 1986 | First three quarters |
||
| Argentina | 31 | 4692 | — | — | |
| Brazil | 731 | 537 | 176 | 843 | |
| Chile | — | 3714 | 9694 | 964 | |
| Costa Rica | — | — | 7 | 84 | |
| Ecuador | — | — | — | 109 | |
| Mexico | — | — | 413 | 909 | |
| Philippines | — | — | 15 | 1575 | |
| Total | 762 | 1,377 | 1,580 | 2,307 | |
Face value of debt converted under officially recognized schemes.
The annual breakdown of conversions is estimated.
January–June 1987.
Of the total conversions 1985–87, an estimated $156 million was capitalized under the Foreign Investment Law (DL 600); $576 million was converted into equity with remittance rights under Chapter XIX; $914 million was converted without remittance rights under Chapter XVIII, and the remainder involved portfolio swaps and write-offs agreed between foreign creditors and domestic debtors mainly in the private sector.
January to mid-October 1987.
Debt Conversions, 1984–Third Quarter 19871
(In millions of U.S. dollars)
| 1987 | |||||
|---|---|---|---|---|---|
| 1984 | 1985 | 1986 | First three quarters |
||
| Argentina | 31 | 4692 | — | — | |
| Brazil | 731 | 537 | 176 | 843 | |
| Chile | — | 3714 | 9694 | 964 | |
| Costa Rica | — | — | 7 | 84 | |
| Ecuador | — | — | — | 109 | |
| Mexico | — | — | 413 | 909 | |
| Philippines | — | — | 15 | 1575 | |
| Total | 762 | 1,377 | 1,580 | 2,307 | |
Face value of debt converted under officially recognized schemes.
The annual breakdown of conversions is estimated.
January–June 1987.
Of the total conversions 1985–87, an estimated $156 million was capitalized under the Foreign Investment Law (DL 600); $576 million was converted into equity with remittance rights under Chapter XIX; $914 million was converted without remittance rights under Chapter XVIII, and the remainder involved portfolio swaps and write-offs agreed between foreign creditors and domestic debtors mainly in the private sector.
January to mid-October 1987.
Official conversion schemes are of two general types: debt conversions by foreigners and debt conversions by nationals. Foreign banks may utilize their own loan claims to swap into an equity investment, usually in a financial institution, while foreign nonbanks may purchase loan claims at a discount in the secondary market to finance direct investment or perhaps purchases of domestic financial assets, benefiting from the redemption at near par by the authorities. Resident nationals of the country may also purchase bank loan claims at a discount, employing their own external assets (e.g., flight capital) in order to convert them into domestic financial assets.
While conversion schemes have a variety of features, reflecting the need to tailor such schemes to the circumstances of each country, certain similarities exist among them (Table 13). In addition to permitting the participation of both nonresident and resident investors, debt conversion schemes have permitted the conversion of both public and private sector external debt. Bank claims are often retired at face value, even if purchased at a discount, but frequently there is some mechanism by which the debtor country benefits immediately from this lower price in the secondary market. Conversion schemes typically impose restrictions on profit remittances and capital repatriation beyond those restrictions that would apply to other types of foreign investment. Moreover, some countries require matching foreign exchange inflows to offset the economic impact of early debt retirement. In addition to the officially recognized conversion schemes mentioned above, many countries, including Argentina, Chile, Mexico, and Venezuela, permit the relatively unrestricted conversion of private sector debt into equity of the original debtor.
Features of Debt Conversion Schemes
Compendium of Rules on International Exchange, Chapters XIX and XVIII.
Introduced in February 1987 and temporarily suspended in August 1987.
Mexico has temporarily suspended receiving applications under the scheme in October 1987.
Before June 1984, any nonresident could participate.
Rescheduled debt only.
Rescheduled debt and debt that falls due on or after January 1, 1987.
Free market exchange rate.
Debt redeemed at face value, but conversion fees apply.
Discount, if any, determined by an auction.
Conversions of public sector debt are subject to a small discount; conversion terms of private sector debt are negotiable.
Discount, if any, determined by newly formed commission with oversight responsibility.
Private sector debt only.
Since March 1987, investment through debt conversion must remain at least 12 years in Brazil before becoming eligible for repatriation.
Chapter XVIII investments only.
Investments in the nonpriority sectors only.
Introduced December 1982; eliminated June 1984.
Features of Debt Conversion Schemes
| Argentina | Brazil | Chile1 | Costa Rica | Ecudor2 | Mexico3 | Philippines | Venezuela | |||
|---|---|---|---|---|---|---|---|---|---|---|
| Eligible investors | ||||||||||
| Nonresidents | ||||||||||
| Any creditor | X | X | X | X | X | X | X | |||
| Original creditor only | X4 | |||||||||
| Residents | X | X | X | X | X | X | ||||
| Eligible external debt | ||||||||||
| Public sector | X | X | X | X | X | X5 | X6 | X | ||
| Private sector | X | X | X | X | X | |||||
| Exchange rate for conversion | ||||||||||
| Official exchange rate | X | X | X | X | X | X | ||||
| Parallel exchange rates | X7 | X7 | ||||||||
| Valuation of debt for conversion | ||||||||||
| Face value | X | X | X8 | |||||||
| Below face value | X9 | X10 | X | X | X11 | |||||
| Eligible domestic investments | ||||||||||
| Equity | ||||||||||
| Parastatal enterprises | X | X | X | X | ||||||
| Private companies | X | X | X | X | X | X | X | X | ||
| Original obligor only | X12 | |||||||||
| Debt | ||||||||||
| Public sector | X | X | ||||||||
| Private sector | X | X | ||||||||
| Repayment of domestic obligations | X | X | X | |||||||
| Restrictions on eligible investments | ||||||||||
| Restrictions on capital repatriations | X | X13 | X | X | X | X | X | X | ||
| Restrictions on profit remittances | ||||||||||
| Same as for all foreign investment | X | |||||||||
| More restrictive than the above | X | X | X | X | X | X | X | |||
| Other features | ||||||||||
| Limit on value of conversions | X | X | X | |||||||
| Auction of conversion rights | X14 | |||||||||
| Conversion fees | X | X | ||||||||
| Additional foreign exchange required | X | X | X15 | X | ||||||
| Tax credits | X16 | |||||||||
Compendium of Rules on International Exchange, Chapters XIX and XVIII.
Introduced in February 1987 and temporarily suspended in August 1987.
Mexico has temporarily suspended receiving applications under the scheme in October 1987.
Before June 1984, any nonresident could participate.
Rescheduled debt only.
Rescheduled debt and debt that falls due on or after January 1, 1987.
Free market exchange rate.
Debt redeemed at face value, but conversion fees apply.
Discount, if any, determined by an auction.
Conversions of public sector debt are subject to a small discount; conversion terms of private sector debt are negotiable.
Discount, if any, determined by newly formed commission with oversight responsibility.
Private sector debt only.
Since March 1987, investment through debt conversion must remain at least 12 years in Brazil before becoming eligible for repatriation.
Chapter XVIII investments only.
Investments in the nonpriority sectors only.
Introduced December 1982; eliminated June 1984.
Features of Debt Conversion Schemes
| Argentina | Brazil | Chile1 | Costa Rica | Ecudor2 | Mexico3 | Philippines | Venezuela | |||
|---|---|---|---|---|---|---|---|---|---|---|
| Eligible investors | ||||||||||
| Nonresidents | ||||||||||
| Any creditor | X | X | X | X | X | X | X | |||
| Original creditor only | X4 | |||||||||
| Residents | X | X | X | X | X | X | ||||
| Eligible external debt | ||||||||||
| Public sector | X | X | X | X | X | X5 | X6 | X | ||
| Private sector | X | X | X | X | X | |||||
| Exchange rate for conversion | ||||||||||
| Official exchange rate | X | X | X | X | X | X | ||||
| Parallel exchange rates | X7 | X7 | ||||||||
| Valuation of debt for conversion | ||||||||||
| Face value | X | X | X8 | |||||||
| Below face value | X9 | X10 | X | X | X11 | |||||
| Eligible domestic investments | ||||||||||
| Equity | ||||||||||
| Parastatal enterprises | X | X | X | X | ||||||
| Private companies | X | X | X | X | X | X | X | X | ||
| Original obligor only | X12 | |||||||||
| Debt | ||||||||||
| Public sector | X | X | ||||||||
| Private sector | X | X | ||||||||
| Repayment of domestic obligations | X | X | X | |||||||
| Restrictions on eligible investments | ||||||||||
| Restrictions on capital repatriations | X | X13 | X | X | X | X | X | X | ||
| Restrictions on profit remittances | ||||||||||
| Same as for all foreign investment | X | |||||||||
| More restrictive than the above | X | X | X | X | X | X | X | |||
| Other features | ||||||||||
| Limit on value of conversions | X | X | X | |||||||
| Auction of conversion rights | X14 | |||||||||
| Conversion fees | X | X | ||||||||
| Additional foreign exchange required | X | X | X15 | X | ||||||
| Tax credits | X16 | |||||||||
Compendium of Rules on International Exchange, Chapters XIX and XVIII.
Introduced in February 1987 and temporarily suspended in August 1987.
Mexico has temporarily suspended receiving applications under the scheme in October 1987.
Before June 1984, any nonresident could participate.
Rescheduled debt only.
Rescheduled debt and debt that falls due on or after January 1, 1987.
Free market exchange rate.
Debt redeemed at face value, but conversion fees apply.
Discount, if any, determined by an auction.
Conversions of public sector debt are subject to a small discount; conversion terms of private sector debt are negotiable.
Discount, if any, determined by newly formed commission with oversight responsibility.
Private sector debt only.
Since March 1987, investment through debt conversion must remain at least 12 years in Brazil before becoming eligible for repatriation.
Chapter XVIII investments only.
Investments in the nonpriority sectors only.
Introduced December 1982; eliminated June 1984.
A secondary market for bank loans has emerged since 1982; this market has been a source of debt claims used in conversion schemes. Discounts in this market ranged from 20 percent to 90 percent for the 15 heavily indebted developing countries, and in late September 1987 averaged around 55 percent. Estimates of the total volume in the secondary market (counting both sides of the transactions) range from $13 billion to $18 billion, a small fraction of the approximate $300 billion of bank debt of countries that have restructured since 1982. A number of banks and investment houses—notably in New York and London—have developed a role as intermediaries in transactions of loan claims.
Two types of transactions appear to dominate this market. The first is swaps among banks that are often designed not to diversify portfolios but to concentrate holdings of claims on countries where banks have a strategic business interest and to eliminate minor holdings. The second is outright sales (by assignment, participation, or novation) for use in debt conversions. Such transactions have been constrained on both the supply and demand sides of the market. Thus far, supply has been limited to smaller banks—particularly those in continental Europe and U.S. regional banks—that have sought to reduce their exposure.
The Economic Impact of Debt Conversions
Debt conversions have implications for a debtor country’s balance of payments, its monetary policy, and budget. Regarding the balance of payments impact of debt conversion schemes, the key issue relates to the availability of foreign savings to the economy. The conversion of one type of external claim to another does not of itself create additional resources for debtor countries. Higher domestic investment will only result if debt conversion schemes lead to an increase in the amount of foreign savings available to the economy. In the absence of greater foreign savings, any rise in foreign direct investment that may result from such schemes would tend to crowd out investment by residents that would have taken place in the absence of the debt conversion.
If the foreign inflow financed through debt conversion would have occurred in any case, then, ceteris paribus, available foreign savings would in fact be diminished, and foreign debt repaid through diverting resources that would otherwise have been available domestically. This consideration applies whether the conversions are made by foreign investors or by residents drawing on foreign assets. For this reason, countries have in some cases set up administrative arrangements to try to ensure that debt conversions are associated with additional capital inflows, although such arrangements may be difficult to administer. The existence of a discount, however, raises the rate of return for investors, so that the operation of such schemes is likely to attract some investment that would not have taken place anyway.
Debt conversion schemes also affect the balance of payments through their impact on net factor payments. They result in a reduction of interest payments abroad, offset to some extent by increased profit remittances or a loss of foreign interest income on residents’ assets abroad. Schemes providing for conversions into equity have typically included restrictions on the timing of profit and capital remittances to seek a more favorable pattern of payments.
Debt conversions financed by repatriation of resident capital—which account for the bulk of conversions under the Chile scheme—in principle would involve a gain for the balance of payments, since (if flight capital is involved) the beneficiaries of buying the debt at a discount are residents. In most cases, the improvement recorded in the accounts will be even larger, since the foreign interest forgone would typically have been reinvested abroad and not registered in the balance of payments accounts. Such an improvement may only be permanent, however, if appropriate macroeconomic policies are in place; by themselves, conversion schemes may not modify residents’ preference for holding foreign assets, and repatriated capital could be exported again.
The impact of debt conversion schemes on domestic spending has implications for the management of financial policies. Such schemes may have a monetary impact, if domestic currency is issued as the counterpart to the converted external claim, with a direct impact on inflation and the exchange rate or reserves. If the schemes are designed to avoid this monetary effect, they may instead affect interest rates. Debt conversion schemes may also have an impact on the budget (or the operating position of the central bank) if the domestic public sector debt that is substituted for external debt involves higher interest payments (appropriately adjusted for exchange rate movements). The public sector may, however, also derive a direct benefit from debt conversion schemes, to the extent that it receives part of the discount.
Finally, an important issue concerns the nature of the signals that may be sent through the operation of debt conversion schemes. To the extent that debt conversions improve countries’ ability to service their remaining external debt over the medium term, such conversions should, over time, enhance creditworthiness. When schemes include conversions to equity, countries’ willingness to open their economies to foreign investment may also give a positive signal to potential foreign lenders. Taken together with the direct incentive resulting from the discount on the loan claims, conversion could thus have a positive effect on foreign inflows.
For some banks, a reason for selling loans is to avoid participation in future concerted lending packages. Banks with large exposures have been reluctant to transact a part of their portfolio because of concerns about the impact on bank regulators’ valuation of remaining claims. The fact that an increasing number of banks have made large loan-loss provisions may increase their flexibility in disposing of assets, whether to rebalance their loan portfolios, to participate directly in debt-equity conversions or to sell claims into debt-equity packages assembled for nonbank corporations. Moreover, the creation by Japanese banks of the Cayman Islands Factoring Company is seen by some market participants as a vehicle for eventual loan sales. As regards demand, the scale and terms of debt conversion programs significantly influence investors’ preferences for loan claims. Liberalization of financial markets in developing countries also enhances demand as it facilitates the conversion of debt into domestic assets by enhancing their liquidity. Changes in regulations regarding commercial banks’ holdings of equity claims could also influence demand. In August 1987, the U.S. Federal Reserve Board amended Regulation K, which governs foreign investment by U.S. banks, to permit certain foreign investment through debt-equity swaps. In particular, U.S. banks were allowed—under certain circumstances—to acquire 100 percent (instead of only 20 percent) of the shares of nonfinancial companies.
In the medium term, the question arises if outside the context of debt conversion programs a significant demand for developing country debt by private non-bank and institutional investors could emerge. Market participants have suggested three important differences between existing high risk instruments with high yields in the United States (e.g., “junk bonds”) and the secondary market for bank claims on developing countries. First, even though the discounted bank debt of most developing countries that has recently been restructured has an implicit yield to maturity above that of noninvestment grade bonds, such developing country debt tends to trade on a “specific situation” basis or on “specific demand” and not on yield. The second difference is maturity. Most noninvestment grade bonds are in a short- to medium-term maturity range (5–10 years), while rescheduling maturities reach up to 20 years—a maturity range of limited interest at present to private investors. Third, the trade-off between yield to maturity and risk associated with sovereign claims is not susceptible to “technical analysis” in the same sense as corporate liabilities.
The Menu Approach
Explicit development of the “menu” approach was initiated with the 1987 package for Argentina; however, it represents the culmination of many developments both within and outside the restructuring process. The menu includes traditional financing modalities, described above, plus recent innovations, such as alternative participation instruments, securitized new money claims, and a fee structure to encourage early participation. In addition, for a low-income country—Bolivia—banks have agreed to permit a direct debt buy-back using donated resources.
Obtaining agreement from hundreds of banks on a new money package became increasingly difficult during 1986. Bank advisory committees sought to make the process more orderly and less expensive by developing techniques to permit banks with small exposures to contribute and then to exit from the process. Two approaches have been tried or suggested. One approach is the de minimis rule applied by official creditors in the context of Paris Club reschedulings. Banks with exposure below a specified amount would be exempt from new money requests. The principal drawback of this approach in the view of some major banks is that it would permit smaller banks to exit without contributing, thus increasing the contribution required of remaining banks.
The second approach—Alternative Participation Instruments (APIs)—permits all banks to reduce their base exposure for calculating new money contributions by up to the same specified limit. APIs were utilized in the 1987 financing agreement with Argentina and were proposed in Ecuador’s restructuring package agreed in principle in November 1987. In the case of Argentina, banks have the option to exchange up to $5 million of their claims on public sector borrowers, or $30 million if it completely extinguishes their exposure, for APIs. These instruments have a fixed rate of 4 percent and a maturity of 25 years with 12 years’ grace. (The new medium-term loan has an interest rate of ⅞ of 1 percent above LIBOR and a maturity of 12 years with 5 years’ grace.) APIs would be excluded from the banks’ base for purposes of calculating new money contributions for the 1987 or future concerted lending programs. These instruments are designed primarily to give banks with a small exposure an alternative technique to participate. Their contribution to this and future new money packages would stem from the banks’ receipt of a lower stream of interest payments. Commercial bank requests for APIs have been very limited, so far.
Securitization, which refers to the substitution of more tradable financial instruments for bank claims, provides banks with an instrument to facilitate reorganization of their portfolios. In some cases, it enhances the perceived priority of the debt vis-à-vis other obligations (see next section). Securitization also may provide debtor countries greater access to nonbank sources of finance.
In general, there are two ways to securitize existing bank loans: a country can refinance existing loans by issuing securities; and banks, or other intermediaries, can issue securities or convertible notes backed by existing bank loans. For example, interbank lines frozen by maintenance of exposure or other agreements have been securitized: in 1986, three Mexican banks and one Brazilian bank refinanced $0.5 billion of such debt, using note-issuance facilities and floating rate notes. Certain types of Nigerian debt were exchanged for promissory notes under the 1983 restructuring agreement, albeit of qualified transferability.
In 1986 Hungary, which had not lost access to international capital markets, borrowed in the Eurobond market through the issuance of $250 million in the form of 20-year floating rate notes that were “collateralized” by a zero coupon U.S. Treasury bond of 20-year maturity and a cash reserve fund that will be invested in short-term U.S. dollar securities. This collateral is intended to secure both the principal of the notes—through the zero coupon bond—and the interest payments expected to fall due after an estimated 12–15 years. In those later years the combined value of the cash reserve fund and the zero coupon bond would cover the principal due on the Eurobond. In addition, earnings on the cash reserve fund in those later years would be used to pay the interest payments on the floating rate notes. Market participants believed that the arrangement had enabled Hungary to obtain longer-term bond finance, but at a higher effective spread than on more traditional medium-term issues.
The 1987 financing agreement with Argentina provided any bank that commited its full share of the new money facilities with the option to receive up to $1 million of its commitment in the form of a bond—a securitized new money contribution. New money instruments (NMIs) were to be issued to subscribing banks on the day of the first drawdown under the 1987 term credit agreement. NMIs are U.S. dollar-denominated bearer bonds that carry the same interest rate, maturity, and grace period as the term credit facility. Such NMIs were also proposed under Ecuador’s 1987 restructuring package, but banks were allowed to replace their contribution to the $200 million new money facility in whole or in part by NMIs, without an upper limit.
With the intention of lessening the adverse impact of rescheduling on access to spontaneous financing, commercial banks have standardized to some degree their procedures for debt restructuring. Bank agreements, where possible, have excluded short-term trade finance, interbank debt, and bonds from formal rescheduling, thereby prioritizing such claims. The setting of a cutoff date and exclusion of short-term debt each offers analogies with Paris Club procedures that are designed with a similar intention. While short-term trade and interbank debt have been better serviced than longer-term obligations, they nevertheless have been covered by agreements to maintain exposure and occasionally have been formally restructured. New money claims often carry higher spreads or shorter maturities, or both, than restructured debt; however, these terms are not always protected by the cutoff date; in a few cases, banks have adjusted the terms of loans contracted after the cutoff date and new money contributions have sometimes been included in the base for subsequent new money packages.
In addition to the above procedures, securitization has been viewed as a means of prioritizing claims. Market participants have pointed out that marketable debt has typically been excluded from rescheduling agreements, reflecting the time and costs involved in rescheduling the relatively small amounts of securitized debt as compared with bank loans. Bankers have thus viewed NMIs as less likely to be rescheduled, given their bearer bond form. Bonds and other securities have generally been better serviced than medium- and long-term bank loans, which tends to support bankers’ perceptions; however, bonds and other securities have been rescheduled on a few occasions.
Experience with capitalization of interest is limited so far to two low-income countries experiencing extreme difficulty in servicing their debt. The 1980–82 restructuring agreements with Nicaragua stipulated that interest was to accrue at spreads of 3¾ of 1¼ percent above LIBOR for the first three years of the agreement and of 1¼ percent above LIBOR for the final four years of the agreement. Actual payments, however, could be limited to 7 percent a year in the agreement of 1980, and to 6 percent in the agreements of 1981 and 1982.
Sudan, as part of its 1985 agreement with banks, accepted an interest rate spread of 1¼ percent for its outstanding debt with the proviso that it pay a minimum of $6.5 million in interest per quarter during the fourth quarter of 1985 to the end of 1986. Any accrued interest that remained unpaid by April 1987 could be capitalized.
Performance incentives for either the banks or a debtor country have been included in three recent restructuring agreements. The 1987 Argentine financing package includes an early participation fee for banks. Those banks which committed to the agreement by June 17, 1987, receive a ⅜ of 1 percent flat fee on the amount of the commitment; those banks which committed between June 18 and July 17, 1987, receive a flat fee of ⅛ of 1 percent. Commitments received thereafter will receive no early participation fees. Bankers believed that such fees played an important role in accelerating commitments. Ecuador’s restructuring package, agreed in principle in November 1987, also included an early participation fee.
The 1987 agreement in principle with the Philippines provides the borrower with an incentive to make scheduled amortization and optional prepayments using a contingent interest rate spread. The spread on the restructured debt is reduced from 1 percent to ⅞ of 1 percent during 1987–89 if the Philippines makes an annual prepayment of at least 4 percent of the outstanding debt, as of January 1, 1987, under the 1984/85 New Money Agreement (equivalent to an annual prepayment of $37 million). Thereafter, the spread remains at ⅞ of 1 percent if during these years amortization prepayments are made as scheduled.
Debt buy-backs permit countries to repurchase their debt at a discount using international reserves or foreign exchange obtained from official or private sources. Under a February 1987 amendment to the 1981 refinancing agreement with Bolivia, creditor banks agreed to permit a two-step approach to resolving Bolivia’s bank debt problem. As a first step, a portion of the outstanding principal and associated unpaid interest will be reduced by a debt buy-back at a discount (along with a concurrent debt-equity conversion scheme) and thereafter the remaining debt will be restructured. The buy-back operation will take place directly between Bolivia and banks rather than in the secondary market and will use foreign exchange obtained from other countries.
Bolivia will offer to buy back its debt at a price that its authorities will determine, while the banks will choose the amount of debt they are prepared to sell at that price. Under the agreement, Bolivia will be able to make multiple offers within a four-month period from November 6, 1987. However, all banks selling their claims on Bolivia will receive the same price under the terms of the amendment. The portion of Bolivia’s debt to banks extinguished through the buy-back will depend on the amount of contributions received for this purpose and the price accepted by the banks willing to avail themselves of Bolivia’s offer. The remaining debt will be restructured after the completion of the buy-back at terms to be decided at that time; the terms are expected to be concessional.
The bank coordinating committee has insisted that only grants will be accepted for the buy-back so as not to divert domestic official reserves from debt servicing. Fund involvement was requested by Bolivia in implementing this scheme to assure bank creditors that the funds received for the buy-back are indeed grants from other countries, to maintain the anonymity of the donors if so requested, and to keep the amount of contributions received confidential. Following the Fund’s Executive Board’s approval of the instrument establishing the voluntary contribution account for Bolivia on October 22, 1987, the banks completed the signing of the amendment, which became effective on November 6, 1987, with the promulgation of a decree by Bolivia authorizing the buy-back and debt-equity conversion arrangements.
Prudential Developments
Provisioning
Banks’ practice of provisioning against claims on countries with debt-servicing problems differs across countries according to the regulatory and accounting framework and the tax treatment of loan-loss reserves. The range of systems in effect in the major industrial countries was described in last year’s capital markets report.5 Increasingly, however, banks have decided to raise their loan-loss reserves to levels beyond those mandated or recommended by their supervisory authorities, partly for competitive reasons.
In continental European countries, provisions for loan losses have traditionally been the highest among industrial countries, but they have been increased further to cover at least one fourth and often more than one third of exposure to countries experiencing payments difficulties, while individual banks in Europe have considerably higher levels of provisions. In the Federal Republic of Germany, there is no general provisioning objective from the regulatory side, as supervisors judge on a case-by-case basis the adequacy of a bank’s provisioning policy, taking into account actions by other German banks in a comparable situation. Provisions are tax deductible and tax authorities have adopted a liberal attitude toward provisioning levels. One of the largest banks has publicly announced provisions of 70 percent, although this magnitude is not representative of the German banking system.
In France supervisors suggest provisions against exposure to about 30 countries but there are no mandatory rules. Provisions are tax deductible, subject to a case-by-case inspection by the tax authorities. In Belgium, banks have also continued to make substantial provisions against developing country exposure. In contrast to other European countries, the Belgian tax system is restrictive in granting tax deductions for provisions. Banks have to prove that a loss is “probable.” In Switzerland, the authorities decided in 1986 to increase mandatory provisioning requirements against claims on a “basket” of about 100 developing countries from 20 percent to 30 percent. Banks had until the end of 1987 to adjust their provisions. Provisions are tax deductible up to the mandatory requirement; tax authorities in the different cantons can grant tax deductions for provisions above the mandatory level.
In the United States, Canada, Japan, and the United Kingdom, provisions against sovereign debt were lower at the end of 1986 than in continental European countries: according to market sources, they averaged about 2 percent in the United States, 5 percent in Japan, and 10 to 15 percent in Canada; provisioning levels in the United Kingdom were between those of Japan and Canada. The much lower provisions in these countries are partly explained by the lack or limits on tax deductibility; partly, by the perception that the level of published profits has a more direct impact on share prices than in some European countries; and to some extent, by the relative exposure positions.
However, following Brazil’s suspension of interest payments on medium- and long-term debt owed to foreign banks, a number of U.S. banks moved these loans to a nonaccrual basis. Subsequently, during the second quarter of 1987, all major U.S. banks increased their loan-loss reserves substantially. The nine money center banks increased provisions against exposure to restructuring countries by $11 billion during the second quarter of 1987, equivalent to 19 percent of their total exposure to these countries.
The new provisions set aside in the second quarter of 1987, together with existing general provisions, are estimated to cover about one fourth of the nine money center banks’ exposure to countries with debt-servicing problems. Some large regional U.S. banks have increased their provisions to 30 to 35 percent of their exposure. In the United States, such provisions are not tax deductible, contrary to the practice in most European countries and Canada. These reserves, however, may be included in primary capital for purposes of monitoring capital adequacy (see below); in almost all other countries, loan-loss reserves are not counted as primary capital.
Some major banks in the United Kingdom have followed the U.S. banks’ move and increased their provisions against sovereign debt to 25–30 percent. Specific provisions do not count as primary capital in the United Kingdom, but their tax deductibility has become easier recently. In July 1987, the Bank of England proposed a new framework for determining the adequate provisioning level against developing country debt. On the basis of a matrix that includes different factors measuring the probability of debt-servicing problems, each bank would calculate a score for each country; certain bands of scores would then suggest the appropriate provisioning level. Such a common framework may assist in establishing a basis for seeking tax deductibility of provisions.
After the additional provisions by U.S. and U.K. banks, bank supervisors in Canada decided in August 1987 to increase banks’ mandatory provisions against a basket of 34 countries experiencing debt-servicing problems to a range of 30–40 percent. Most Canadian banks with international exposure are expected to report significant losses in 1987 after meeting the government’s new guidelines, although provisions are tax deductible in Canada. But, unlike in the United States, such reserves are not counted as primary capital for the purpose of capital adequacy measurement.
In Japan, loan-loss reserves against claims on developing countries with debt-servicing problems are estimated to be around 5 percent. Only 1 percent of rescheduled debt and increased exposure since a base date is tax deductible. In March 1987, however, the major Japanese banks set up a factoring company in the Cayman Islands that purchased new money extended earlier by Japanese banks to Mexico, at a price below face value. The losses incurred through this transaction are deemed to be tax deductible. Following the worldwide move toward higher provisioning, the Japanese Ministry of Finance has invited banks to present proposals to increase their provisions.
Capital Adequacy
In addition to more provisioning against doubtful loans, banks’ balance sheets in most industrial countries, with the exception of Japan, have been strengthened since 1982 by increasing capital relative to total assets. Improvements in capital-asset ratios have been most pronounced in the United States, the United Kingdom, and Canada.
As a result of increases in capital and a decline in U.S. banks’ claims on developing countries, there has been a further increase in the ratio of U.S. banks’ capital to claims on developing countries (Table 35). This ratio had doubled since 1982 to 95 percent in 1986 and increased further to 105 percent by mid-1987; about four fifths of this improvement was due to the increase in banks’ capital during those years, while one fifth was accounted for by a decline in exposure. Among the U.S. banks, the ratio for the nine money center banks doubled between the end of 1982 and mid-1987 (from 31 percent to 64 percent), while those for the next 15 largest U.S. banks and for the regional U.S. banks more than doubled (from 47 percent at the end of 1982 to 108 percent by mid-1987 and from 113 percent to 271 percent, respectively). For banks outside the United States, the depreciation of the U.S. dollar since early 1985 and a continued buildup of capital has improved considerably these banks’ capital coverage of developing country exposure.
A “critical mass” is the minimum amount of bank commitments to a new money package that gives reasonable assurance that the financing assumptions of an adjustment program are realistic.
Some of these financing modalities were explicitly endorsed in Institute of International Finance Restoring Market Access—New Directions in Bank Lending (Washington, June 1987).
For the significance of the 12-month interest rate and retiming date, refer to the section on retiming below.
These operations were described in Maxwell Watson, and others, International Capital Markets: Developments and Prospects, World Economic and Financial Surveys (Washington: International Monetary Fund, December 1986).
Maxwell Watson, and others, International Capital Markets: Developments and Prospects, World Economic and Financial Surveys (Washington: International Monetary Fund, December 1986).