II Commercial Bank Debt Restructuring
- International Monetary Fund
- Published Date:
- January 1995
Progress has been made by a number of the heavily indebted middle-income developing countries in regularizing their relations with commercial bank creditors. To many observers, the conclusion of the Brazilian debt package in April 1994 is seen as marking the end of the debt crisis that began in August 1982 when Mexico announced its inability to service its external obligations to commercial creditors. Along with Brazil, Bulgaria, the Dominican Republic, Jordan, Poland, Sao Tome and Principe, and Zambia completed debt-and debt-service-reduction operations or comprehensive debt buy-backs over the past year. Ecuador and its bank creditors also reached agreement, and the restructuring package is scheduled to be completed before the end of 1994. By that time, 21 countries will have concluded debt- and debt-service-reduction operations restructuring $170 billion of original commercial bank claims (Tables 1 and A2), or 75 percent of commercial bank debt owed by heavily indebted developing countries at the end of 1989.5 Debt reduction achieved will amount to an estimated $76 billion at a cost of about $25 billion.
|Debt and Debt-Service Reduction (DDSR)2|
|Total Debt and|
|Costa Rica (1989)||1,456||991||—||—||101||36||1,128||77.5||196|
|Dominican Republic (1993)||776||272||177||—||—||63||511||65.8||149|
|Sao Tome and Principe||10||10||—||—||—||—||10||100.0||1|
Allocations to the different options available in bank packages have varied depending (among other things) on explicit limits imposed by debtor countries, on interest rate developments following the issuance of term sheets, on creditors’ perceptions of country creditor risks, and on the prospect of capital gains (Tables 2 and A3). In general, packages have been cost-effective in that the cost per unit of debt reduction obtained has been broadly in line with prices prevailing in the secondary market at the time agreements in principle were reached (Tables 3 and A4).
at Time of
Following the trend of previous years, debt conversion activity was less buoyant in 1993. This partly reflected a shift in emphasis in the privatization program in Argentina, which accounted for about half of debt conversions in 1992, as priority shifted from reducing foreign commercial bank debt to reducing foreign currency denominated domestic debt instruments. In addition, the decline in debt conversions reflected the rise in secondary market prices for the debt of many countries and the reduced scale of privatizations, owing to countries having substantially completed their schemes.
Recent Bank Packages
While Argentina’s debt- and debt-service-reduction package closed on April 7, 1993, about 6 percent of eligible principal (amounting to $19.4 billion) and 100 percent of past due interest ($8.6 billion) were exchanged at a later date because of reconciliation problems. All collateral and guarantees (totaling $3.1 billion), however, were deposited with the collateral agent (the Federal Reserve Bank of New York), and the downpayment on past due interest ($0.7 billion) and the bonds related to unreconciled debts were deposited with the escrow agent (the Bank of England) on the closing date. Reconciliation of the remaining principal was completed on September 27, 1993, and the release of bonds covering past due interest and the corresponding cash payments was made in four tranches: the first on October 29, 1993 (83 percent); the second on December 29, 1993 (14 percent); the third on February 28, 1994 (3 percent); and the fourth and last on April 28, 1994 (negligible amounts).
Brazil completed one of the largest and most complex debt- and debt-service-reduction operations on April 15, 1994. Completion of the deal came almost two years after the agreement in principle was reached, following four extensions of the closing date. Since an arrangement with the Fund was not likely to be in effect at closing (this had been a condition in the term sheet), a waiver from bank creditors had to be requested. This waiver was granted on March 24, 1994. The process was also delayed because of problems in obtaining full creditor participation.6
The deal restructured $40.6 billion in eligible principal and $6.0 billion in past due interest. Out of a menu of six options, only five were actually used. Creditors accepted the May 1993 limits suggested by the authorities on the amount of debt allocated to the par and new money options and the minimum allocation for the discount bond. The final allocation was (1) 35 percent for the discount bond; (2) 32 percent for the par bond; (3) 22 percent for the capitalization bond with temporary interest reduction; (4) 6 percent for the new money option; and (5) 5 percent for the front-loaded interest reduction bond (FLIRB). No allocation was made to the restructuring option.
The cost of the enhancements required for the operation is estimated at $3.9 billion, of which $2.8 billion in collaterals was delivered at closing, with the rest to be phased in over a two-year period in four semiannual installments. Phase-in bonds and partly collateralized bonds were issued at closing and were to be exchanged for fully collateralized instruments over the next two years.7 The Bank for International Settlements is serving as the collateral agent. Financing for the operation comes from $0.4 billion collected in the new money option and from Brazil’s own resources. Zero-coupon U.S. Treasury securities used as collateral for the deal were purchased by Brazil in the secondary market.
In one of the fastest completions of a menu-based debt- and debt-service-reduction operation, Jordan concluded a deal with its banks on December 23, 1993, two weeks after the formal signing of the agreement and less than six months after reaching an agreement in principle. The package covered eligible principal of $740 million and past due interest of $120 million. Following considerable official buy-backs in the secondary market before the commitment date (about 12 percent of the total bank debt outstanding), the final allocation of eligible principal was (1) 67 percent for the par bond; (2) 33 percent for the discount bond; and (3) negligible amounts for the (below-market price) buy-back. The $150 million cost of the operation included $29 million for cash payments on past due interest. Financing was covered entirely by the country’s own resources.
Bulgaria reached an agreement in principle with its commercial bank creditors on November 24, 1993. A term sheet was distributed to banks on March 11, 1994, and the package was completed on July 29, 1994. Eligible principal amounted to $6.2 billion, including $1.9 billion in short-term debt. The menu consisted of three options: (1) a 50 percent discount exchange; (2) a FLIRB; and (3) a buy-back at 25
The discount bond involves a 30-year bullet repayment and bears an interest rate of
The term sheet limited the allocation for the FLIRBs to 30 percent. Rebalancing was not needed by the commitment date (May 18, 1994), since the allocation was (1) 60 percent for the discount bond; (2) 27 percent for the FLIRB; and (3) 13 percent for the buy-back. Interest arrears estimated at about $1.9 billion were included in the operation. A cash payment of 3 percent was made, with remaining amounts (other than amounts purchased in connection with the buy-back option) rescheduled in the form of a 17-year uncollateralized bond bearing a market interest rate of
On February 14, 1994, the Dominican Republic formally signed an agreement to restructure $1.1 billion of its commercial bank debt, including interest arrears of $320 million. The operation closed on August 31, 1994. After an initial allocation failed to provide the 50 percent debt reduction included in the term sheet, creditors were asked to rebalance their commitments. The final allocation on eligible principal was 65 percent to the discount exchange, 35 percent to the buy-back, and no allocation to the FLIRB. The up-front cost of the operation was about $190 million, financed entirely by the country’s own resources.
A highly innovative and somewhat controversial agreement in principle was reached between Poland and its bank advisory committee on March 10, 1994. The larger-than-anticipated debt reduction entailed in the agreement produced a significant decline in the price of Polish debt in the secondary market after the announcement. The agreement restructured $12.7 billion, comprising virtually all of Poland’s outstanding commercial bank debt. A term sheet was distributed to banks on May 23, 1994, and commitments were due on June 29, 1994. That date was subsequently extended to improve chances that approval of a waiver for a buy-back would be received from creditors holding 95 percent of the debt. That figure was achieved, and the deal was completed on October 27, 1994. Eligible principal amounted to $9.9 billion, of which $1.1 billion was short term. The menu for eligible principal included six options, four for medium- and long-term debt and two for short-term debt. The options for medium- and long-term principal were (1) a buy-back at 41 cents on the dollar per unit of claim; (2) a 45 percent discount bond exchange; (3) a below-market interest rate par exchange; and (4) a new money option, whereby in exchange for 35 percent of new money, old claims are rescheduled on somewhat more favorable terms than in the other options. The options for short-term principal were (1) a buy-back at 38 cents on the dollar per unit of claim and (2) a below-market interest rate par bond exchange, with an interest rate profile marginally higher than that for the par bond exchange for medium- and long-term principal.
The discount bond in the Polish package involved a 30-year bullet repayment bearing a market interest rate of
Bank creditors allocated their medium- and long-term debt as follows: (1) 24.6 percent to the buy-back; (2) 60.8 percent to the discount exchange; (3) 10.3 percent to the par exchange; and (4) 4.4 percent to the new money option. Allocation of the short-term debt was as follows: (1) 26.1 percent to the buy-back and (2) 73.9 percent to the par exchange.
In the Polish package, past due interest of $3.5 billion was effectively subject to debt and debt-service reduction. Debt reduction of about 15 percent was obtained by reducing the capitalization rate on interest arrears. Debt-service reduction was also obtained through a below-market interest rate for the associated bond. In theory, there were five modalities for dealing with past due interest, two for interest arrears on short-term principal and three for interest arrears on medium- and long-term principal. The options for short-term interest arrears are exactly the same as the options for short-term principal. The three options for interest arrears on medium- and long-term principal included (1) a cash payment corresponding to 85 percent of interest due in December 1989 to regularize previous anomalies and catch up on payments of interest due on medium- and long-term principal accruing since May 1993 (about $160 million); (2) a buy-back at the same price as medium- and long-term principal; and (3) a bond covering past due interest at below-market rates. The latter bond has a 20-year term and is uncollateralized; it carries an interest rate that starts at 3.25 in year one and rises to 7 percent in year nine and thereafter. The amortization schedule on these bonds provides for eight years grace followed by back-loaded semiannual payments. Starting in March 1994, partial interest payments on medium- and long-term principal were increased to 30 percent of interest due. The final agreement did not include a rebalancing clause, except for the limit of 5 percent of eligible principal on the new money option and an undetermined maximum on the buy-back in the event that insufficient financing was available. There was no currency option or value recovery clause. Implementation of a debt-conversion program is expected. The cost of the operation was $2.1 billion, financed with resources from the Fund, the World Bank, the new money option, and Poland’s own contribution.
Ecuador reached an agreement in principle with its bank advisory committee on May 2, 1994, to restructure debt amounting to $7.4 billion. A termsheet was circulated to banks on June 14, 1994. The menu of options for eligible principal, amounting to $4.5 billion, includes (1) a 45 percent discount exchange; and (2) a par exchange at a submarket interest rate. The discount bond has a 30-year term with a bullet repayment; it bears a market interest rate of
Interest arrears on Ecuador’s bank debt is estimated at $2.9 billion. Implicitly, this estimate involves some debt forgiveness, because past due interest is calculated from the end of October 1986 to the end of December 1993 at three-month LIBOR plus
Sao Tome and Principe concluded a comprehensive buy-back of commercial bank debt covering $10.1 million of claims (about 87 percent of eligible debt) at 10 cents on the dollar in August 1994. The $1.0 million cost of the buy-back was entirely financed by the Debt Reduction Facility for IDA countries.
Zambia completed a comprehensive buy-back at 11 cents per dollar of principal and past due interest in two transactions, the first on July 26, and the second on September 14, 1994. Eligible principal covered amounted to about $200 million (about 79 percent of eligible debt) and included commercial bank debt, as well as trade and supplier credits. The cost of the operation thus far has been roughly $25 million, financed by a $13 million grant from the debt reduction facility for IDA countries and grants from Germany, the Netherlands, Sweden, and Switzerland. Further buy-backs could take place by the end of 1994, which is the expiry date for Zambia’s grant facility to finance the operation. An innovation in this buy-back operation is that, due to initially low levels of creditor participation, the operation has taken place in several tranches, instead of the usual single transaction.
South Africa agreed on a fourth and final rescheduling arrangement with its commercial banks at the end of September 1993. The arrangement, which became effective at the beginning of 1994, rescheduled those debts (some $5 billion) that were still subject to the “standstill” on repayments imposed in 1985. The arrangement involved a cash payment of 10 percent of outstanding debt, with the remainder being rescheduled for eight years on a graduated schedule. Interest margins were to be negotiated between South African debtors and foreign creditors, with margins in excess of 2.5 percent over the relevant base rate requiring approval by the authorities under exchange control arrangements.
A rescheduling agreement between Gabon and its commercial bank creditors was signed on May 26, 1994 and became effective on July 1, 1994. The agreement covers the principal on debts contracted before September 1986 (which amounts to $100 million). These debts are rescheduled for ten years with 2½ years of grace. Interest arrears accumulated since 1986 (estimated at $50 million) were also rescheduled but at shorter maturities. This operation covered most of the country’s commercial bank debt.
On July 30, 1993, a preliminary rescheduling agreement was reached between Russia and its bank creditors. This agreement rescheduled the entire stock of pre-cutoff date debt with a ten-year maturity and a five-year grace period. Russia agreed to pay $500 million toward interest accrued but unpaid through the end of 1993. Remaining interest arrears were expected to be rescheduled on the same terms as pre-cutoff date principal. In the event, Russia did not make payments on interest, and the agreement did not come into effect. Major stumbling blocks included the Russian authorities’ refusal to waive sovereign immunity and questions regarding which official Russian agency should sign the agreement. These issues were finally resolved in October 1994, and the agreement was scheduled to come into effect by the end of 1994, following Russian payment of $500 million on past due interest in 1993, as was previously agreed.
After reaching a peak in 1990, debt conversions fell over the last three years. In 1993, debt conversions were at their lowest level since the outbreak of the debt crisis over a decade ago (Table 4). High debt prices in the secondary market, regularization of relations with commercial bank creditors, and advances already made in most privatization programs were responsible for declining conversion activity.
Argentina, which accounted for two thirds of conversion activity in 1992, shifted its privatization program to encourage exchanges involving foreign currency denominated domestic debt. With buoyant equity markets worldwide, Argentina also elected to privatize part of the state oil company, Yacimientos Petroliferos Fiscales (YPF), through an international share placement, rather than by means of conversions made with commercial bank debt. Despite these developments, Argentina still accounted for about one fourth of total bank debt conversions in 1993. While involving only small amounts, debt conversions more than doubled in Brazil during 1993, reflecting some pickup in interest by foreign investors in the country’s privatization program. Debt conversion activity in Chile fell by one fourth during 1993, with the high price of commercial bank debt in the secondary market continuing to curtail demand for debt conversions under the formal mechanisms. All conversion activity took place through “informal” schemes, under which residents retire their debt to the Central Bank by delivery of Chilean debt acquired in the secondary market.
Among other countries, conversions in the Philippines declined by about 15 percent as investors’ interest dropped and debt prices edged up. Activity was negligible in Mexico and Nigeria owing to the suspension of conversion programs. In Venezuela, political and financial uncertainties were factors behind a further reduction in conversion activity in 1993.
Secondary Market Developments
After remaining stable in the first quarter of 1993, secondary market prices for bank claims and Brady bonds rose sharply later in the year and into early 1994 (Chart 3). The weighted average of prices for claims on 15 heavily indebted countries peaked in January 1994 at about 70 cents on the dollar (compared with 51 cents in December 1992), its highest level in the last seven years. The strength in secondary market prices reflected improving economic situations in major developing countries and greater investor interest in emerging market securities. Subsequently, prices fell sharply in response to higher interest rates in the United States and market reactions to adverse economic and political developments in some major countries. Moreover, during the 1993 run-up in prices, some investor groups built up some highly leveraged positions; their subsequent need to unwind these positions added to the drop in debt prices during the first half of the year. By the end of June 1994, the weighted average price for the 15 countries had fallen to 58 cents on the dollar.
Chart 3.Secondary Market Prices of Bank Claims on Selected Countries
Sources: Salomon Brothers; and ANZ Grindlays Bank.
The stripped price of Argentina’s restructured bank claims rose by 82 percent in 1993, reaching about 80 cents on the dollar by the end of the year.9 Completion of the debt- and debt-service-reduction operation, good economic prospects, the privatization of the largest public enterprise (YPF), and Congressional approval of the social security reform accounted for the solid performance of Argentine debt prices. By the end of June 1994, the price of Argentine claims had declined in line with overall market developments to 62 cents on the dollar.
Following market trends, the price of claims on Brazil also performed well in 1993. Debt prices climbed by 62 percent in 1993, reaching about 50 cents on the dollar by the end of the year, despite political uncertainties and difficulties in completing the debt deal. By the end of June 1994, the price of Brazilian claims had fallen back to 41 cents on the dollar. In Mexico, while the stripped price of its claims did not change much over the first three quarters of 1993, prices jumped in the last quarter by about one third following the approval of the North American Free Trade Agreement. By year end, Mexican Brady bonds were trading at almost 90 cents on the dollar. Concerns resulting from an uprising in Chiapas and the assassination of the leading presidential candidate, together with the tightening of monetary policy in the United States, led by June 1994 to a decline in the stripped price of Mexican bonds to 73 cents. The stripped prices on Venezuela’s debt increased by about one fourth to reach about 69 cents on the dollar at the end of 1993, despite political uncertainties. Concerns about the health of the banking system in the wake of the failure of a major bank and more generally about the country’s economy, contributed to a sharp decline in Venezuelan claims in the first half of 1994. By June, they had fallen to 42 cents on the dollar.
In 1993 and early 1994, considerable price speculation accompanied reports that various countries were making progress in their discussions with commercial banks on restructuring agreements. In the case of Ecuador, the price of its debt (including past due interest) increased by 84 percent in 1993 to reach a level of about 53 cents on the dollar at the end of the year. For Peru, expectations of a debt-conversion program linked to privatization ran prices up sharply; the price of Peruvian claims (including past due interest) rose by about 250 percent in 1993 and closed the year at 69 cents on the dollar. In both cases, prices slid in the first half of 1994, falling to 40 cents and 48 cents, respectively, by the end of June.
Price developments on Eastern European countries’ debt resembled the behavior of debt prices for other indebted countries. Prices of claims on Eastern European countries increased by about 150 percent to reach almost 50 cents on the dollar by the end of 1993, before declining by one third in the first half of 1994. The announcement of Bulgaria’s agreement in principle with commercial banks in November 1993 produced a 50 percent increase in the price of its claims to about 44 cents on the dollar; it fell to 33 cents by the end of June 1994. Expectations of a bank debt agreement for Poland contributed to a rise in the price of Polish debt, which peaked at 51 cents on the dollar in January 1994. It then dropped in line with the general fall in debt prices; the decline accelerated following the announcement of the restructuring agreement in March 1994. After falling to 32 cents, it recovered to 35 cents by the end of June.
There were indications of significant growth in the volume of debt instruments trading in the secondary market during 1993. These instruments continue to be relatively liquid, as reflected in relatively tight bid-ask spreads. Market analysts estimate that trading volume reached nearly $2 trillion in 1993.10 For short periods of time during the turbulence in bond markets during the first half of 1994, however, trading was reported to have slowed appreciably, with bid-ask spreads widening and dealers at times being reluctant to quote prices.
A further 10 percent of the stock of commercial bank debt outstanding in 1989 has been extinguished through debt conversions and other mechanisms. Of the remaining debt that has not been restructured, Peru and Panama account for more than 20 percent, and four low-income countries (Cameroon, Congo, Côte d’lvoire, and Nicaragua) account for another 17 percent.
In the end, one major creditor, a large nonbank investor holding roughly $1.4 billion of Brazil’s debt, refused to participate in the deal. That creditor subsequently filed a law suit in the United States to force payment of past due interest on Brazil’s original debt and to accelerate payments of principal arrears.
These phase-in and partly collateralized bonds apply only to the par and discount bond options. The FLIRBs were fully collateralized at closing, and the other options did not require collateral.
Original contractual interest rates on Ecuador’s debt were generally higher, with some loans priced at LIBOR plus 2 ¼.
The stripped price is a measure of country risk. It is the ratio of the market value of unguaranteed payments to the present value of such payments discounted at a risk-free interest rate.
The Emerging Markets Traders Association (EMTA) estimated volume at $733.7 billion in 1992. EMTA is planning to implement a computerized trade-clearing system to verify bond and loan trades. The system is expected to be in place by January 1995 and will provide uniform pricing as well as daily volume information, thus reducing transaction costs, contentious trade disputes, and the possibility of error arising from manual processing.