VI Bank Debt Restructurings and Secondary Market Developments

International Monetary Fund
Published Date:
January 1991
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Previous reports in this series have documented the shift in financing arrangements for countries with debt-servicing difficulties that took place during the last few years. This involved a move away from more traditional financing packages—primarily involving reschedulings of principal and, in some cases, concerted new lending—and toward more innovative financing instruments (e.g., debt-equity conversions, cash buy-backs, collateralized debt exchanges, and securitization) aimed at reconciling the diverse interests of debtors and creditors within a market-based framework. This trend has been associated with the emergence of an active secondary market for claims on developing countries. During the period under review, continuing efforts to strengthen the debt strategy through debt and debt-service reduction operations supported by the Fund, the World Bank and other official creditors has built upon and reinforced such market-based techniques, in conjunction with more traditional options. This section discusses recent developments in these areas, covering recent bank debt restructurings, developments in debt conversion schemes, and in the secondary market for claims on developing countries.

Bank Debt Restructurings

There were relatively few rescheduling agreements in 1989, in part because of uncertainty over changes in the debt strategy, including the elaboration of new proposals for commercial debt and debt-service reduction with support from official creditors (Table 14). Moreover, for a prolonged period in 1989, creditors and debtors preferred to await the conclusion of discussions between Mexico and its creditor banks. Smaller debtors, in particular, were generally unable to make progress in their negotiations with banks in view of the latter’s hesitancy to agree to what could constitute precedent-setting terms. Preliminary agreement on the Mexican commercial bank package in July 1989, which incorporated innovative debt and debt-service reduction elements, was followed by similar understandings for the Philippines and Costa Rica, in August 1989 and November 1989, respectively. In addition, Nigeria and Trinidad and Tobago completed bank rescheduling agreements in 1989, after having reached agreements in principle with bank creditors in 1988. In 1989, agreements in principle or tentative agreements with bank advisory committees on reschedulings were reached in the cases of Honduras, Jordan, Poland, and Zaïre, the latter two cases representing deferments. The amount of medium- and long-term bank debt restructured in 1989 amounted to $51.5 billion, of which over 90 percent was accounted for by the financing agreement between Mexico and its creditor banks (Table A30).

Table 14.Chronology of Bank Debt Restructurings and Bank Financial Packages, 1984-March 1991
Agreement classified by month of signature1
Brazil: January2
Chile: January, June, and November
Sierra Leone: January
Guyana: January, July (deferment)
Nicaragua: February (deferment)
Peru: February3
Senegal: February
Niger: March
Mexico: April (new financing only)
Sudan: April (modification of 1981 agreement)
Yugoslavia: May
Jamaica: June
Zaïre: June (deferment)
Poland: July2
Madagascar: October
Liberia: December3
Zambia: December3
Côte d’Ivoire: March2
Mexico: March, August
Costa Rica: May2
Senegal: May
Philippines: May2
Zaire: May (deferment)
Guyana: July (deferment)
Argentina: August2
Jamaica: September
Panama: October2
Sudan: October (modification of 1981 agreement)
Chile: November2
Colombia: December4
Ecuador: December2
Madagascar: December (modification of 1984 agreement)
Yugoslavia: December
Dominican Republic: February
Morocco: February
Venezuela: February
South Africa: March (standstill)
Niger: April
Zaïre: May (deferment)
Brazil: July
Uruguay: July
Poland: September2
Romania: September
Congo: October2, 3
Côte d’Ivoire: December
South Africa: March
Mexico: March (public sector debt)2 August (private sector debt)
Jamaica: May
Mozambique: May3
Zaïre: May (deferment)
Chile: June
Honduras: June3
Madagascar: June (modification of 1985 agreement)
Argentina: August2
Morocco: September
Romania: September (modification of 1986 agreement)
Bolivia: November (amendment to 1981 agreement)
Ecuador: November (modification of 1985 agreement)2, 3
Nigeria: November2, 3
Venezuela: November
Gabon: December5
Philippines: December
Gambia, The: February
Chile: August (amendment to 1987 agreement)3
Uruguay: March (modification of 1986 agreement)
Côte d’Ivoire: April2, 3
Guinea: April
Togo: May
Poland: July
Yugoslavia: September2
Malawi: October
Brazil: November2
Nigeria: April
Zaïre: June (Deferment)
Poland: June (Deferment)3
Honduras: August3
Jordan: September2, 3
Niger: October3
Poland: October (Deferment)3
Trinidad and Tobago: December
Philippines: February
Mexico: February2
Madagascar: April
Bulgaria: April (standstill)3
Costa Rica: May
Jamaica: June
Morocco: September
Senegal: September
Colombia: December4
Chile: December (amendments to previous agreements)
Venezuela: December
Niger: January
Uruguay: January
Nigeria: March3
Under negotiation
ArgentinaBrazilCameroonCôte d’IvoireGabonHondurasMozambiquePoland
Sources: Restructuring agreements.Note: “Restructuring” covers rescheduling and also certain refinancings of member countries.

Agreement either signed or reached in principle (if signature has not yet taken place); not all signed agreements have become effective.

The restructuring agreement includes new financing.

Agreed in principle or tentative agreement with banks’ Steering Committees.

Refinancing agreement.

A separate club deal for new financing was arranged at the same time.

Sources: Restructuring agreements.Note: “Restructuring” covers rescheduling and also certain refinancings of member countries.

Agreement either signed or reached in principle (if signature has not yet taken place); not all signed agreements have become effective.

The restructuring agreement includes new financing.

Agreed in principle or tentative agreement with banks’ Steering Committees.

Refinancing agreement.

A separate club deal for new financing was arranged at the same time.

Several countries concluded financing packages with their commercial bank creditors in 1990 and early 1991. These included debt and debt-service reduction packages with Costa Rica, Mexico, Niger, Nigeria, the Philippines, Uruguay, and Venezuela (Tables 15 and A31). Other agreements included a rescheduling for Jamaica and Madagascar, a two-stage restructuring agreement with Morocco, a rescheduling agreement that included waivers for debt-reduction operations with Senegal, amendments to previous rescheduling terms for Chile (with agreement also on new commercial bank loans), and an agreement with Colombia to refinance bank debt amortization payments falling due during 1991–94. (These agreements are discussed in detail below and terms are listed in Tables A32-A34.) The total of medium- and long-term bank debt restructured during 1990 amounted to $26.7 billion. In addition to the above agreements, in September and November 1990, Argentina obtained specific waivers from commercial bank creditors to permit purchasers of the telephone company (Entel) and of the national airline (Aerolíneas Argentinas) to tender certificates of foreign debt for part of the purchase price. Early in 1991 a number of other countries were at various stages in discussing a restructuring of their debt to commercial banks, including Argentina, Bolivia, Brazil, Bulgaria, Cameroon, Congo, Côte d’Ivoire, Ecuador, Gabon, Guyana, Honduras, Jordan, Mozambique, Paraguay, Poland, and Togo. In most of these cases, debtors have requested that restructuring options include debt and debt-service reduction instruments.

Table 15.Impact of Debt and Debt-Service Reduction Packages(in billions of U.S. dollars)
Public Sector Bank Debt Before Debt OperationsEligible Bank Debt Before Debt OperationsEligible Bank Debt Extinguished by Principal Reduction OperationsDebt Subject to Lower Interest RatesEffective Reduction in Gross Bank DebtDebt Incurred for EnhancementsUse of Own Reserves for EnhancementsNet Effective Reduction in Total Debt1New Money
Face ValueDebt reduction equivalent
Source: Fund staff estimates based on information provided by the authorities.

Includes use of own-resources for debt enhancements but excludes impact of collaterals and new money facilities from commercial banks.

Obtained through grants from the IDA Debt Facility and bilateral donors.

To be replenished through new borrowings.

Source: Fund staff estimates based on information provided by the authorities.

Includes use of own-resources for debt enhancements but excludes impact of collaterals and new money facilities from commercial banks.

Obtained through grants from the IDA Debt Facility and bilateral donors.

To be replenished through new borrowings.

Recent Financing Packages

Mexico formally initiated negotiations on a multiyear bank financing package in April 1989; preliminary agreement was reached with the bank advisory committee in July 1989 and the term sheet was issued in September.104 The package was completed in February 1990 and participating banks allocated 9.2 percent of claims to the new money option, 42.9 percent to the discount bond exchange, and 47.9 percent to the par bond exchange. As a result, bank debt amounting to $7 billion was extinguished outright, while claims of $23 billion were subject to a below market rate of interest of 6.25 percent. This implied a total reduction in the present value of bank claims on Mexico of about $15 billion (about 30 percent of bank debt and 15 percent of total debt). In cash flow terms, the agreement provided for annual debt-service savings equivalent to 0.5 percent of GDP, backdated to July 1, 1989. New money commitments for the period ending in 1992 amounted to $1.1 billion. The cost of the principal and interest guarantees on the new bonds amounted to $7 billion, which was covered by financing received from the World Bank, the International Monetary Fund, and bilateral sources, as well as own reserves.

The Philippines’ bank financing package was agreed in outline in August 1989, and the term sheet was circulated in October 1989. Banks were invited to participate by providing new money in securitized form or to exit through a cash buy-back at a market-related price. The package also provided for waivers to allow for second round debt and debt-service reduction operations, a rescheduling of previous new money disbursements, and a statement of intent by the Philippine authorities to revive the debt-equity conversion scheme. In January 1990, the Philippines completed a buy-back of $1.3 billion of claims (about 20 percent of the eligible stock of bank debt and 5 percent of total debt) at a price of 50 cents per dollar of face value, close to the prevailing secondary market price. This was financed through resources obtained from the World Bank, the International Monetary Fund, and bilateral sources, and from own reserves. The operation provided for a net reduction of external interest payments of about $80 million a year over 1990–92, equivalent to about 0.2 percent of GDP. The other components of the package were signed in February 1990, including new money of $715 million and the rescheduling of about $200 million a year of principal falling due. Discussions on a financing package for 1991–92, which could include debt and debt-service reduction operations, are continuing.

In November 1989, after a lengthy period of negotiation, Costa Rica reached agreement in principle with its bank advisory committee on a package including debt and debt-service reduction and the regularization of arrears, without a new money component. The package was signed in May 1990. In contrast to the cases of Mexico and the Philippines, Costa Rica had made only partial interest payments to banks during the period of negotiation. Banks allocated 62 percent of claims to a buy-back option, while remaining debt was divided evenly between two bond exchanges. As a result, claims of about $1 billion were eliminated outright through the buy-back and cash downpayment on past due interest, while the reduction in interest rates on the bonds was equivalent to additional debt reduction of about $160 million. This implied a total reduction in the present value of bank claims of about 70 percent. These operations required funding of $226 million, which was obtained from bilateral official sources and own reserves.

On June 25, 1990, Venezuela reached agreement with its bank advisory committee on a term sheet including a menu of five options. Four of the five options involve debt or debt-service reduction by means of exchanging eligible debt: (i) through a “buy-back” involving three-month, fully collateralized notes with present value equal to 45 percent of the eligible debt; (ii) at a ratio of 1:0.7 for new bonds with a fully collateralized 30-year bullet maturity, and with a 14-month rolling interest guarantee for the life of the bonds; (iii) at par for new bonds carrying a below market, fixed interest rate of 6.75 percent, with a 30-year bullet maturity, full principal guarantee, and 14-month interest collateral; and (iv) at par for new bonds carrying a temporary, front-loaded reduction in the interest rate, 17-year maturity (including 7 years’ grace), and a 12-month rolling interest guarantee for the first five years. The fifth option involves new money in the form of a 20 percent increase in exposure via the purchase of new money bonds (15-year maturity, including 5 years’ grace), which entitle banks to exchange simultaneously at par eligible debt for noncollateralized “debt conversion bonds” (17-year maturity, including 7 years’ grace) in an amount equal to five times their new money commitment; a portion of the new money bonds entail rights to conversion into equity at par. At least 40 percent of the new money bonds are to be issued by the Central Bank of Venezuela at LIBOR plus ⅞ of 1 percent; the remaining new money bonds would be issued by the Government at LIBOR plus 1 percent. Par and discount bonds feature a value recovery mechanism that takes the form of fully detachable and negotiable oil warrants that give the holder the right to receive increased payments in the event that Venezuela’s oil export price exceeds $26 a barrel on April 15, 1996, or the same price adjusted for inflation thereafter. The agreement elicited virtually 100 percent participation from creditor banks, whose choices resulted in the following allocation of eligible bank exposure ($19.8 billion): 38 percent to the reduced interest par bonds; 31 percent to the new money bonds; 15 percent to the front-loaded interest reduction par bonds; 9 percent to the floating rate discount bonds; and 7 percent to the buy-back option. The buy-back operation (through the exchange of eligible debt for fully collateralized, three-month notes) was implemented on October 18, and final signing took place on December 5, 1990. The package provides an average of about $380 million in net interest savings a year over the period 1991–95, and $1,212 million of new money. The cost of financing the package was $2.6 billion.

The authorities of Chile and the bank advisory committee completed a term sheet on October 5, 1990 that amended previous rescheduling agreements. Although pricing arrangements remained unchanged, the amendment extended the amortization schedules for previously restructured debt and for the 1983–85 new money loans, and also provided for an extension of the retiming periods during which annual interest periods will be maintained, for more flexible provisions enabling Chile to engage in market-based buy-backs and debt exchanges over the next three years, for modifications to allow any amendment or waiver currently requiring approval by 100 percent of the banks instead to require approval by banks having at least 95 percent of the unpaid principal amount under each agreement, and, finally, for an extension of the existing short-term trade-related debt facility through December 31, 1991. The agreement was finalized on December 12, 1990 and covers total maturities of $1.8 billion. In addition, the authorities successfully placed, with a group of twenty banks, $320 million in bonds that was not tied pro rata to existing banks’ exposure.

On November 5, 1990, the authorities of Uruguay and the bank advisory committee agreed on a term sheet for a financing package that includes three main options: a buy-back, a par bond exchange, and new money. Total eligible debt amounts to $1,604 million, or 100 percent of medium- and long-term maturities. The buy-back price was set by Uruguay at 56 cents per dollar of face value. Debt exchanged at par for new bonds carries a fixed interest rate of 6.75 percent, with a fully collateralized 30-year bullet maturity and an 18-month rolling interest guarantee for the life of the bond. The new money option involves a 20 percent increase in exposure via the purchase of new bonds (15-year maturity, including 7 years’ grace, at LIBOR plus 1 percent), which would entitle banks to exchange simultaneously at par eligible debt amounting to up to five times the amount of new money for noncollateralized “debt conversion notes.” Purchasers of fixed rate notes will be entitled to a value recovery clause allowing for larger payments in the event of the favorable performance of an index of Uruguay’s terms of trade, to be calculated on the basis of developments in the export prices of beef, rice, and wool and the import price of oil. Banks which committed to the deal by December 7, 1990 received an early participation fee of ⅛ of 1 percent of their Uruguayan exposure. Available information on the choices submitted by banks indicate the following allocation of exposure: 39 percent to buy-back, 33 percent to the par exchange, and 28 percent to the new money option. The agreement was finalized on January 31, 1991 and the exchanges took place on February 19, 1991. The cost of financing the package is estimated at $461 million. In addition to providing $89 million of new money, implementation of the package is expected to lead to a net reduction of interest payments of about $30 million a year over 1991–95, equivalent to about 0.3 percent of GDP or 1.3 percent of exports of goods and nonfactor services.

On December 1, 1990, Colombia and the steering committee of its commercial bank creditors reached agreement in principle on a new refinancing package. The preliminary agreement consists of a syndicated loan for $1,775 million to refinance about 93 percent of principal payments falling due to banks during 1991-94. The package would include two facilities: a basic loan and two series of floating rate notes. The basic loan (“integrated loan facility”), which would amount to $1,575 million, would have a 12½-year maturity and a spread of 1 percentage point over the 6-month LIBOR. Disbursements would take place semi-annually and would be front-loaded to correspond to the present amortization schedule. In addition, there is an early participation fee of ½ of 1 percentage point. The floating rate notes would bear an interest rate of 1½ percent over the 6-month LIBOR, with a 5-year repayment period and 2 years’ grace. The first series, amounting to $100 million, would be issued in 1991-92, while the second series, for a similar amount, would be issued in 1993-94. By the early participation deadline of January 17, 1991, 95 banks had confirmed their participation, accounting for 97 percent of the total package.

After reaching an agreement in principle in October 1989, Madagascar and its bank creditors signed a final agreement in April 1990. Under the agreement all principal falling due on December 15, 1989, and half the principal falling due in 1990-93 (totaling about $21 million) have been rescheduled with a 9-year maturity period, including 3½ years’ grace. The agreement also allows for debt buy-backs, subject to the restriction that buy-backs of more than $5 million a year of debt (face value) must be undertaken with concessional funds provided specifically for that purpose. Two months later, in June 1990, a rescheduling agreement was signed between Jamaica and its bank creditors. It covers some $330 million of claims, which are rescheduled for periods up to 14½ years, and provides for a reduction in the spread from 1¼ percent over LIBOR to 13/16 of 1 percent, while allowing for buy-backs of up to $35 million annually. On September 28, 1990, Senegal and its commercial bank creditors concluded an agreement to reschedule maturities for an amount of $37 million, comprising most of the country’s commercial bank debt and to provide flexibility for future buy-back operations and debt-equity conversions.

On January 14, 1991, Niger and its commercial bank creditors reached a preliminary agreement on a debt and debt-service reduction package, which would be the first to involve official funding from the Debt Reduction Facility of the International Development Agency (IDA). The agreed package covers approximately $110 million of bank debt under two options, the first involving the exchange of claims for 60-day notes with a face value equivalent to 18 percent of the outstanding principal amount of the debt, the second involving the exchange of claims at par for 21-year, non-interest-bearing notes. The principal on these notes is to be guaranteed by zero-coupon bonds purchased by the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO), with their net present value estimated at around 18 cents to the dollar. The operation has been structured to involve a novation, that is, the substitution of a new contract, debt or obligation for an existing one, between the same or different parties, in order to avoid the invocation of sharing clauses by nonaccepting banks. The package is to be financed by grants from the IDA facility, France, and Switzerland. To simplify processing the offer, the two options will be mutually exclusive; that is, banks will not be able to split their claims between the short- and long-term note exchange.

Finally, on March 2, 1991, Nigeria and the steering committee of its commercial bank creditors agreed in principle on a financing package including three options: a buy-back, a par exchange for registered bonds, and new money. Total eligible debt amounts to $5.8 billion. Debt exchanged at par for the new registered bonds would carry a fixed interest rate of 6.25 percent with a fully collateralized 30-year bullet maturity and a 12-month interest guarantee. The new money option involves the exchange of existing debt for registered bonds and the provision by banks of new loans equivalent to 10 percent of the amount of exchanged debt. The agreement also provides for the payment of some $300 million in arrears accumulated since March 1990.

Debt Conversion Programs

The amount of debt extinguished through official ongoing debt conversion programs rose to an estimated $10.3 billion in 1990 (Table 16), largely reflecting the privatization of two state-owned enterprises in Argentina. The $3.1 billion increase compared with 1989 brought the total volume of debt conversions past the previous peak of $8.3 billion reached in 1988. In a number of countries, the pace of debt conversions had slowed in recent years as conversion programs were curtailed in the face of concerns about the domestic liquidity implications of such operations, the additionality of associated investment, and pricing (Table A35). Conversion activity has revived recently, however, and may be expected to continue to be strong for several countries in the period ahead, reflecting new commitments under bank financing packages and accelerated efforts to attract foreign investment.

Table 16.Debt Conversions, 1985-901(In millions of U.S. dollars)
Costa Rica7894412417
Sources: Central Bank of Argentina; Central Bank of Brazil; Central Bank of Chile; Mexico, Ministry of Finance; Central Bank of Philippines; Bank of Jamaica; Central Bank of Venezuela; and Fund staff estimates.

Face value of debt converted under official ongoing schemes. Figures do not include large-scale one-off cash buy-backs and debt exchanges.

As of June 30, 1990.

As of September 30, 1990.

Does not include an estimated $6-8 billion related to prepayment at a discount of private sector debt since August 1987 signing of an agreement to restructure FICORCA debt.

Includes partial data for some countries.

Sources: Central Bank of Argentina; Central Bank of Brazil; Central Bank of Chile; Mexico, Ministry of Finance; Central Bank of Philippines; Bank of Jamaica; Central Bank of Venezuela; and Fund staff estimates.

Face value of debt converted under official ongoing schemes. Figures do not include large-scale one-off cash buy-backs and debt exchanges.

As of June 30, 1990.

As of September 30, 1990.

Does not include an estimated $6-8 billion related to prepayment at a discount of private sector debt since August 1987 signing of an agreement to restructure FICORCA debt.

Includes partial data for some countries.

The Government of Argentina has sharply stepped up the pace of debt-equity conversions as it seeks to privatize and recapitalize the country’s state-owned enterprises. Initial efforts focused on the sale of the telephone company, Entel, and the state airline, Aerolíneas Argentinas, the fourth and fifth largest state-owned enterprises. Entel, which was auctioned as two separate entities (Telnor to operate in the northern part of the country and Telsur to operate in the south), was sold to two consortiums for a total of $214 million in cash and $5.03 billion in Argentine foreign debt certificates. In addition, the purchasers committed some $5 billion in capital improvements over the next ten years. Aerolíneas Argentinas was sold for $260 million in capital, half up-front and the remainder over five years, $2 billion in debt and a commitment to $700 million in capital improvements over a seven-year period. In both cases, finalization of the sale was dependent on obtaining necessary waivers from commercial banks. In the case of the Telnor purchase, delays in assembling commited debt instruments resulted in the original consortium losing its acquisition rights. The rights were awarded to a third consortium on the same terms as the previously accepted offer. The privatization effort was expanded in October 1990 with the passage of a decree establishing a framework for the sale of a number of other companies, as well as for granting concessions in the operation of the national electricity and gas companies. In response to these initiatives, the formation of the Argentine Private Development Trust was announced in April 1990. The fund manages $1.2 billion in Argentine debt claims, which are to be converted into shares of privatized Argentine companies. Participating banks, which include Argentine, Asian, European, and U.S. banks, subscribe to the fund by contributing Argentine claims.

Mexico, which suspended its debt-equity conversion program in 1987, announced regulations for a new debt-equity system in March 1990. Under the 1990 financing package with commercial banks, the Mexican authorities committed to introduce a new program that would allow for the conversion of $3.5 billion of existing bank claims (original face value). Auctions were held in July and October 1990. In the first auction, 27 of 359 offers were accepted for $1 billion of claims. The lowest successful bid, which determined the auction price for all successful bidders, was for a discount of 52 percent. In the second auction the authorities exercised their right to increase the offered amount of conversion rights beyond the initially-specified $1.5 billion in view of the attractiveness of the offers. As a result, an additional $1 billion of debt was accepted, bringing the total in the two exchanges to $3.5 billion and establishing a discount of 52 percent. The book value of the reduction in the debt stock would be $2.6 billion against which $1.7 billion of swap rights would be issued. Successful bidders were required to deposit claims equivalent to 5 percent of the rights acquired, with the remainder to be paid within 18 months. Under the regulations, eligible investments are to be limited to approved infrastructure projects and up to 50 percent of the cost of privatization purchases.

In 1989, Venezuela introduced a number of changes to its debt-equity program, including establishment of an auction-based mechanism to replace the administered pricing and allocation mechanisms of the previous program. Auctions were initially held on a monthly basis with an annual ceiling on conversions. Successful bidders, having placed a 5 percent deposit at the outset of the process, received a nontransferable, nonnegotiable right, valid for 60 days, to effect a conversion of the tendered bid at the bid discount. In the second half of 1990, the authorities progressively moved to emphasize debt-equity conversions involving large investment projects in selected sectors (particularly petrochemicals and aluminum) at administratively determined discounts. In November and December 1990, a series of decrees were issued establishing norms applicable to large projects.105 Following completion of the bank-debt restructuring agreement at the end of 1990, the pace of debt conversions, which had fallen off sharply, was expected to pick up once again. As of February 1991, the authorities had already approved nine investment projects in the petrochemical sector, involving a total investment of $2.6 billion, of which $0.6 billion was to be financed through debt-equity swaps. Under the terms of the restructuring agreement, Venezuela is committed to maintaining a program of debt conversions of at least $600 million (discounted value) a year during 1991-93.

The debt converted by the Philippines in 1990 was largely associated with privatization operations under debt-for-asset schemes. In line with announcements made at the time of the 1989 bank debt restructuring agreement, the authorities introduced a new auction-based system for debt-equity conversions in December 1990. The new program specified that conversion rights for central bank debt with a face value of $300 million a year would be auctioned on a quarterly basis over a three-year period. The number of sectors eligible for investment under the scheme was reduced from nine to four: bank privatizations and export, energy, or agricultural ventures. The Philippines held its first auction of conversion rights under the new system on February 20, 1991; it was fully subscribed and discounts ranged from 50 percent to 55 percent.

The pace of conversions for Chile, accounting for the largest portion of commercial bank debt extinguished through official ongoing debt conversion operations, fell off sharply in 1990 as discounts became more limited and eligible debt stocks declined. Conversions under Chapter 18 of the country’s foreign exchange regulations, which the authorities began to limit during 1989 in response to concerns about domestic liquidity, recovered to around $0.6 billion in 1990, after having fallen by $0.5 billion to $0.4 billion in 1989.106 A substantial decline was observed in foreign investment related conversions under Chapter 19, down to $0.4 billion from $1.9 billion in 1989.

The bank restructuring agreements for a number of other countries also contained commitments to engage in debt-equity swaps. In Costa Rica, the Government committed to retire up to $20 million of debt a year over a five-year period. Uruguay committed to converting 30 percent of the new money bonds issued under its 1991 restructuring agreement into equity at par over the next three years. In late 1989, Nigeria expanded its debt conversion scheme to include restructured bank debt, in addition to restructured debt, in the form of promissory notes, owed to foreign suppliers; the scheme was suspended in October 1990, but reactivated in January 1991.

The resurgence of such debt-equity programs has been accompanied by increased interest in other forms of conversions, particularly debt-for-nature and debt-for-development swaps. These operations have tended to take the form of acquisition of debt, through purchases by charitable organizations at a discount on the secondary market, which are then converted into local currency instruments, often at par and generally at a discount less steep than that prevailing in the secondary market. In some instances, banks have donated debt to charitable groups. Such operations effectively involve two expenditure components for the host country’s public sector: a buy-back of debt intermediated by the charitable organization; and a contribution to a given project’s financing, which is commensurate with the differential between the discounts obtained by the charitable organization in the secondary market and that applied when the debt is converted into local currency. In addition, the project may entail future recurrent expenditures for the host country’s public sector. As detailed in previous reports in this series, such programs were established in Bolivia, Costa Rica, Ecuador, and the Philippines in 1987-89. A number of other countries have subsequently established similar programs. Several programs were launched or expanded during 1990. The Dominican Republic initiated a four-year program to convert up to $80 million into nature conservation funds in March 1990. In Argentina, a program was introduced under which up to $60 million in debt could be exchanged to finance local environmental groups. Ecuador set the maximum amount of debt conversions under similar schemes to $150 million, and the coverage of the program was widened to allow for local currency proceeds also to be used for agriculture and other social projects. Similar programs are underway or under consideration in a widening range of countries.

Developments in the Secondary Market for Claims on Developing Countries

The increased use of market-based debt-reduction operations has been facilitated by, and in turn contributed to, a marked growth in the importance of the secondary market for private claims on developing countries. In the period under review, available indicators suggest that the nominal value of debt traded in this market continued to grow, contributing to a narrowing of bid-offer spreads. After rising by around $20 billion to a level of around $60 billion in 1989, the volume of nominal claims exchanged on the secondary market is estimated to have reached around $70 billion in 1990. Most trading involved claims on larger debtors. In particular, the trading volume for claims on Mexico is reported to have risen substantially following the completion of its debt-restructuring agreement in early 1990.

The increasing volume of transactions has reportedly been accompanied by changes in the composition and financial strategies of market participants. Banks seeking to restructure their portfolios and investors acquiring debt claims for exchange under debt-equity conversion schemes continue to account for much of the market’s volume. Increasingly, however, nonbank institutional investors attracted by perceived high yields are purchasing claims for their own portfolios (Chart 14).107 Nonbank participants have reportedly shown more interest in securitized as opposed to syndicated debt. The restructuring of Mexico’s sovereign debt into collateral-backed par and discount bonds is viewed as having contributed to a significant increase in interest by nonbanks in developing country bond issues in general. While familiarity and proximity to the United States have been cited as special factors encouraging interest by nonbank investors in claims on Mexico, nonbank holdings of claims on Venezuela are also expected to increase following completion of its restructuring agreement in December 1990. Some of this demand is expected to derive directly or indirectly from Venezuelan insurance companies, which have been permitted to hold several of the newly issued debt instruments as part of their required reserves.

Chart 14.Yield on Selected Debt Instruments, 1987-First Quarter 1991

(In percent a year)

Sources: International Monetary Fund; Merrill Lynch; and Salomon Brothers.

1 Weighted average yield on medium- and long-term bank claims on the 15 heavily indebted countries.

2 Yields are calculated as if debts were structured as perpetuities, that is, the calculated yield is the contractural interest rate divided by the secondary market price. Price data are taken from Salomon Brothers.

3 Yield on restructured bank debt; after April 1990, the yield on the par and discount bonds after stripping off the principal and interest guarantees.

4 Yield on restructured bank debt.

5 Merrill Lynch index of high-yield (BB to CCC grade) U.S. corporate bonds.

6 Ten-year constant maturity.

The secondary market for developing country debt is centered mainly in New York and London and almost all of secondary market transactions are handled by about a dozen institutions; the four largest reportedly account for over 40 percent of the volume. Many of the trading firms are associated with U.S. money center banks that had large exposures to developing countries at the start of the debt crisis, although securities firms, and in one case a medium-sized European bank not heavily committed to developing country lending in 1982, also play important roles, especially in marketing claims to nonbank investors. Traders generally deal in both bonds and syndicated loans, and it is estimated that they currently hold between $250 million to $1 billion in claims on their books at any given time. In December 1990, the formation of the LDC Debt Traders Association Inc. was announced. The association seeks to improve the efficiency of the secondary market through adoption of standard documentation procedures.

Recent bank debt-restructuring exercises with a number of countries have contributed to a growing diversity of instruments now trading in the secondary market.108 Yields in the secondary market vary significantly between various types of claims on the same country, reflecting perceptions of payments priorities on different types of debt. Furthermore, in contrast to the conventional expectation that sovereign debt is less risky than corporate debt, and notwithstanding their partial collateralization, the Mexican par and discount bonds trade with higher yields than those currently observed for recent, shorter-maturity bond issues by Mexican corporations. On December 18, 1990, Moody’s Investors Service set the sovereign ceiling rating for Mexico at Ba2 while giving the par and discount bonds ratings of Ba3. Explaining the lower rating attached to the debt-reduction bonds, Moody’s cited their registered form, the high proportion held by banks, together with their links to previous debts to banks, and the fact that they account for a high percentage of total Mexican indebtedness. Subsequently Moody’s gave Ba2 ratings to three bond issues by a publicly owned Mexican corporation.

With the growing availability of time series data on secondary market prices, a body of literature is emerging studying the statistical properties of reported prices.109 These studies have highlighted a number of ways in which the price behavior of developing country debt appears to differ from markets for corporate debt. Plausible indicators of creditworthiness, such as lower levels of indebtedness in relation to output, higher per capita income, lower inflation, and a higher rate of growth, have been found to correlate in an expected manner with the relative discounts on claims on various developing countries. But some studies have suggested that discounts are not sensitive to unexpected changes in fundamentals; in particular, according to these studies, unanticipated movements in macro-economic conditions either in industrial countries or in developing countries do not appear to have strong explanatory powers. The maintenance and intensity of debt conversion programs and the degree to which a country services its obligations in a timely fashion have in most cases been found to correlate positively with both the relative ranking and the movements in prices for individual countries, although one recent study has reported evidence that the introduction of debt conversion schemes has lowered secondary market prices. Some analysts have argued that these latter variables may correlate with the market’s perceptions of a debtor’s willingness, as opposed to capacity (which might be more closely correlated with macroeconomic indicators), to service its debt. Most analysts have attributed a strong role to increased provisioning on the part of banks in 1987 in explaining the prolonged and sustained decline in prices in that year, although emphasis has varied between seeing increased provisioning as a reflection of the market’s perception of impaired value versus seeing provisioning itself as a cause.110

After declining sharply from mid-1988 to February 1989, the weighted average price on the secondary market for developing country debt began to recover in March 1989, coinciding with U.S. Treasury Secretary Brady’s announcement of proposals for official sector support for debt and debt-service reduction operations and with subsequent decisions by the World Bank and IMF to provide financial assistance for such operations. The upsurge in prices peaked in July 1989 after an agreement in principle was reached between Mexico and its commercial bank creditors. Prices eased later in the year in the wake of the announcements of increased provisioning by major U.S. and U.K. banks, the emergence of interest arrears on the part of Brazil, and uncertainty regarding the financing package for Mexico. After mid-1989, several borrowers that continued to enjoy market access encountered deeper discounts and widened spreads between bid and offer rates. Prices for restructuring countries generally rose in the first half of 1990 in response to the finalization of the debt and debt-service reduction packages for three important debtors, and the actual or intended resumption of debt-equity conversion programs in several debtor countries engaged in privatization programs. Recent aggregate movements in prices have been associated primarily with events in the Middle East, with prices falling sharply in August, reflecting the disposing of claims by a number of Middle Eastern, and, to a lesser extent, Japanese banks. After recovering by the end of the year, prices again fell sharply in mid-January as traders attempted to reduce their trading portfolios ahead of potential hostilities in the Middle East crisis and in anticipation of possible further distress sales by some banks. Those sales did not materialize, and prices rebounded strongly in February as trading portfolios were reconstituted. Overall, the weighted average secondary market price as of the beginning of March 1991, which stood at 38.9 cents (i.e., a discount of 61.1 percent of face value), was at its highest level since 1988.

Note: This section was prepared by John Clark, Juan Carlos Di Tata, Alessandro Leipold.


For details on the terms of the agreements with Mexico, the Philippines, and Costa Rica, see International Monetary Fund, International Capital Markets (1990), pp. 32-33.


Under the 1990 agreement, 50 percent of certain specified new money bonds may be converted into equity at par. Thus, up to $364 million of the $1.2 billion in new money commitments are eligible for debt conversion at par. The decrees also establish that a 15 percent minimum discount applicable to most larger projects would not be binding in the case of infrastructure projects, where it could be less and is left to the discretion of the President.


Chile’s debt conversion programs were introduced in 1985 and have undergone minor modifications since then. Official debt-equity conversions with remittance rights are covered by Chapter 19, which enables investors to convert debt into domestic currency to finance equity purchases. Other conversions without remittance rights are carried out under Chapter 18, which allows exchanges on the basis of repatriation of foreign assets of Chilean residents and the foreign exchange acquired on the parallel market. By collecting a fee related to the size of the discount on external debt and the spread between the parallel and official exchange markets, the authorities have been able to effectively retire public debt at a discount.


While the difference between yields on corporate “junk bonds” and U.S. Treasury borrowings (the yield spread) has nearly doubled since early 1989, reflecting, inter alia, reduced liquidity in the junk bond market following the bankruptcy of the market’s principal dealer (Drexel Burnham Lambert) and the closure of many savings and loans that had been active in the market, yields on developing country claims have on average declined somewhat over the period.


Among the types of instruments that have been introduced in the context of recent restructuring exercises are partially collateralized bonds, with collateral covering principal and interest obligations, temporary interest reduction bonds, and value recovery facilities. While the range of instruments continues to grow, the number of debt instruments in the market remains considerably smaller than that in existence at the time of the onset of the debt crisis. Analysts have credited the consolidation of debts through multiyear rescheduling agreements in a number of countries, which simplified pricing and documentation procedures, as a significant factor in promoting the early growth of the secondary market.


While announcements of increased provisioning have been cited as important causes of declining secondary market prices, they have generally tended to be associated with increases in the share prices of the banks making the announcements.

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