II Bank Debt Restructuring
- G. Kincaid, K. Dillon, Maxwell Watson, and Chanpen Puckahtikom
- Published Date:
- October 1985
No formal framework existed for conducting commercial bank debt negotiations when the serious problems of major debtor countries became evident during the course of 1982. Earlier bank debt restructurings were sporadic, involved relatively small amounts, and posed less serious difficulties for bank management and for the international financial system. The problems emerging in 1982 required procedures to restructure large volumes of debt due to hundreds of creditor banks, and to help resolve issues of burden sharing among private and official creditors. Moreover, both creditor banks and authorities in debtor countries needed a framework to facilitate the maintenance of short-term bank exposure during and after debt restructuring and to reach agreement where appropriate on commitments of new money.
The repeated need to resolve such problems resulted in further convergence in the framework and approach adopted by commercial banks. While there remain important variations in modalities, the major restructuring operations have included a number of common features.
An advisory group or steering committee of bankers has been established to assist liaison with all bank creditors, to discuss the coverage and terms of the restructuring and, where required, to coordinate the maintenance of short-term bank exposure and the provision of new financing. There have also generally been close links between the debtor country’s negotiation of a restructuring through the advisory committee and its discussion of a Fund-supported adjustment program. In this context, the Fund, at the request of the interested parties, has participated in meetings with bank creditor groups. Successful restructuring has demanded both intensive coordination among banks, governments, the Fund, and other multilateral agencies on the financial requirements associated with adjustment programs, and continuous liaison by the coordinating banks with all creditor banks to secure agreement on the restructuring packages. During these negotiations, bridging finance to debtor countries has been provided in various ways, including loans from commercial banks, interested governments, and the BIS.
Bank advisory committees established at the time of an initial restructuring have subsequently maintained liaison between the debtor country and the other creditor banks. This coordinated approach, as well as helping to prevent an even sharper reduction in net new lending by commercial banks, has allowed the banks to monitor policies pursued by the debtor country more closely. As a result, bank managements have gained greater experience in assessing countries’ economic and financial policies. The existence of this framework has also greatly facilitated subsequent rounds of restructuring.
In concluding these major negotiations, two aspects of the framework have proved especially important. The first has been the role played by bank advisory committees—and their regional coordinators—in ensuring broad financial support for the package from all banks with exposure to the debtor country. The second has been the continuing link between the commitment of the borrowing country to a viable economic program and the assurance of adequate financing.
Coverage and Amounts
The coverage of bank debt restructurings has reflected a number of factors. A first consideration was the need to achieve equitable burden sharing among banks, to prevent any uneven reduction in exposure that could undermine the cohesiveness of the creditor groups and aggravate a country’s debt-servicing problems. Consequently, bank advisory committees have tried to make the coverage of bank debt in restructuring agreements as broad as practical. At a minimum, all uncollateralized medium-term credits have normally been subject to formal rescheduling. Increases in exposure—both in terms of amounts and distribution among banks—have depended on banks’ exposure on a cutoff date agreed between the debtor and the advisory committee once the need for a restructuring has been formally recognized. The same cutoff date has been maintained for successive financial packages so as not to penalize subsequent spontaneous lending.
Burden sharing among bank and official creditors also has been a general concern. At times, agreements for bank debt restructurings have required certain official commitments to be made before the agreement has been finalized, while the Paris Club has made rescheduling contingent on countries securing comparable debt relief from other creditors. (Comparability of treatment between various creditor groups is discussed in greater detail in Section IV.)
For developing countries, a crucial consideration has been to minimize the damage to their prospects of regaining access to international capital markets. For that reason, interest payments falling due or in arrears have been excluded from reschedulings in almost all cases. Formal restructuring of trade credits and interbank deposits has also been avoided wherever feasible, on the grounds that a medium-term restructuring could severely damage a country’s future recourse to such instruments and also threaten the stability of those markets. However, the sheer size of these short-term credits has often made their maintenance essential to a viable adjustment program. Therefore, in a number of cases, access to trade credits has been protected by a “maintenance of exposure” facility, under which new trade credits are extended as the old are repaid. For the interbank market, agreements have also been reached that deposits be rolled over. Bonds and floating rate notes owned by nonbanks have not in general been rescheduled to protect countries’ prospects of future access to international bond markets.
In addition to restructuring debt owed or guaranteed by the debtor government, a number of debtor countries have encouraged the restructuring of nonguaranteed debt owed by their private sector in order to regularize the sector’s relations with creditors and to secure additional balance of payments relief. To facilitate these restructurings, and to soften the impact of sharp currency depreciations on the external debt-servicing costs of the private sector, a preferential exchange rate scheme has been instituted in connection with restructuring in several cases. In order to limit the budgetary cost of such schemes, some countries have introduced complex eligibility criteria, which have occasionally caused lengthy administrative delays and delayed restructuring of both private and public sector debt. In some cases, too, banks have pressed countries’ authorities to assume or mitigate the commercial risk of their loans to the private sector.
During 1983 and 1984 a total of 32 bank debt restructuring agreements (excluding 7 cases of deferment) were reached—at least in principle—by 26 countries. In addition, a number of cases for which the initial approach to banks was made in 1984 or early 1985 remain under negotiation. The amount of bank debt restructured in agreements signed or agreed to in principle, excluding short-term debt that was rolled over, is estimated at $34 billion in 1983 and $103 billion in 1984. The amount of short-term debt rolled over or converted into medium-term loans under arrangements concluded in the context of debt restructurings is estimated at $28 billion in 1983 and $36 billion in 1984 (Tables 16 and 17).
New Financing Agreements
Prior to 1982, spontaneous bank lending frequently resumed once countries had implemented firm adjustment measures and had regularized relations with creditor banks. When widespread payments difficulties emerged, however, countries engaging in debt restructurings and adjustment programs were unable to obtain spontaneous new financing. The potential relief provided by bank and official debt restructurings was insufficient to close the ex ante financing gap confronting a number of debtor countries. Although additional adjustment measures by countries could have been envisaged to close such financing gaps, there was serious concern about the consequences of more rapid adjustment. A need for additional financing therefore arose and with the encouragement of the Fund the concerted lending approach toward the provision of new money evolved.
Concerted bank lending had a number of advantages. It was multilateral and was based on a dialogue between creditor banks and debtor countries. The balance between adjustment and financing was tailored to the country’s circumstances and outlook. Furthermore, concerted lending appeared to minimize the damage to a country’s prospects of regaining more normal access to international capital markets. Other approaches, such as the limitation of interest payments, could have produced the same cash flow relief, but were viewed as substantially less compatible with a return to normal market access. Moreover, if debtor countries as a group had become unable to meet scheduled interest payments, the international banking system would have been jeopardized and future bank lending to developing countries severely limited.
The new money approach resulted in bank creditors making an analysis of a country’s prospective payments situation and linking new lending to appropriate adjustment policies. Thus, notwithstanding the difficulties in assembling new money packages, which reflected the different business interests of banks as well as their varying regulatory, tax and accounting environments, concerted lending was the common approach adopted by creditor banks.
In 1983–84, ten member countries reached agreements, or agreements in principle, with banks on concerted lending packages in the context of restructuring agreements (Table 15). Approval of a country’s economic adjustment program by the Fund was dependent on the prior commitment of a high proportion of this lending (which came to be known as the “critical mass”). In 1983 concerted lending commitments for eight countries amounted to $13.9 billion, or 40 percent of new external commitments to developing countries in that year (Table 18). In 1984, firm concerted lending commitments for three countries totalled $11.1 billion (approximately the same share of commitments as in 1983), while three other countries reached agreements in principle on concerted loans for a total amount of about $5.2 billion. In 1983–84, most of the increase in banks’ claims on developing countries that had recently restructured their debt consisted of concerted lending packages for seven countries in the Western Hemisphere, and for Yugoslavia.
Links with Adjustment Programs
To strengthen the ability of debtor countries to service both existing and new debt, banks have made almost all restructurings conditional on the approval of a Fund-supported adjustment program, and have linked their disbursements of concerted lending to purchases under Fund arrangements. Nonobservance of performance criteria under a Fund arrangement has delayed disbursements under new money packages until the country’s drawing rights under the Fund arrangement have been restored. While banks have sometimes formally halted debt restructuring when a country has been unable to make purchases under a Fund arrangement, they have nevertheless continued in practice to roll over amortization payments.
The magnitude of external financing to be provided by official and bank creditors and uncertainties regarding its availability have frequently required the Fund to seek formal assurances that the external financing assumptions of the program would be met, in order to ensure that the program would be fully financed and properly designed. In such cases, Fund-supported programs were only submitted to its Executive Board when adequate progress in assembling a critical mass of commitments gave a reasonable assurance that the financing assumptions of the program were realistic. At the request of the authorities of debtor countries, Fund staff have exchanged information and discussed the implications of alternative levels of financing with creditor banks. Where appropriate, the exchange of information has also included a description of the policy measures undertaken and the broad policies pursued under the Fund-supported programs.
Commercial banks have conducted debt negotiations on a country-by-country basis. The terms accorded to a particular country have reflected a variety of considerations, including the effectiveness of the country’s economic adjustment policies and the historical pattern of the relations between the country and its creditor banks. This latter factor makes it difficult to distinguish common features in the terms and conditions of debt restructurings across countries.9 Nonetheless, some basic elements may be identified.
Spreads have generally been higher and maturities shorter for the first debt restructuring of a country. During the initial stages of countries’ payments difficulties, the consolidation period was generally limited to about one year (in addition to restructuring arrears of principal). Restructurings focused attention on identifying, with the Fund’s assistance, the appropriate balance between adjustment and financing for the coming year. Due to considerable uncertainties about external developments and the adjustment that debtor countries would achieve, bank advisory committees generally did not establish medium-term plans for debt-service payments. A combination of one-year consolidation periods and medium-term maturities for reschedulings contributed to a bunching of countries’ amortization payments. For countries implementing adjustment policies successfully, banks have agreed to more favorable terms in subsequent restructurings-including finer spreads, lower fees, longer repayment and grace periods, and (most recently) longer consolidation periods.
The readiness of banks to extend more favorable terms to countries committed to adjustment programs is illustrated by the terms of the MYRAs with Mexico, Venezuela, and Ecuador. For these countries, banks have agreed to longer consolidation periods and maturities, to reduced spreads, and to no rescheduling fees. In the case of Mexico, maturities falling due in 1985–90 were rescheduled and the repayment period was lengthened from 8 years to 14 years from the date of the agreement in principle (September 1984). Margins were set at ⅞ percent over LIBOR for the period 1985–86, 1⅛ percent over LIBOR for 1987–91, and 1¼ percent for 1992–98. (LIBOR is the London Interbank Offered Rate.) These margins compare favorably with those agreed in previous restructurings. In the case of Venezuela, the period of final repayment for maturities due in 1983–88 was set at 12½ years from the date of agreement in principle (also September 1984), and the margin was set at 1⅛ percent over LIBOR. For Ecuador, maturities falling due in 1985–89 were agreed to be rescheduled on a serial basis, with final repayment in 1996. Banks have waived rescheduling fees in the case of these MYRAs. Thus, when banks have envisaged early progress toward normal payments relations with a country, the terms of restructuring have been fashioned to facilitate a return to normal creditor-debtor relationships.
More generally, recent agreements with countries that had previously undertaken debt restructurings and have adjustment programs show a narrowing of spreads, and a lengthening of grace periods and maturities, compared with earlier agreements. A number of recent agreements show spreads of 1¾ percent or less over LIBOR, considerably lower than was generally the case in the first year after widespread payments difficulties emerged in late 1982. Maturities for restructurings other than MYRAs have recently ranged up to ten years, compared with typical maturities in 1982–83 of up to eight years.
Where no improvement in economic performance has been apparent, or where the country has been unable to fulfill the terms of an existing restructuring agreement, banks on occasion have entered into de facto or informal deferment agreements that have been periodically renewed. For some countries that were experiencing extremely protracted payments difficulties, banks have also been prepared to stretch out repayment terms over a relatively long period. However, in such cases there has been no provision for new medium-term financing by banks, and banks have considered that there was little prospect of an early return by the countries to normal access to capital markets.
Developments in the terms of restructuring are reflected in statistics on outstanding bank claims. The maturity structure of the outstanding bank debt of many non-oil developing countries lengthened significantly in the first half of 1984, continuing the trend that started in 1983 (Table 19). The largest change was reported in the maturity structure of countries in the Western Hemisphere. In particular, the share of debt with maturities of one year or less in Mexico fell from 43 percent at the end of 1983 to 26 percent by end-1984. The trend toward lengthening maturities marks a significant departure from the tendency toward a general increase in the share of short-term debt, which had prevailed through mid-1982.
As regards concerted lending, recent data on maturities and spreads on new bank lending commitments confirm that the terms for concerted lending account for a significant part of the recent general improvement in the terms of lending to developing countries. Data compiled by the OECD on the maturity of new long-term bank credit commitments indicate that the average maturity of these commitments lengthened in 1984, reversing the previous trend (see Chart 1).10 The average maturity for all countries increased from seven years and three months in 1983 to seven years and eleven months in 1984 (Table 20). A substantial part of the recent improvement in maturity structure was accounted for by the longer maturities obtained on concerted loans, which amounted to 42 percent of new lending commitments to developing countries in 1984.11
Multiyear Bank Debt Restructuring
An important development in 1984 was the negotiation of MYRAs with Mexico, Venezuela, and Ecuador. As indicated earlier, these agreements were intended to facilitate a return by debtor countries to more normal relationships with creditors, that is, to move away from a concerted approach to new lending and to reestablish independent decision making by market participants. MYRAs were considered appropriate and feasible in these cases because the debtor countries had made significant progress in their domestic and external adjustment efforts and were seen as committed to policies that would constrain the need for net external financing with a view to regaining access to credit markets on a more spontaneous basis.
While these countries were viewed as having demonstrated an ability to return to more normal access to credit markets, the amortization profile on their existing debt was such that the refinancing of that debt appeared to require an annual rate of gross new commitments that normal market mechanisms could not reasonably be expected to handle. A key objective of these MYRAs was to remove this “hump” in future amortization payments, which would be an obstacle to normalizing debtor-creditor relationships. In such situations, MYRAs, by providing a clearer planning horizon for creditors and investors, as well as the debtor government, could facilitate the return to spontaneous financing. These considerations were laid out by the Managing Director of the Fund in a presentation to banks at the International Monetary Conference in Philadelphia on June 4, 1984.
As discussions of multiyear restructurings proceeded, banks sought economic monitoring procedures for the period when these countries would no longer be using Fund resources. Uncertainties about the possible evolution of domestic economic policies and the external environment led creditor banks to seek more timely and comprehensive information on countries’ economic developments and policy plans. Banks also sought to link restructuring to a continuing evaluation of countries’ economic developments and policies. In this connection, Mexico agreed with commercial banks that it would make more economic information directly available to creditor banks and also requested the Fund to enhance arrangements for the regular Article IV surveillance of its economy with a view to making copies of Fund staff consultation reports available to the banks. The desire of external creditors for more timely information and analysis has been facilitated by the implementation of procedures that may also improve the availability of economic information to domestic policymakers.
The arrangements requested by the Mexican authorities provide for the Fund to conduct Article IV consultations with the authorities twice a year. Annual consultation reports will review and appraise the adequacy of a quantified financial program prepared by the country’s authorities, commenting specifically on the internal consistency of its objectives and targets and addressing their compatibility with sustained growth and a viable external payments position. Interim consultations will address the progress achieved in implementing the financial program and evaluate the country’s economic performance on the same basis as annual consultations. While enhanced surveillance by the Fund staff can support banks’ risk assessment, it can in no way substitute for independent economic evaluations by commercial banks, which must take full responsibility for their own credit decisions based on their own assessments and using information from various sources. The general features of this approach were followed by Venezuela and Ecuador.
During recent months, banks have entered into discussions about debt restructurings with extended consolidation periods with several other countries. The objective is to secure arrangements that link debt relief to the pursuit of sound economic policies, while providing a predictable planning horizon for policy-makers, for creditor banks, and for the private sector. Since countries’ adjustment and financing circumstances differ, banks have indicated that they prefer to shape arrangements according to each circumstance, but taking into account precedents and implications for other arrangements.
Banks and debtor countries have thus negotiated or are currently discussing MYRAs that differ in their length and the structure of the consolidation period, monitoring procedures, covenants, and events of default. A wide range of possible monitoring procedures can be applied to different consolidation periods that are adapted to a country’s situation. Within a multiyear consolidation period, creditors may make only sub-periods immediately eligible for restructuring (which then becomes a “serial” restructuring), with the restructuring of the remaining subperiods subject to the country’s economic performance and prospects. In some cases, banks have insisted that a country commit itself to seek a Fund arrangement for one or more years of a multiyear consolidation period. Banks have also agreed with debtor countries on differing covenants and events of default relating to a deterioration in the country’s economic performance or prospects. The objective of these different arrangements is to secure, as far as possible, prompt changes in policies to respond to any adverse developments.
Other Current Developments
Other important developments in bank debt restructurings have taken place in recent months. First, under several recent restructuring agreements, banks have been permitted at their option to redenominate, over time, a portion of existing loans into their domestic currencies or the ECU. Redenomination may reduce funding risks for non-dollar-based banks, both in terms of market financing and liquidity support from central banks, and would reduce the effect of future exchange rate movements on the banks’ exposure relative to domestic currency capital.
For the debtor country, diversification into currencies for which market interest rates are below U.S. dollar interest rates would reduce current interest costs. On the other hand, depreciation of the U.S. dollar would reduce this gain, as would a narrowing or reversal of interest rate differentials. In light of these uncertainties, redenomination may be scheduled over an extended period (e.g., 42 months in the case of Mexico). For these reasons, the advantages of currency diversification for the debtor country are difficult to estimate. Nevertheless, currency diversification, by providing banks with claims in a preferred form, can facilitate banks’ participation in these agreements and assist in laying the basis for a resumption in spontaneous lending.
A second development in some recent financial packages has been a preference on the part of banks to extend fresh funds in the form of (or convertible into) trade or project-related loans, rather than purely financial credits to the government. Such loans enable banks to support the export activities of their customers and to some degree monitor more closely the use of these funds, although, in the context of covering an external financing gap, such lending cannot substitute fully for balance of payments lending. In addition, some arrangements to “on-lend” restructured debt to private sector borrowers have been included in restructuring agreements.
Banks also have expressed interest in the greater involvement of the World Bank in assessing sectoral policies and in evaluating projects. The advantage of cofinancing with the World Bank lies in its potential to associate commercial bank lending with productive projects. The World Bank’s sectoral expertise and techniques for project evaluation are viewed by banks as making an important potential contribution to unlocking future bank lending.