Last year saw a series of large, complex and successful foreign debt exchanges in Latin America, a tribute to the remarkable economic successes of borrowers such as Mexico and Brazil. For Ecuador, which carried out Latin America’s largest single exchange ever, its $6.46 billion swap marked a turning point in its economic rehabilitation and helped reinforce President Gustavo Noboa’s political authority.
But our prize for debt exchange of the year goes to Brazil’s $5.16 billion Brady swap, launched in August. It was notable for its size, swift execution and for pushing out Brazil’s yield curve to 40 years with the new bond.
The Brazilian central bank retired $5.22 billion in Bradys and issued $5.16 billion in new 40-year bonds carrying a generous 11% coupon. The exchange, carried out exclusively via the Internet, was the first long-term callable new issue by an emerging market sovereign. A call option-the first-ever for a long-term Latin American bond-gives Brazil the right to pay down the bond after 15 years.
Brazil should be able to realize $980 million in cash flow savings over the next 10 years. The exchange cut the country’s foreign debt stock by $242 million and released $312 million in collateral used to back some of the original Brady bonds. The central bank replaced debt that had an average maturity of 7.7 years with new, 40-year debt, and has the option to pay it down at any time between 2015 and 2040. The amount of principal due over the next 10 years fell by $3.77 billion.
One large emerging market fund manager comments that while the exchange was aggressively sold to investors, it was particularly good for holders of illiquid Bradys. “However, those who exchanged liquid Bradys – C-Bonds and EI bonds – are in the red. But as an outright buy, the Brazil 40 is great.” Another portfolio manager says, “It was a good deal, right on their curve. It worked well for Brazil.”
Audacious Timing
The timing of the exchange was audacious, coinciding with a $4.32 billion secondary equity offering on the New York Stock Exchange by Petrobras, the national oil company (see public-sector equity issue, page 34). In the space of two days, Brazil pulled off two landmark transactions in the international markets worth more than $9 billion, indicating strong investor confidence in the country’s recovery from the January 1999 collapse of the real.
However, the greatest surprise of the year came from Ecuador. The government mandated Salomon Smith Barney to structure and market a debt exchange program, and after a year of arduous talks, the bank devised a mechanism that was ingenious, reasonably fair to all parties and provided some upside for the bonds once they began trading.
Nazareth Festekjian, head of Salomon’s global capital market products, says, “You had banks, hedge funds, trading houses all of them with different agendas and completely different objectives. It was a challenge to design a structure so that [holders of] Bradys and Eurobonds and collateralized and uncollateralized [Bradys] were not treated differently.”
Alberto Verme, Latin American chairman at Salomon, says, “It was a real landmark transaction and a very complex deal to take care of the entire debt inventory of a single country in one shot while its entire economy was being dollarized.”
Debt negotiators had to deal with one coup d’état, two Ecuadorian presidents and five finance ministers. Ecuador also became a battleground for supporters of official and private-sector burden sharing and this confrontation almost derailed the talks.
Finally, Ecuador managed to retire $6.46 billion in defaulted Brady and Eurobonds and substitute them with a new series of 12- and 30-year bonds with a face value of $1.25 billion and $2.70 billion respectively. This achieved $2.51 billion in net debt reduction for the government. Although bondholders complained of being coerced into accepting apparently onerous terms, Salomon was able to ensure 97% in bondholder participation. This was achieved by offering bondholders liquid instruments, cash payment of missed coupons and principal, backed by strong incentives to prevent a future default by Ecuador.
In June, Argentina successfully executed the first-ever sovereign debt exchange carried out over the Internet, replacing close to $3.3 billion in Bradys with a new $2.4 billion, 15-year global bond, plus $290 million in cash returned to investors. The Internet ensures a fast, efficient exchange process that reduces market risk for investors and issuer alike by reducing the time they are exposed to market volatility while orders are processed.
Most of the orders arrived in the last two hours before the closing deadline, allowing investors to reduce market exposure. Nearly 500 letters of transmittal were submitted, close to twice the experience of prior Brady exchanges, and participants received confirmation of the receipt of their orders via automatically generated e-mails.