Ecuador’s tough debut

Issuer: Republic of Ecuador

Amount: $500 million

Launched: April 18 1997

Lead manager: Chase It seemed like a good idea at the time. Chase would loan Ecuador $300 million, and then lead-manage a debut Eurobond which would repay that amount a couple of months later.

Chase is famous for its loan abilities, less so for its bond issues. But while Chase languishes at 28th in the Eurobond bookrunner league table, the Ecuador deal has brought it up to fourth place in the league table of Latin American issuers since the start of 1997.

The first bit was easy – the bridging loan was made in December. The second bit proved rather more difficult. Part of the problem was the government of then-president Abdala Bucaram. Its attempts to fill a gaping fiscal hole with energy price hikes caused massive public demonstrations, and the president became increasingly unpopular.

The bridging loan, rather than going to pay down the public debt, went on a last-ditch attempt to buy popularity, rapidly dubbed “Bucaram’s scorched-earth policy”. Benefits were hiked, the cooking-gas price lowered, corporate income tax reduced, and congressmen allegedly bribed (at $1 million each) not to vote for his impeachment. And that was before the monies that Bucaram and his secretary pocketed for themselves – estimated at over $100 million by the prosecutors.

This was happening at the perfect time for a Latin American borrower to issue. There was over $6 billion in Latin American issuance in the Euromarkets in January, including a $2 billion 20-year global bond by Argentina. At the beginning of February, just as the appetite for Latin debt was being sated, Bucaram was impeached.

There followed an unseemly fight for the presidency between the vice-president and the speaker, Fabian Alarcon, who eventually won. Spreads on Ecuador’s Brady bonds went through the roof, and the Eurobond issue was postponed.

Things went from bad to worse, as European retail demand for Latin American sovereign debt dried up and the US Federal Reserve started on its tightening cycle. February’s $4 billion of Latin Euromarket issuance collapsed to just $772 million in March.

“A lot of the [Latin American Eurobond] deals which had been mandated had to be renegotiated,” says Paul Charman, managing director of Chase’s emerging markets syndicate in London. “With a debut borrower, these negotiations can take a while.”

The negotiations dragged on well into April. At the beginning of April, talk was of a $300 million five-year bond at between 350bp and 400bp over US treasuries – significantly above the 300bp or so originally mandated. A couple of weeks later, the final structure had emerged: a five-year fixed-rate tranche and a seven-year floating-rate tranche. The expected pricing on the five-year had gone up to 475bp.

The day before the deal was announced, a newswire reported that the bond had been delayed for 10 days. “There were a lot of rumours going around the market,” says Charman, “and it was a very fraught time”.

The final structure was larger and longer than the market expected: $350 million of five-year bonds at 470bp over treasuries, and $150 million of seven-year floating-rate notes at 475bp over six-month Libor. It was much higher than the 180bp to 190bp spread on Brazilian and Argentine four-year global bonds, but much lower than the the 975bp stripped spreads on Ecuador’s own Brady bonds.

With a coupon on the five-year note of 11.25%, even the announcement of the impeachment of a further 13 senators couldn’t keep investors away. The five-year note tightened in 23bp after issue, and within a week was trading at 385bp over.

“Investors like the Eurobond because of the coupon,” says Charman. “There’s a high income, a high return, and it’s a clean five-year bullet deal. There’s always room in emerging market portfolios for a new issuer at the right spread.”

About 65% of the issue went to institutional investors in the US, 30% was placed with a broad range of Europeans, and the final 5% was sold into Ecuador itself.

But with the original $300 million loan – paid back with the Eurobond proceeds – all but frittered away, Ecuador still has a big fiscal deficit to finance. At present rates of expenditure it is running at between 6% and 7% of GDP; even with projected tax increases and spending cuts. A reduction to less than 3.5% of GDP – some $650 million – is virtually impossible. The unelected Alarcon is politically weak, and will find it difficult to get much controversial legislation past congress.

Ecuador spent more than half the $200 million remaining from the Eurobond, after repayment of the bridging loan, to buy back its own Brady bonds. Economically, that makes sense – the Bradys were cheap at the time (Ecuador paid just 45 cents in the dollar) and much more expensive to service than the Eurobond. It also freed up $37 million in zero-coupon US treasury bonds which were being used as collateral.

But fiscally, it leaves the lion’s share of the projected budget deficit still unaccounted for. Ecuador, with a GDP of little over $18 billion, can’t find that sort of money domestically. So it will have to tap international markets again.

Market talk is of a second Eurobond in October, after Ecuador secures a credit rating from Standard & Poor’s. The grade is likely to be speculative, around B or B+.

The spreads, in a context of rising US rates, are unlikely to tighten much further – not, at any rate, before Ecuador manages to renegotiate its $380 million of Paris Club debt.

Ecuador’s only other hope for the money is to get it from the IMF. But the IMF was reportedly not amused by Ecuador’s failure to negotiate with the Paris Club, or by the draft 1997 budget, which was based on an oil price $2 a barrel above present levels.

So it will probably not be long before one of the largest-ever sovereign Eurobonds as a percentage of GDP (over 2.75%) is succeeded by another. As ever, there will be appetite for the debt – but only at the right price.