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| Djelic: sceptical that the rally in Serbian debt prices is based on fundamentals |
THE STORY OF Serbian debt is complicated. In fact, as Jerome Booth, head of research at Ashmore Investment Management, says: “It’s the most complicated instrument in emerging markets.” The first complication, is that it was originally Yugoslav debt.
The other countries that were formally parts of Yugoslavia have all completed their own restructurings, leaving around $2.4 billion in principal and past deferred interest (PDI), as well as the precedents of what sort of deals they struck. Another complication is that the other countries paid back principal but ignored PDI, quite legally under the contract of the original debt. This means that Serbia has less principal remaining than the IMF originally decreed, but more PDI.
A third complication is the form the debt takes. Around $330 million is in two obscure structures called trade deposit facility agreements and alternative participation agreements. These aren’t liquid, and for the purpose of this article we can ignore them. The slightly more liquid debt is the $2.4 billion in new financing agreements (NFA). To complicate matters further, the NFAs are in many different currencies – from dollars to yen to escudos. However, around 56% is dollar debt, and is considered the benchmark for NFAs in general.
The final complication is Balkan and Serbian politics, with its unfathomable network of personal and national feuds, alliances, grudges and attacks. That’s enough for any investor to think twice about investing in Serbian distressed debt.
Yet a glance at secondary market prices in Serbian debt shows the opposite. Investors, analysts say, are queuing up for Serbian debt. Dollar NFA debt has risen in the secondary market from around 10% of face value at the beginning of 2002 to the high 70s now, according to analysts and hedge funds. In July, frozen foreign currency bonds rallied by 200 basis points in just four weeks.
The reason for this recent rally is that the restructuring negotiations, which had stalled after the conclusions of the Paris Club negotiations in November 2001, seem to be gathering momentum.
The negotiations stalled because Serbia demanded comparable treatment from London Club creditors to that received from Paris Club government creditors – a 66% face-value haircut. For political reasons the Paris Club creditors had been keen to see a quick deal. London Club creditors, of which the largest is Crédit Agricole Indosuez and include hedge funds such as Thames River Capital, refused to meet the Paris Club face-value level. They were willing to accept around a 45% face-value forgiveness. Serbian negotiators simply walked away from the table.
In the summer of this year, however, the process abruptly picked up. Tim Ash, CEE analyst at Bear Stearns, says: “One of the last reforms the government wants to achieve, before elections in 2004, is a deal with the London Club. It’s a priority for them.” In June, a Serbian delegation led by treasurer Madjid Pajic visited Paris and London for informal negotiations with governments and creditors. Perhaps as a result of their meetings in Paris, French finance minister Francis Mer wrote to Crédit Agricole Indosuez, asking it to make a deal, including accepting the comparable treatment of debt if necessary. As one Serbian government source puts it: “They may not have liked to hear it but that’s just the way things are.”
Following the informal talks, Serbian finance minister Bozidar Djelic said “the atmosphere may be right for us to schedule official talks with the London Club for the beginning of July”. However, in July the negotiations were disrupted by a rift between Djelic and central bank governor Mladjan Dinkic, who left office, taking with him several members of the debt negotiation team.
By September the process was back on track, with the first formal meeting with creditors at the offices of JPMorgan, Serbia’s agent, in London. Some investors have questioned whether the Serbian delegation at any of the recent meetings has been formally mandated – Djelic tells Euromoney that he and the other negotiators have been. Since then, another informal meeting with the major creditors has taken place in Dubai, according to sources.
Djelic says some progress has been made, and that “if investors are serious about getting a deal, they need to seize the opportunity in the next few weeks and months, because next year is an election year”. Crédit Agricole Indosuez is also optimistic that a deal will emerge soon, and analysts are hoping for it by the year-end.
The deal most analysts now expect is, first of all, one in which both principal and PDI will be included and treated the same. Second, they expect a 66% haircut of net present value (NPV) which, because of the high value of CEE debt in general and Serbian debt in particular, would actually only mean a face-value haircut of 45% to 55%.
A 66% haircut in NPV could be sold as a victory to the home political front and the Paris Club, and still satisfy the creditors.
Towards convergence Third, analysts expect the NFAs to be repackaged into liquid bonds with maturities of about 22 years, with a credit rating and a spread, in UBS’s model, of 500 to 600 basis points over treasuries. UBS’s Serbian analyst, Alex Garrard, thinks the debt will then be an attractive convergence play. “This isn’t just a restructuring play. Serbia is a real country with real assets and real potential. Its destiny is with the EU,” he says. “EU expansion won’t be considered complete until the Balkan countries are members. That means, over the longer haul, the debt has the scope to mirror the performance of Bulgaria.” At press time Bulgaria was trading at around 200 basis points over Bunds in the 2013 Eurobond. Bernt Tallaksen, a fund manager at Thames River Capital, concurs: “It’s an integration story. Serbia will have to integrate into Europe and the EU.”
Garrard says: “I have confidence that once the debt is restructured, you’ll have a liquid bond that will be part of global indices. It’s something you want to get hold of before every index player is scrambling after it.” It is this, perhaps, that has led to what Garrard calls “pent-up demand for exposure” among emerging-market investors for foreign-currency Serbian debt, and which has driven up its secondary-market price to the high 70s. Some analysts think it could go higher. Bear Stearns’ Ash thinks fair value would be about 88%, while Garrard believes it is between 95% and 114%.
Others are not so sure, among them Djelic. “I’m not impressed by what’s being presented in the secondary market, with prices apparently in the mid-70s,” he says. “These are negotiation tactics on the side of some, rather than any liquid or credible market. If it was so high, why not sell now?”
Djelic echoes a point made by Booth at Ashmore, who is sceptical about the recent rally. Booth says: “A lot of the scenarios I’ve been seeing coming out of investment banks assume Serbia paying $50 million to $60 million in debt servicing every six months. But the IMF has been saying very clearly that the government has $25 million a year to service its debt. Getting on with the IMF is much more important than pleasing bond creditors for Serbia right now. It’s a reconstruction story – it’s going to take years, and priority number one is getting hand-outs from multilaterals.”
Djelic says: “We want to be fair, but one has to take into account our debt servicing won’t be in excess of $20 million to $25 million a year. Creditors are starting to understand that. One has to have credible assumptions behind one’s model. It’s easy to have a spreadsheet with theoretical debt servicing figures in it, but I believe these are unrealistic assumptions based more on secondary market prices and not on our GDP figures and debt servicing capabilities.”
Djelic obviously has his own negotiating position to consider, but there are other obstacles to a quick and clean deal. Analysts are assuming a deal will be based on an NPV, not a face-value haircut. But one banker says: “This belief is the outcome of informal meetings, which have been misleading. A negotiator may have agreed informally to an NPV haircut, but if he has, he hasn’t been thinking straight since that would contradict what’s agreed with the IMF.”
Booth thinks a face-value haircut is more likely. He points out that there is no guarantee that PDI will even be included in any restructuring deal. He says: “Under the NFA contracts, exchanges can only work under the qualified exchange mechanism, and that only covers principal, not PDI. Under past exchanges, such as Bosnia’s exchange, all PDI was forgiven. That’s a precedent. If the Serbians and creditors want to include PDI, they have to change the NFA contracts. But the central banks of the other former Yugoslav countries, after their exchanges, now hold a lot of NFAs in their reserves, so Serbia would have to renegotiate with them.
“All parties would have to agree to any changes. It would take years and years, and involve many outstanding political issues of contention, not least about asset disputes and the exclusion of Serbian investors from Croatia’s exchange. Those kinds of negotiations simply aren’t a priority for Serbia. So the logical thing is to use the NFA contracts as they are, which means PDI is forgiven.”
If Serbia followed such a tactic, it would be a shock for analysts, and perhaps some investors. Ash says: “That’s potentially explosive. I just can’t see that happening. Spreads for the whole region would go out, and everyone’s position would be undermined. There is an obligation to pay the interest.” Garrard at UBS says: “Serbia could say ‘we won’t pay PDI at all’, but that would add up to a debt repudiation. No government wants to go down that route.”
Booth insists that we are seeing that unlikely thing – a Serbian bubble. He says: “A bit of research has basically fed this thing. A lot of western banks have piled into anything high-yieldish in eastern Europe. We’re in a market where distressed debt is massively overvalued, and not everyone fully understands it.
“The same thing has happened in Argentina. I’ve spoken to investors in Argentine debt who still believed a few weeks ago that they’d get all their principal back.” Booth believes fair value for Serbian debt now would be around 17%, some 60 points lower than now. He says: “Is it likely to go below 40 in a month? Yes.”
But neither Booth nor investment bank analysts are in the negotiation meetings, and those who are remain reticent, though both Djelic and Crédit Agricole seem optimistic a deal can be reached in the next few months.
Djelic will not go into the PDI/principal debate, but he says: “Some people in Serbia are making the case that we should just reimburse the principal. What is important is to have something fair for us and investors.” The question of Paris Club comparability may still be a sticking point – Credit Agricole suggested to Euromoney it wasn’t happy with comparability, while Djelic stresses that remains crucial. But some other way round may still be found. Djelic says: “We could consider some other elements to a deal, such as using benefits from the process of privatizing banks.”
