Sovereign debt restructuring: Debt exchange may leave Jamaica feeling rum

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By:
Chloe Hayward
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Swap sees 97% uptake; Further restructuring might be necessary

Jamaica has successfully closed its debt exchange with a staggering 97% uptake but there are suggestions that the transaction is insufficiently comprehensive to actually strengthen the country’s unstable finances.

At the end of 2009, the Caribbean island’s debt-to-GDP ratio peaked at 140% and interest payments on the debt sucked up 65 cents of every tax dollar earned. With upcoming amortizations included, 100% of tax revenues would have been spent on the debt burden.

"Jamaica has got a balance sheet problem in the public sector. The public sector’s debt is too high and it is choking off the ability of the private sector to access credit and it’s choking off any ability of the government to spend money on what it should be spending money on – such as education, roads and so on," says Carl Ross, managing director of investments at Oppenheimer & Co.

He adds: "They tried for years to grow out of their debt problem but they were not able to. This year with the aftermath of the financial crisis and with capital being less accessible from the private sector the government decided it needed a blunter approach and launched this debt restructuring plan."

The debt exchange was launched on January 14 and closed on February 3.

Attractive exchange

The exchange involved $8 billion of Jamaica’s domestic debt stock, which included all debt other than treasury bills. No foreign debt was included in the exchange.

In short, 350 different fixed, variable and dollar-indexed bonds, which had interest payments as high as 24%, and an average of 18%, were exchanged for 25 new bonds.

This included a new CPI-linked bond instrument that helped satisfy the needs of longer-dated investors, such as the pension funds and building societies operating in Jamaica. The exchange meant that average maturities were extended while the average interest rate was slashed to 12% – still a very attractive rate for investors compared with the rest of Latin America and the Caribbean.

The exchange also marked the end of a unique Jamaican peculiarity that made all issued debt callable at par. "The Jamaican government took pains to consult with stakeholders, including Guardian Holdings Ltd, with a view to ensuring that the exchange was designed to minimize, as far as practical, its consequences on the financial community," said Jeffrey Mack, chief executive of GHL, a Caribbean financial institution, in a letter to shareholders.

Chris Gilfond, co-head of debt markets for Latin America at Citi, which led the restructuring, says: "We wanted to make sure the new securities were more attractive and valuable than the old securities to justify the lowering in interest rates on the bonds."

Lots of sense

He adds: "With all the old debt capped at par it was clear that the investors had all of the downside of Jamaica potentially slipping further but none of the upside. So we said, look, part of the package means you get lower interest rates but also these new bonds are going to be non-callable and so investors may be earning less on a current basis and you still have the downside, but there is also some upside potential too that you didn’t have before. Investors said that made a lot of sense and they said they were happy to take less return in order to get the upside. This is why this exchange saw so many come into it."

The non-callable bonds issued through the exchange also had specific advantages for institutional investors that manage long-term actuarial liabilities, such as GHL, because reserve requirements, linked to the unmatched liability of a callable bond, were eliminated.

Promised reforms

The Jamaican government also took steps to reassure investors that exchanging the debt was a worthwhile proposition by promising fiscal reform and gaining support from multilateral agencies such as the IMF. Its reforms include rebalancing the tax system; stringent belt tightening within the public sector and the planned sale of the national airline.

A series of development banks signed agreements to support the country on the back of the government’s ambitious economic programme.

The total support package of nearly $2.4 billion is about 20% of Jamaica’s economic output. Just under $1 billion will go into the Financial Sector Support Fund to assist banks and securities dealers with short-term weaknesses.

"The multilaterals wouldn’t pledge this much money unless they had faith in the Jamaican government to follow through with their fiscal plans. I think their support really added credibility to the Jamaican government’s efforts," says Gilfond. "This debt deal gives Jamaica a very reasonable and credible shot at breaking the perilous debt trajectory it has been on and put it onto a more stable footing with a more sustainable future."

Even though the swap constituted a technical default in the sense that coupons were cut by 35% and tenors extended by two years, there is no reduction of the debt’s principal and the government presented the deal in a market-friendly way. Jamaica also has the advantage of having a high willingness to pay.

Sceptics

Still, some analysts are sceptical about Jamaica’s future and wonder whether the exchange is sufficiently drastic to put the country on a stable footing. The deal represents a reduction in fiscal costs of only about $450 million for each of the next two years.

"Even with this fiscal programme and the debt exchange, the debt burden is extremely onerous," says Ross.

"I can see why the government didn’t contemplate a complete restructuring with a significant haircut. However, maybe there are no options but to reset the clock?"

AJ Mediratta, Greylock Capital

AJ Mediratta, senior managing director at Greylock Capital
AJ Mediratta, senior managing director at Greylock Capital, says: "Jamaica’s debt levels are widely considered unsustainable and have not improved over the past decade despite heroic efforts by the government. The local debt exchange is encouraging. However, this is a multi-variable situation – plug one leak but another one pops up. Lowering interest rates will lower interest payments, but lower domestic rates in a low-growth environment may put pressure on the currency. And if the currency starts to go, all the savings from the domestic debt swap may be used to defend the currency."

Economic growth will be key to the exchange’s long-term success. In 2009, the Jamaican economy shrank by 3.5%.

Ross says: "The success of this debt exchange is based on a set of very optimistic assumptions."

Mediratta adds: "Cutting local rates will help but the domestic debt is still relatively short term and has the potential to reset higher when it rolls over. Ultimately they may need to consider a much more comprehensive restructuring with a material reduction in debt. They have to grow again so they have to really reduce the amount of money they are spending on debt service."

Haircuts

But a more drastic restructuring programme with a bigger haircut and including external as well as local debt was not considered possible.

"Most of Jamaica’s debt is held locally and so the system, while healthy now, wouldn’t be healthy if the financial institutions were handed massive haircuts," says Gilfond. "As the recent crisis showed us all, the financial sector is a contingent liability of every government and so a massive haircut would have had knock-on effects throughout the system, leading to the government owning the problem in the end anyway. It all comes back in a circle and that route would destroy much more value then you would otherwise need to. It would ruin confidence and margin calls would be triggered. It would send the country into a vicious spiral."

Mediratta adds: "I can see why the government didn’t contemplate a complete restructuring with a significant haircut – given the damage that would do to the banking system, it could have led to collapse of the current administration. However, maybe there are no options but to reset the clock?

As the saying goes, you have a choice when you are badly hurt – do you sit by the curb and slowly bleed to death or lurch into the road, get hit by a truck and taken to hospital? You may be in hospital a long time but you will be in better shape when you get out."