Superbond ll: The Price of a Belizean Haircut Belize needs to be more innovative!

In 2007, the country of Belize, at the time considered to be in default on its debt by Standard & Poor, issued a $550 million bond on international markets.

The so-called “super bond” due in 2029, would bear interest only for 12 years, giving Belize time to achieve fiscal consolidation and grow its economy before principal payments began in 2019.

Just five years later, with the dark cloud of default looming yet again, the government of Belize has assembled a Debt Review Team, tasked with a comprehensive review of its commercial external debt.  I guess, the more things change, the more they stay the same.

When Belize sought to restructure in 2007, its external debt amounted to more than 90% of the gross domestic product (GDP), and interest payments on public sector debt alone were above 27% of the government’s fiscal revenue.

Having already implemented a significant tightening of fiscal policy years earlier, the country was still forced to retain financial advisor Houlihan Lokey Howard & Zukin to negotiate with its creditors.

Though the debt restructuring did not involve a “haircut” (a reduction in the amount of the money owed or the interest paid), the deal, with its extended maturity date and temporarily reduced coupon payments, was viewed by both sides as a win-win.

Unfortunately the   global economic  down-turn soon followed and turned what looked like a great deal into a weighty debt burden for Belize, causing considerable concern to international credit rating agencies.

Despite maintaining an impressive primary surplus throughout the financial crisis and projected oil revenues of over $90 million in 2012, Belize’s hefty debt and burdensome repayment schedule, along with a stagnant tourism industry, increased expenditures, and a significant drop in credit ratings.

Belize is once again faced with a debt-to-GDP ratio that is unsustainable.

In June 2012, Moody’s cut Belize’s credit rating – for the second time this year – down to Ca, citing a likely restructuring and the country’s weak economic growth.

Belize’s current public debt burden is near 80% of its GDP and interest payments on the government’s debt account for 2.4% of national income.

(Interestingly, Belize’s debt burden, while significant, is not the worst in the region – Jamaica has the world’s highest public debt burden and interest payments on its debt account for 10% of her national income.)

The current government has blamed the size of the superbond (itself the result of a necessary debt restructuring in 2007) on the previous government.  The adopted post-election rhetoric seems to be circling the concept of “odious debt,” a legal theory which holds that national debt incurred by a party for purposes that do not serve the best interests of Belize should not be enforceable.

Such debts are deemed personal debts of the party that incurred them and not debts of the country. (The government of Ecuador put forward a similar argument in 2008 when it boldly declared the majority of its outstanding debt illegitimate, and defaulted.)

Belize’s bondholders have formed an ad hoc creditors coordinating committee out of concern that Belize will  default on its debts. The committee is advised by BroadSpan Capital, an investment boutique that also advised international creditors to Saint Kitts and Nevis, the Caribbean island federation, in debt restructuring.

Despite these events, and in light of recent remarks by the GOB, it seems clear that a superbond 2.0 is in the works. The only questions remaining are when and how the restructuring will be carried out.

While it is still too early to assess what the precise terms of the new superbond will look like, the question of when is easier to answer. Though some investors were anxious to see if Belize would pay the $23 million coupon due February 20, most realized that it would be politically counterproductive for the government to default just before an election.

However, if a renegotiation is to take place, investors would require that Belize demonstrate a willingness to pay and not default (under an odious debt or some other theory) by making the coupon payment due this August. Belize’s debt restructuring could trigger credit-default swaps that insure the superbond.

The collective action clause of the superbond requires the consent of at least 75% of the bondholders and the ad-hoc committee is made up of holders of more than US$200m of the current bond. Investors, on the whole, tend to value their interest over their position, so they would prefer renegotiations to a default. Given that, Superbond 2.0 will probably take the following shape:

1) Exit yield between 9% and 12% (This is comparable to other countries in the region – Jamaica’s bond is currently trading below 9%; Argentina’s exit yield when it defaulted in 2005 was just below 10%);

2) Extension of the maturity date to 2042, adding an additional 13 years to pay;

3) Lowering the coupon rate to around 5% instead of the current coupon of 8.5%.

Though principal reduction would be the 4th theoretically possible restructuring feature, it is highly unlikely. Such a reduction would cause the bond to be ineligible for any index, making the debt even more illiquid.

Under a Superbond 2.0 as described above (assuming 2% GDP growth a year), Belize would only pay about 1% of GDP to the interest on the debt, as compared to approximately 3% with the current superbond. The 1% ratio would max out at 2.5% of GDP in 2022, as compared to a maximum 4.5% of GDP when the current superbond begins to amortize in 2019.

So what does Belize pay for this haircut?

1)  Fiscal consolidation, including raising taxes, as well as taking a hard look at the pension system.

2) Involvement of international financial institutions in Belizean fiscal policy.

3) Greater fiscal transparency.

4) Creation of a private-sector friendly business environment in order to attract direct foreign investment;

5) Pressure to devalue the Belize dollar and end the more than 30-year-old peg to the U.S. dollar.

In other words, creditors will attach these so-called austerity measures to force Belize to meet deficit targets and reduce its debt-to-GDP ratio.

Such measures have proven unsuccessful in Greece, Spain, Portugal and Jamaica. They put the government in a position where the economy limps from one restructuring to another or worse, a disorderly default like Argentina’s – jumping from the frying pan to the boiling pot and then into the fire.

Belize needs to pursue more innovative debt cancellation policies such as the debt-for-nature swap.

One idea could involve taking advantage of the carbon-rich mangrove forests covering over 70,000 hectares of Belize. The GOB could sell these “carbon stocks” to foreign governments of industrialized countries wishing to comply with international efforts to reduce emissions of greenhouse gases from deforestation and forest degradation (known as REDD or REDD+).

As an example, Norway’s $1 billion USD REDD+ investment in Indonesia led to a one-year moratorium on logging, which has the potential to safeguard 45% of one province’s forests.

The investment also provided new livelihood and income opportunities for the Indonesia’s local population.  The estimated market value of such a project being implemented in Belize would be over $300,000,000 USD.

Belize might also consider taking a page out of Ecuador’s book. In 2008, after declaring the illegitimacy of its government debt, Ecuador had a national bank, Banco del Pacifico, buy its debt for cents on the dollar. Belize’s current superbond is trading at extremely depressed levels.  This atmosphere, similar to that which existed before Ecuador’s debt buyback scheme, creates room for mutually beneficial gains for both bondholders and the government.

Belize’s Central Bank could use some of its reserves to repurchase the 8.5% notes at 50 cents on the dollar and then refinance the amount with a multilateral at a significantly lower interest rate (perhaps 3%).

The bondholders will receive the current market value of their holdings and Belize’s debt would be reduced by more than $200M USD.

In the event of subsequent default on the August coupon payment, the credit default swaps (now, along with the debt, also owned by Belize) would be triggered, allowing Belize to collect millions in insurance.

These types of innovative approaches to Belize’s debt crisis could ensure real and sustainable fiscal change, rather than just more of the same.