On Tuesday we ran a fascinating post by professors Mark Weidemaier, Ugo Panizza and Mitu Gulati on a partly World Bank-guaranteed Ghana bond that looks like it will complicate the country’s debt workout. This sent us on a prowl though the history of sovereign debt restructuring.
First of all, a quick recap. In 2015 Ghana issued a $1bn bond due in 2030, Markets were rocky at the time, so the World Bank stepped in with a “policy-based guarantee” for 40 per cent of the principal, or $400mn. Here’s what the bank said in a triumphant 2018 postmortem:
Market sentiment was negative in 2015 and this made Ghana a challenging credit story. The country needed to undertake a large capital market financing, but falling export prices and currency instability meant the country was under pressure. Ghana did not have access to the international bond market on a standalone basis and, despite the International Monetary Fund’s (IMF) program, the drop in oil and commodity prices and Ghanaian Cedi instability were having a negative impact. Yet the country needed to meet pressing refinancing deadlines, extend debt maturities to reduce fiscal pressure, and smooth out its debt service profile. World Bank support helped the country meet its debt management objectives and raise $1 billion with a 15-year tenor, despite international financial markets being inaccessible to Ghana for large-scale capital raisings. Both the amount and tenor were unprecedented.
Why this seemed attractive at the time is a mystery. Resources at the World Bank and IMF can sometimes be stretched, and direct support has to come with tortuously-negotiated strings. But simply guaranteeing a bond issue — in practice extending the super-seniority and impeccable creditworthiness of a major multinational organisation — can be done more easily.
A press release hailed the guarantee as marking “a successful return of the World Bank guarantees to the international bond market after 15 years”. Whoops! A few years on, Ghana is in deep debt distress, negotiating with the IMF on a financial rescue package, and has said it needs to restructure both its foreign and domestic debts. As Mark, Ugo and Mitu detailed, the guaranteed bond looks like it will become quite the headache.
So what happened the last time the World Bank issued a similar guarantee? Step forward Argentina, perennial IMF ward and serial defaulter extraordinaire. Here’s what the WSJ reported the “novel” bond offering back in October 1999:
NEW YORK — Argentina has found a novel way to begin raising $17 billion in financing for next year, and save some money to boot.
On Thursday, the government sold $1.5 billion in bonds backed by a
“policy-based guarantee,” a rolling credit from the World Bank. This structure, the first of its kind, lets Argentina pay less than it would for unsecured bonds and offer a huge issue when investors generally aren’t disposed to buy emerging-market debt.The transaction received an investment-grade rating from Standard & Poor’s Ratings Services, even though Argentina’s ordinary foreign-currency debt is rated below investment grade. S&P cited the World Bank’s backing plus Argentina’s “unblemished record” in servicing multilateral debt.
The high rating allowed the government to sell bonds to investors who only buy investment-grade securities and wouldn’t otherwise be in the market for Argentine debt. John McIntire of Goldman Sachs Group Inc., which managed the sale with JP Morgan & Co., said two-thirds of the bonds were sold to such clients, with the rest going to emerging-market and high-yield accounts.
. . . A World Bank official said the bank was seeking to relieve financial pressure on Argentina, stemming from presidential elections this month and concerns about the year 2000 computer glitch. The official said the bank will offer similarly structured bonds a few times each year, and then only for countries that meet economic and social-reform targets.
Let’s take a moment to savour how millennium bug preparedness helped trick the World Bank into guaranteeing some of Argentina’s debts — because as FTAV readers will know, only one of those things caused havoc. Buenos Aires reneged on $80bn worth of its debts in 2001, the seventh of by-now nine sovereign defaults, which was a nightmare for the World Bank.
The structure of the bond guarantee was kinda cool. The Bank had guaranteed the first $250mn of a six-part zero-coupon bonds worth a total of $1.5bn. Once one bond was paid off, the guarantee rolled on to the next one, limiting the World Bank’s exposure to $250mn at any given time but still helping Argentina borrow $1.5bn.
Given the World Bank’s super-seniority — “preferred creditor status” in the industry’s argot — the idea was that if Argentina defaulted on a bond payment, then the Bank would make creditors whole but then be easily able to demand the $250mn from Buenos Aires within 60 days and reinstate its guarantee for the next bond. Because:
However, when push came to shove, the World Bank blanched at actually de facto expanding the umbrella of super-seniority to a bunch of bondholders. When Argentina first defaulted the Bank made good on its guarantee, but then rather than in turn demanding its money from Argentina within 60 days and reinstating the guarantee for subsequent issues, it instead gave Argentina five years to repay the money, starting in 2005.
While it might have made sense for the World Bank and Argentina, this “essentially destroyed the structure of an innovative bond it had partly guaranteed,” then-Euromoney writer Felix Salmon wrote in 2002.
What no-one dwelt on at the time was the fact that the structure depended on the Bank being willing to force Argentina to treat bondholders as preferred creditors.
There is, however, a clear loophole in the bond documentation. “The World Bank,” it reads “may, in its sole discretion, demand payment from Argentina immediately, or over a period of time, on terms to be determined by the World Bank.”
By entering into this deal, “the World Bank was sending a message that they were willing to extend their preferred creditor umbrella,” says Lacey Gallagher, who rated the deal for Standard & Poor’s at the time and is now co-head of Latin American research at CSFB. “Now the fact that they’ve decided to use this loophole shows that they’ve changed their mind.”
. . . In doing so, the Bank broke with the spirit, if not the letter, of the bond’s structure. But it also ensured that the bond has nothing in common with a multilateral obligation. That, in turn, has preserved the exclusivity of Argentina’s preferred creditors (the IMF and the multilateral development banks), increased the Bank’s own chances of being repaid by the sovereign, and helped to preserve the Bank’s triple-A credit rating. It has also eliminated a class of creditors that had occupied a grey area between preferred and non-preferred status, the existence of which posed many problems for redesigning the international financial architecture.
We are reliably informed that Ghana and Argentina are the only two times the World Bank has guaranteed a country’s bond issuance. Given its experience with those cases, it may be at least another 15 years before it tries something similar again.
Source: Economy - ft.com
