Financial Institutions Management, 3/e
By Anthony Saunders
Irwin/McGraw-Hill
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 In 1970s:
•
Expansion of loans to Eastern bloc, Latin
America and other LDCs.
 Beginning of 1980s:
•
Poland and Eastern bloc repayment problems.
• Debt moratoria announced by Brazil and
Mexico.
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 Late 1980s and early 1990s:
•
Expanding investments in emerging markets.
• Peso devaluation.
 More recently:
•
Asian crises.
• MYRAs
•
Brady Bonds.
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 Governments can impose restrictions on debt repayments to outside creditors.
• Loan may be forced into default even though borrower had a strong credit rating at origination of loan.
•
Legal remedies are very limited.
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 Debt repudiation
•
Since WW II, only China, Cuba and North
Korea have repudiated debt.
 Rescheduling
•
Most common form of sovereign risk.
• South Korea, 1998.
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 Outside evaluation models:
•
The Euromoney Index
• Institutional Investor Index
 Internal Evaluation Models
•
Statistical models: country risk-scoring models based on economic ratios.
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 Commonly used economic ratios:
•
Debt service ratio: (Interest + amortization on debt)/Exports
•
Import ratio: Total imports / Total FX reserves
• Investment ratio: Real investment / GNP
•
Variance of export revenue
• Domestic money supply growth
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Problems with Statistical CRA Models
•
Measurements of key variables.
•
Population groups
»
Finer distinction than reschedulers and nonreschedulers may be required.
• Political risk factors
»
Strikes, corruption, elections, revolution.
•
Portfolio aspects
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Problems with Statistical CRA Models
(continued)
 Incentive aspects of rescheduling:
•
Borrowers and Lenders:
» Benefits
» Costs
•
Stability
» Model likely to require frequent updating.
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 Secondary market for LDC debt:
•
Sellers and buyers
 Market segments
•
Brady Bonds
•
Sovereign Bonds
• Performing LDC loans
•
Nonperforming LDC loans
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Key Variables Affecting LDC Loan Prices
 Most significant variables:
•
Debt service ratios
• Import ratio
•
Accumulated debt arrears
• Amount of loan loss provisions
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 Debt-equity swaps
•
Example:
» Citibank sells $100 million Chilean loan to Salomon
Brothers for $91 million.
» Salomon (market maker) sells to IBM at $93 million.
» Chilean government allows IBM to convert the $100 million face value loan into pesos at a discounted rate to finance investments in Chile.
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 Aspects of MYRAs:
•
Fee charged by bank for restructuring
• Interest rate charged
•
Grace period
• Maturity of loan
•
Option features
 Concessionality
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 Loan sales
 Debt for debt swaps (Brady bonds)
•
Transform LDC loan into marketable liquid instrument.
•
Usually senior to remaining loans of that country.
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