By Simons Chase
Argentina defaulted on more than $80 billion of debt in 2001, the largest sovereign default at the time.
For three months in 2012, the three-masted Libertad, an Argentine naval ship and the flagship of her fleet, was detained in Ghana following legal action by US-based hedge fund, Elliot Capital Management, as it applied a legal maneuver to recover money it was owed after Argentina’s debt default.
Cristina Fernández de Kirchner, a left-wing populist who was then President of Argentina, escalated the ugly Ghana episode by characterizing the actions of the hedge fund holders as a, “trick” played on her country by “unscrupulous financiers.” Later she was forced to conduct official business aboard a commercial jet in order to avoid another humiliating public seizure of her country’s assets abroad.
Three and a half years after the temporary seizure of the Libertad, Argentina’s new president mended fences with creditors by negotiating a settlement and then successfully concluding a massive bond offering to seal the deal. Fortunately, no lives were lost in this modern-day battle for riches. In an amazing turn of events, Argentina’s $16.5 billion bond issuance last month was the largest emerging market debt deal on record – and it occurred without the full blessing of multilateral financial institutions such as the International Monetary Fund (IMF).
Despite her long history of defaults and protracted legal conflicts, Argentina attracted $70 billion in orders from investors, more than four times the planned issuance. A wide variety of investors bought into the 7.5%, 10-year bond – roughly on par with the yield on similar debt from El Salvador. The buyers were undoubtedly the same type of “unscrupulous” investors who were the subject of Argentina’s scorn just a few years ago. In an act of shrewdness on par with a hedge fund manager, Argentina increased the issuance amount and reduced the issuance yield by almost 100 basis points in the hours leading up to the sale.
Is a Bond Offering in Cuba’s Future?
With the demand side of the equation so strong, it is increasingly looking like the market may be receptive to any sovereign bond issuer willing to provide yield — any yield. Indeed, investors have short memories. In a world gripped by deflation – or outright negative interest rates – Cuba’s renewed relations with the US and its apparent willingness to open up – could make a bond sale possible in the near future – perhaps as early as next year.
Negative Yield Conditions
According to calculations from Bank of America-Merrill Lynch’s European credit strategy team, 23% of bonds globally yield less than 0% at present, up from 13% at the beginning of the year. This data suggests around $9 trillion in bonds are currently trading with negative yields, a figure that could grow larger if the current trend continues.
Regional Deal Flow is in Decline
What’s more, the banking side of the business is suffering in ways suggestive of a desire to push the credit envelope to get a deal done. According to Reuters, after enjoying a Latin American bond bonanza that saw yearly volumes peak at US$138.75 billion in 2014, bankers are now having to adjust to much thinner deal flow.
Deal flow plummeted to US$70 billion last year.
“This is the worst I have seen it since 1998 — much worse than 2008,” according a veteran banker in the region who spoke with Reuters. “We have a pipeline but it isn’t nearly what it was last year. The only thing that is vastly different from before is Argentina.”
Cuban Bonds Could Satisfy Yield Hungry Investors
A lot of things are happening with Cuba as the communist national attempts to grow the economy and create an economic transition that emphasizes much larger private sector participation in the economy. Despite the country’s isolation, poverty and communist revolutionary rhetoric, there are a variety of factors that could make a Cuban bond offering an attractive option for yield hungry investors with short memories.
First is the slow but promising effort by Cuba’s President, Raul Castro, to open the economy and attract foreign investment. There have not been any major wins in terms of attracting interest from large investors, but there have been some smaller deals mostly the in travel and tourism sector. As the rapprochement with the US gains momentum, more foreign investors are likely to see potential in Cuba’s highly educated population (the highest in Latin America) and in the incentives available in Cuba’s Mariel Port Special Development Zone. One example is a recent deal with Dutch-British conglomerate Unilever plc in which the company negotiated a majority interest in a partnership with the Cuban government that will operate in Mariel.
Second, Cuban entities like Gaviota, a government owned hotel and travel company, are making substantial investments in the sector along with foreign hotel operators like Melia. Judging by the current hotel-resort pipeline, luxury travelers with a $1,000/day spending footprint are the object of President Castro’s favor. Today, the Cuban government owns all the hotels and, in many cases, partners with foreign companies to operate the hotels. Yachting infrastructure, five-star hotels and upgrades to existing all-inclusive resorts are the investment focus for Cuba and its foreign partners. This narrative should market well among investors in a potential Cuban bond deal.
Third, in terms of demand, Cuba received a record 3.52 million visitors last year, up 17.4% from 2014. Digging a little deeper shows a more striking statistic; only 160,000 (non Cuban-American) US citizens visited Cuba last year. That compares to 20 million Americans who visited Mexico last year. A recent poll suggested 37% of Americans are considering a trip to Cuba – especially among the prized affluent millennials segment. That’s more people than is reasonable to forecast, but the point is that Cuba has visibility on massive growth in its travel and tourism sector (presently 50% of the economy) that corresponds with the repayment period of any bond deal Cuba could organize in the near future.
For a variety of reasons, Cuba is what the travel industry would love to be if it could.
Momentum with Existing Creditors
Cuba defaulted on all its debts in the 1980s and is estimated to have restructured about $50 billion in old debt in the past few years. The country’s pace of resolution is gathering steam under highly favorable repayment terms offered by its creditors.
A country’s debt is made up of official debts it has with other countries (bilateral) and commercial debts with banks and other private creditors. When a country defaults, creditors have traditionally organized themselves into two groups based on the type of debt. Official bilateral creditors, called “Paris Club” creditors, often organize themselves into a non-binding rescheduling framework. Each member negotiates the particulars bilaterally with the debtor in question, and the honor system compels the members to abide by the club’s terms. Commercial creditors often organize into a “London Club.”
Restructuring a country’s burdensome debt obligations (or “workouts”) is a common occurrence. As of 2012, worldwide sovereign debt restructurings have been a pervasive method of resolution, amounting to more than 600 cases in 95 countries. Of these, 186 debt exchanges were with private creditors while 447 agreements restructured bilateral debt with the Paris Club structure.
Cuba is no exception. Last year, the country concluded a favorable debt restructuring with most of its Paris Club creditors (representing 14 of its 19 bilateral creditors). France is the largest single creditor. The US was not part of the Paris Club creditors included in this negotiation.
In the Paris Club deal, creditors forgave $8.5 billion of Cuba’s $11.1 billion bilateral debt. The deal covers official debt defaulted on through 1986, plus interest, service charges and penalties. All the debts were denominated in euros and other currencies.
The Paris Club calculated Cuba’s total debt to its members at $11.1 billion, which is less than the previously reported $15 billion. Interest is forgiven through 2020, and after that interest is just 1.5% of the total debt still due.
Subsequent to the Paris Club deal, France expanded its arrangements with the remaining balance of its Cuban debt. Half of the outstanding arrears owed to France will be converted into a 212 million euro joint Cuba-French fund to finance projects in Cuba.
In 2014, Russia’s parliament ratified an agreement whereby Moscow wrote off 90% of Cuba’s $35.2 billion debt stemming from loans made by the Soviet Union. The agreement stipulates that Cuba must pay back $3.2 billion over a 10 year period in exchange for Russia forgiving the remaining $32 billion.
Last week, visiting British foreign minister Philip Hammond reached an agreement on restructuring its Cuban debt. The agreement deals with Cuba’s mid and long-term debt with Britain, according to a Cuban government statement. Details were not disclosed, but a statement reads that the agreement, “should contribute to the development of economic, commercial and financial relations between the two nations.” This language suggests that Britain may convert its debt into developmental financing like France’s recent debt conversion.
Finally, last month, reports indicated that Cuba’s commercial creditors (its London Club) have hired Rodrigo Olivares-Caminal, a professor at Queen Mary University of London, to help organize an effort to negotiate settlement terms for Cuba’s defaulted private sector claims. This typically does not happen unless the debtor country has given an indication of a willingness to talk.
Natural Endowments Bode Well for Investors
Cuba’s economy is presently dominated by the travel and tourism sector. With a largely undeveloped coastline that is 40% longer than Florida’s, there is a bright future for yachting, exclusive resorts and adventure travel for people are eager to pay a premium to consume the equivalent of an endangered species as a destination. Furthermore, Americans will not need to travel thousands of miles to access Cuba. For millions of new travelers who have yet to discover Cuba, a flight of only a few hours of or less is all that is needed taste the forbidden fruit.
But the story of Cuba’s natural endowments does not end there. The island nation is endowed with natural resources including nickel, sugarcane and oil reserves (onshore and offshore).
In 2004, the USGS released an assessment of the North Cuba basin and its three sub-basins. The assessment area covered the northern one-half of the island and the portion of Cuba’s maritime Exclusive Economic Zone (EEZ) that extends into the Gulf of Mexico to the north, northwest, and west of the island. The total amount of undiscovered technically recoverable hydrocarbon resources was estimated to be 9.8 trillion cubic feet of natural gas, 4.6 billion barrels of crude oil, and 0.9 billion barrels of natural gas liquids (U.S. Geological Survey, 2004). Current prices make oil production uneconomic (Cuba’s oil is of lower quality and requires additional processing), but low commodity prices will likely be resolved as a new cycle emerges.
For investors in developing countries, the potential for a nation to diversify its hard currency earning greatly reduces risk of a default that could be triggered by trouble in a single industry or a single export.
It’s Just a Matter of Time
Market conditions can sometimes have more to do with the potential for a country to raise capital than the conditions present in that country. There are significant obstacles for Cuba to overcome, not the least of which is an existing embargo with the US and the lack of a resolution to the vast amount of US claims stemming from asset seizures after the 1959 revolution.
Yet Cuba does not need US approval for a bond issuance. London would be a logical place to market a Cuban bond deal. The fact that Britain and France have settled with Cuba gives them an incentive to assist the country in gaining access to the external financial resources it needs to develop its infrastructure – and ultimately deliver on its promise to repay its new, lower debt obligation stemming from the recent workouts.
In any case, the question is likely to be more about timing than possibility.
