Countries do not usually gain friends when telling creditors they can’t pay them back. Yet Ecuador earned serious plaudits as it went about restructuring $17.4bn of bonds this year. The Ad Hoc Bondholder Group that owned more than half of the sovereign’s bonds even said that the process “set a precedent” for Covid-19 era restructurings.
Jan Dehn, head of research at Ashmore, part of the Ad Hoc group, explains that on one hand the group was referring to modifications in collective actions clauses that some creditors hope will become standard practice. Second, says Dehn, “Ecuador had one of the most mature approaches ever to a restructuring.
“From the beginning, Ecuador recognised that maintaining access to markets is important. There was a very honest, realistic assessment of the inability to pay owing to the oil price collapse, Covid, and an extraordinary sell-off in external debt.”
A valuable proposition
Richard Martínez, Ecuador’s finance minister until he left for a senior role at the IADB in October, says the key to what proved to be a remarkably smooth process was not the economics.
“Negotiations are based on values,” Martínez tells GlobalMarkets. “The numbers are somewhat secondary.
“Our values were clear: transparency, good faith, a strong defence of the state’s interests, and being fair and balanced rather than falling into the trap of ideology.”
Martínez says Ecuador “did not start by bartering over the numbers”, saying that each side first had to agree on objectives.
“It was important for each party to sit in the other’s chair for a moment,” says Martínez. “It was agreed that Ecuador needed debt relief, but we also made clear that we understood the fiduciary responsibility of investors.”
Still, the numbers were not pretty. Ecuador was running out of cash fast as it faced a healthcare crisis amid plummeting oil prices. With a $325m maturity due on March 24, Martínez faced a difficult decision.
To much political outcry, the government paid up — avoiding hard default to ensure continued access to the multilateral funding that would get it through the crisis. However, Martínez said he would not make looming coupon payments, instead entering grace periods and requesting bondholder consent to delay debt payments until August. This bought time for comprehensive restructuring discussions.
Though they faced losses, bondholders appreciated the approach.
“It strikes me as somewhat bizarre that a finance minister should get political heat for respecting a contract, as happened when he made the March payment,” says Graham Stock, head of EM sovereign research at BlueBay, also a member of the Ad Hoc group. “This was a strategically sensible decision that helped talks develop more smoothly because Ecuador was not in default.”
Indeed, in early July, just weeks after negotiations had begun, Ecuador reached an agreement with the Ad Hoc group. Though smaller creditors protested, and two funds tried and failed to block the deal in court, the swap concluded with the consent of more than 95% of creditors.
Plaudits flooded in. Paul Greer, portfolio manager at Fidelity International, believes Ecuador “did a cracking job”.
“We have seen, on many occasions, issuers playing games,” says Greer. “Indeed, Argentina did it this year. Ecuador was incredibly pragmatic, with no delaying tactics or crazy deadlines that were endlessly being pushed back.”
Argentina’s toils
Comparisons with Argentina, a fellow serial defaulter, became commonplace.
A restructuring of Argentina’s $65bn external bond stock had been inevitable since long before Covid-19 broke Ecuador’s ability to pay. Argentina had initially given itself until a March 31 deadline to complete a deal.
Yet Argentina submitted its first offer only in mid-April, and it was clear the approach would differ from Ecuador’s. Finance minister Martín Guzmán called for unity among Argentine politicians against investors who would “play very hard”, while creditors rejected the terms, lamenting the absence of “good faith negotiations” and economic proposals.
Conversations with Argentina remained truncated. Hard default arrived in May; Guzmán said it was merely an “anecdote”. More than once, Argentina claimed it had made its “final offer”, walking away from the table. Finally, the two sides came together in a matter of days in early August.
Nathalie Marshik, head of EM sovereign research at Stifel Nicolaus & Co, saw Argentina’s strategy as “to clinch an agreement that left them paying as little as possible until the mid-term elections”, due in October 2021.
“A sub-50 NPV [net present value] recovery seemed to be a psychological limit for a long time,” she said. “It would have made a nice headline, had Guzmán achieved an NPV with a four-handle.”
By the time the agreement came, creditors were fed up of the headlines; the apparent leaking of private discussions to the Argentine press, including the naming of certain people on the creditor committee, was a particular a sore point.
A mere snapshot
Yet Stock of BlueBay — which, like Ashmore, was in Argentina’s largest creditor group — argues the contrasts between the two processes are “exaggerated”.
“Though it is easy to criticise Argentina for how long negotiations dragged on, in both cases neither side is happy with the outcome — which is the definition of a good negotiation,” he says.
Indeed, the numerical substance of the final results — significant upfront payment relief, low coupons, small principal haircuts, and NPV recoveries in the 50s — did not strikingly differ from one country to the other.
Does talk of values and trust romanticise yet another failure by Ecuador to meet its obligations? It is true that Ecuador’s extreme reliance on external funding to a certain extent forced its hand. The country needed to reach a deal with bondholders quickly for the government to sign an IMF programme and “access necessary funding, including all the ancillary multilateral support that comes with such a programme”, Marshik says.
As Stock says, “If we had reached an agreement with Argentina in April, we would still be asking the same questions about balancing the budget and how the government is going to finance next year’s deficit.”
Ultimately, a debt swap is just a snapshot in time, and the haircut and maturity extension do not determine whether the country got a good or bad deal, says Dehn.
“The measure of success of a restructuring is whether it allows the issuer to return to markets on a sustainable basis,” he says.
Whereas, in Ecuador, Ashmore saw “a confluence of common objectives” between issuer and creditors, “Argentina was a classic case of a government negotiating without any long-term objectives in mind,” says Dehn. “It just wanted to drive the toughest deal, so played all the games possible and tried to split all the bondholders.”
Beyond relief
With the restructuring done, the focus moves on to whether the countries can take advantage of debt relief. In both countries, notes Marshik, the low coupons and lack of carry on the restructured bonds mean they “effectively became an equity play”.
“This gives governments leeway but fewer incentives to implement the right policies,” says Marshik. “It is vital for governments to take advantage of the lower interest payments afforded to them and address macro and fiscal issues.”
The nature of negotiations provides clues about each country’s chances of making a success of their deals.
One Latin American sovereign that recovered well from restructuring was Uruguay, in 2003. Dehn notes that it has gone “from strength to strength” ever since.
“A key part of this was that Uruguay left a great impression on bondholders,” says Dehn.
Argentina’s president, Alberto Fernández, had actually suggested in September 2019 that Argentina could carry out a “Uruguay-style” debt reprofiling. But if there was little evidence of this during negotiations, there is even less likelihood Argentina will be able to replicate another key ingredient of Uruguay’s transformation: economic and fiscal policy.
“Argentina showed us that restructuring without an economic plan is a bad idea,” says Marshik. “You might buy yourself time, but fundamentals will always catch up to you, and a case in point is [the country’s] incapacity to stabilise FX reserves, and the pressures on the currency.
“Without confidence in policymaking,
Argentina’s new bonds will continue to underperform.”
Dehn adds that “the government does not view continued access to the markets as an objective in itself. Its focus is very political and short term”.
Argentina and Ecuador’s restructured bonds went free to trade within a week of each other at the start of September, inviting another comparison that does not reflect favourably on Argentina, which was yielding about 15%. Market access, indeed, looks distant.
“Based on what we saw from Argentina during the negotiations, it is not going to be an improving credit over the next five years,” says Dehn.
Yields on Ecuador’s new bonds are closing in on 10% — but the outlook depends heavily on presidential elections due in February 2021.
“There is no certainty in Ecuador that an investor-friendly government will be in place after next year’s elections, although the odds are slightly better for Guillermo Lasso [considered market-friendly] after PSC’s Nebot bowed out of the race [to support Lasso],” says Marshik. “If you think there is going to be a recovery in oil prices, and that the right policy mix will be in place, there is value in Ecuador.”
Psychological shift
Elections mean prospects for Ecuador’s bonds are rather binary. But the country should reap the benefits of its pragmatism during restructuring.
On one hand, the fast deal triggered an IMF agreement that surpassed all expectations and could relieve pressure on the government in the coming months — potentially increasing chances of a market-friendly candidate winning the vote.
Moreover, the new debt structure means the next president cannot argue external debt payments are a burden.
“Regarding the numbers, the most important thing was to obtain the greatest relief possible over the next five years,” says Martínez. “We knew the next administration would benefit and wanted to leave little margin for demagoguery or populism.
“We certainly managed to give enough fiscal space for Ecuador to grow and continue with reforms.”
On a deeper level, Martínez hopes that Ecuador can shake off its history as a poor debtor. “This negotiation was a message to the country that a good debtor has better options with its creditors. We took great care to prioritise the population and explain what we were doing,” he says.
Reforms implemented during Martínez’s tenure often sparked protests, but he believes it was easier for citizens to grasp the benefits of the debt restructuring.
“Debt relief is tangible for everyone. We are demonstrating that doing the right thing, as painful as it may be, brings benefits.”
Should Martínez’s optimism be well placed, it would show that net present values are not always the most important values in a restructuring.