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Introduction

Introduction. In 1970s: Expansion of loans to Eastern bloc, Latin America and other LDCs. Beginning of 1980s: Debt moratoria announced by Brazil and Mexico. Increased loan loss reserves Citicorp set aside additional $3 billion in reserves for example. Introduction (continued).

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Introduction

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  1. Introduction • In 1970s: • Expansion of loans to Eastern bloc, Latin America and other LDCs. • Beginning of 1980s: • Debt moratoria announced by Brazil and Mexico. • Increased loan loss reserves • Citicorp set aside additional $3 billion in reserves for example

  2. Introduction (continued) • Late 1980s and early 1990s: • Expanding investments in emerging markets. • Peso devaluation and subsequent restructuring • U.S. loan guarantees under Clinton Administration • More recently: • Asian and Russian crises. • Turkey and Argentina • Argentina’s focus on fiscal surplus • Economic growth in the 2000s and reduction in external debt. • MYRAs • Brady Bonds

  3. Were Lessons Learned? • U.S. FIs limited exposure to in Asia during mid and late 1990s • Not all: Chase Manhattan Corp. emerging market losses $150 million to $200 million range • Poor earnings by J.P. Morgan. • Losses in Russia with payoffs of 5 cents on the dollar

  4. Credit Risk versus Sovereign Risk • 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. • Need to assess credit quality and sovereign risk

  5. Sovereign Risk • Debt repudiation • Since WW II, only China, Cuba and North Korea have repudiated debt. • Recent steps to forgive debts of most severe cases conditional on reforms targeted to improve poverty problems • Rescheduling • Most common form of sovereign risk. • South Korea, 1998 • Argentina, 2001

  6. Debt Rescheduling • More likely with international loan financing rather than bond financing • Loan syndicates often comprised of same group of FIs versus large numbers of bondholders facilitates rescheduling • Cross-default provisions • Specialness of banks argues for rescheduling but, creates incentives to default again if bailouts are automatic

  7. Country Risk Evaluation • Outside evaluation models: • The Euromoney Index • The Economist Intelligence Unit ratings • Highest risk in countries such as Iraq, Zimbabwe and Myanmar. • Institutional Investor Index • 2006 placed Switzerland at least chance of default and Liberia as highest. • U.S. not the lowest risk.

  8. Web Resources • To learn more about the Economist Intelligence Unit’s country ratings, visit: The Economist www.economist.com

  9. Country Risk Evaluation • Internal Evaluation Models • Statistical models: • Country risk-scoring models based on primarily economic ratios.

  10. Statistical Models • 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

  11. Problems with Statistical CRA Models • Measurements of key variables. • Population groups • Finer distinction than reschedulers and nonreschedulers may be required. • Political risk factors may not be captured • Strikes, corruption, elections, revolution. • Corruption Perceptions Index

  12. Problems with Statistical CRA Models (continued) • Portfolio aspects • Many large FIs with LDC exposures diversify across countries • Diversification of risks not necessarily captured in CRA models • Incentive aspects of rescheduling: • Borrowers and Lenders: • Benefits • Costs • Stability • Model likely to require frequent updating.

  13. Using Market Data to Measure Risk • Secondary market for LDC debt: • Sellers and buyers • Market segments • Brady Bonds • Sovereign Bonds • Performing LDC loans • Nonperforming LDC loans

  14. Key Variables Affecting LDC Loan Prices • Most significant variables: • Debt service ratios • Import ratio • Accumulated debt arrears • Amount of loan loss provisions

  15. Pertinent Websites BIS www.bis.org Heritage Foundation www.heritage.org Institutional Investor www.institutionalinvestor.com IMF www.imf.org The Economist www.economist.com Transparency International www.transparency.org World Bank www.worldbank.org

  16. *Mechanisms for Dealing with Sovereign Risk Exposure • Debt-equity swaps • Example: • Citibank sells $100 million Chilean loan to Merrill Lynch for $91 million. • Merrill Lynch (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.

  17. *MYRAs • Aspects of MYRAs: • Fee charged by bank for restructuring • Interest rate charged • Grace period • Maturity of loan • Option features • Concessionality

  18. *Other Mechanisms • Loan Sales • Bond for Loan Swaps (Brady bonds) • Transform LDC loan into marketable liquid instrument. • Usually senior to remaining loans of that country.

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