Sovereign Analysis /
Ecuador

Ecuador: Alternative restructuring plan seeks enhanced terms and wider support

  • Alternative restructuring proposal published on Monday by another group of creditors implies higher recovery values

  • A key feature is nominal haircuts are conditional on successful completion of an IMF programme

  • We retain our Hold on the US$ bonds given deal risks, election uncertainty and IMF programme risks

Ecuador: Alternative restructuring plan seeks enhanced terms and wider support
Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

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Tellimer Research
15 July 2020
Published byTellimer Research

Following the authorities' agreement in principle (AIP) on restructuring terms with a group of major bondholders (the Ad Hoc group) that was announced last week (see our research here), an alternative restructuring proposal was published on Monday by another group of creditors, the so-called Steering Committee (SC). According to their statement, the SC consists of more than 25 global funds, along with an ad hoc group of holders of the 2024 Global bonds, holding more than 25-35% of certain bonds across the maturity spectrum, thereby conferring a blocking stake in some circumstances under the bonds' collective action clauses (CACs). Indeed, it seems to us that support from both main bondholder groups will be needed to reach the relevant thresholds to close a deal; one group alone cannot do a deal without the other, so some convergence in their positions will likely be required.

The SC sees room to enhance the terms that were presented in the agreement in principle, and hence improve recovery prospects, consistent with the authorities' debt sustainability framework. Compared to the AIP, the SC's proposal provides slightly lower cash flow relief over the first four years (cUS$1bn less) and involves a slightly higher average coupon rate. The SC proposal provides aggregate cash flow relief exceeding US$9bn over the next four years and a further US$6bn between 2025 and 2030 (a total of US$15bn over ten years). This compares to aggregate cash flow relief of US$16bn in the AIP (US$10bn over the first four years, and US$6bn over 2025-30). The SC proposal implies a weighted average coupon rate of 5.8%, compared to 5.3% in the AIP, versus the original bond's weighted average 6.9% over the life of the instruments. In common with the AIP, the SC proposal envisages amortisation from 2026.

Revised terms

The broad payment structure under the SC proposal is similar to the AIP. A common feature is an exchange of existing bonds into three new instruments – the same maturities (2030, 2035, and 2040), with the same amortisation profiles. In fact, the 2030 bond is identical. The exchange of existing bonds into the package of new bonds follows the same allocation ratio as in the AIP (suitably scaled – see below), except here that the 2022s, 2023s and 2024s all get the same treatment.

However, there are three key differences between the SC proposal and the AIP:

  1. Higher coupons on the 2035 and 2040 bonds, with a faster step up to the same terminal coupon, in the SC proposal. This shifts more value to the middle and long end.

  2. A nominal haircut is conditional on performance under the intended IMF programme. Unlike the upfront 9% nominal haircut in the AIP, the SC proposal envisages a two-stage process, with an initial par exchange and a subsequent 10% principal reduction upon the successful completion of a funded IMF programme (except the 24s, where no haircut is planned). This two-stage haircut is reminiscent of Grenada's 2015 restructuring (see here). Conditioning the haircut on the successful completion of the IMF programme reinforces policy discipline and aligns incentives.

  3. Shorter PDI bond. PDI, subject to the same 14% haircut, is also paid in a zero-coupon amortising bond, to consenting holders only, but maturing in 2027, not 2030. This offers a bit more value (but not much).

In addition, a new and novel feature compared to the AIP, is that the SC proposal states that coupons on the 2040 bond will be reduced upon achieving mutually agreed ESG criteria by 31 December 2022. It doesn't say by how much though. This feature might widen the bond's appeal to an ESG-minded investor base.

As with the AIP, completion of the restructuring is also conditional on the conclusion of a staff-level agreement (SLA) on a new funded IMF programme.

Recovery values

Our estimated recovery values for the package of bonds received are shown below for two different scenarios – no haircut and with a haircut.

We caution that particular care needs to be taken on interpreting these recovery estimates, as which scenario to use (whether or not the 10% haircut is applied) depends on one's assumption about whether the IMF programme is completed successfully or not. This will impact the exit yield assumption, and we argue that the way this should be measured might appear counter-intuitive. For example, while recovery values at any given exit yield will be higher in the no haircut scenario, compared to the haircut scenario, it doesn't necessarily follow in our view that the no haircut scenario is a better outcome. The reason there is no haircut would be because the IMF programme is not completed successfully, which should drive a higher exit yield. It may therefore not be appropriate simply to compare recovery values in each scenario at the same exit yield. Hence we think the baseline exit yield assumption should be higher in the no haircut scenario than in the haircut scenario. However, we recognise that we are talking about risks materialising some time in the future (years) which may be too far away to be material now.

To simplify, we assume a 12% exit yield in the no haircut scenario and a 10% exit yield in the haircut scenario.

For modelling purposes, we assume a three-year IMF programme is approved forthwith such that the 10% principal haircut is applied in July 2023. As we noted in our previous research, there are risks around being able to agree a new programme and its timing. Crucially, delays mean that the window of opportunity for securing a programme will narrow as the presidential election approaches in February 2021.

On that basis:

  • We estimate recovery values for the package of bonds received are around US$57.6 on average, expressed per unit of existing principal, at a 12% exit yield in a no nominal haircut scenario, excluding PDI. This is about 10pts higher than we estimate in the AIP on average at the same exit yield.

  • We estimate recovery values for the package of bonds received are around US$61.7 on average (excluding the package for the 24s), and US$68 for the 24s, expressed per unit of existing principal, at a 10% exit yield in a nominal haircut scenario, excluding PDI. This is about 4.5pts higher than we estimate in the AIP on average (excluding the 24s), and 10pts higher for the 24s themselves, at the same exit yield.

Still, the SC proposal implies higher recovery values in either scenario compared to the AIP at any given exit yield, and could therefore get broader bondholder support.

Moreover our estimates also suggest there might be value compared to current prices in the haircut scenario (ie the good scenario where the IMF programme is completed) with recovery values estimated at US$62 on average across the curve (ex 24s) and US$68 (for the 24s) at a 10% exit yield compared to prevailing prices of cUS$56 at the front end (2022-2024) and cUS$53 in the belly and long end of the curve (2025-30). There might even be a bit of value left in the belly and long end of the curve in the no haircut scenario at a 12% exit yield, with a recovery value estimated at US$57 for the package of bonds compared to prevailing prices of US$53. There is little value at the front end however (recovery estimated at US$58.5 compared to prevailing prices of US$56).

While an enhancement for bondholders, the question will be whether the government, and the IMF, like the terms and agree that it is consistent with their own debt sustainability framework and capacity to pay, and is politically acceptable. For example, conditioning the haircut on the successful completion of the IMF programme provides an incentive for this (and the next) administration to complete the programme, although politicians may see success for a domestic audience as delivering an upfront nominal haircut. We also wonder whether, with an effective average coupon rate of 4.5% in 2022, implying annual interest of around US$780mn, this will be seen as too much for the government compared to what is implied in the AIP (given the higher coupons on the 2035 and 2040 bonds in this proposal). It compares to an effective coupon rate of 1.8% in the AIP, and annual interest of US$290mn, less than half that in the SC proposal.

We retain our Hold on the US$ bonds given deal risks, election uncertainty and IMF programme risks.