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AmericasApril 2 2006

Appetite for debt grows

Appetite for Dominican Republic paper is growing on the back of the debt restructuring that pulled it out of financial crisis and the successful corporate debt issue from power company AES Dominicana. Tom Blass reports.
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One of the most telling signs that the government of the Dominican Republic was facing financial trouble in 2003/04 was that it was having problems meeting coupon repayment deadlines on two bonds, representing a combined total of $1.1bn of external debt, due 2006 and 2013. But a remarkable exchange with the original pricing intact is, equally, a sign that confidence in the country, the region and emerging market debt generally is returning.

Enrique Alvarez of the New York office of research outfit IDEA Global explains: “The republic started to run into its grace periods on repayments. While it ultimately made good, it became pretty apparent that it was going to need to restructure in the market. The Fernández government made this one of his [the president’s] main tasks, speaking to the market and explaining his cash flow limitations.”

The exchange offer was launched on April 20, 2005 and completed in July; bondholder participation was 97%. Law firm Cleary Gottlieb Stein & Hamilton, which represented the sovereign, said: “The exchange offers invited holders of the 9.50% bonds due 2006 to exchange for new 9.50% amortizing bonds due 2011, and holders of the 9.04% bonds due 2013 to exchange for new 9.04% amortizing bonds due 2018. Although the new bonds have the same coupon as the old ones, they partially capitalise interest payments due in 2005 and 2006. In effect, the exchange extended the maturities of the republic’s outstanding bonds by five years.”

The bonds included collective action and aggregation clauses, permitting the issuer to modify payment terms, maturity date, interest rate and other key provisions with the consent of 85% of the aggregate outstanding amount, plus 66.66% of each affected series.

Return to normality

Most importantly, the exchange was seen almost universally as a return to normality; that if the government of Leonel Fernández was doing its financial housekeeping, the market would respond accordingly. The IMF – the support of which was a crucial leg-up in the new administration’s bid to turn things around – said the exchange showed that Dominican financial authorities had “successfully engaged creditors in a collaborative effort to address the public sector’s short-term liquidity constraints, in a manner consistent with debt sustainability”, soothing nerves and reducing bond spreads from 700 basis points (bp) in early 2005 to 300bp by mid-2005.

Mr Alvarez says that the timing was also helpful. “The overall scenario with emerging markets was and remains very bullish. There’s a surplus of liquidity created by low interest rates and a lot of searching for yields. It was the hunt for yield that allowed Mr Fernández to come to the market and achieve an extension in bond maturities without raising coupons.”

Positive signs

A New York bond dealer told The Banker that the Dominican Republic was showing “all the right signs” for Dominican debt to be a good buy. Recovery of international reserves, return of capital, inflation reduction and – compared with some other regional players – a modest GDP/external debt ratio (“35% in the Dominican Republic compares to 150% in Jamaica”) were all “positive indicators”, he says.

“Dominican debt is paying about 8% – that’s more than a lot of other sovereigns. It has strong fundamentals that warrant a ratings upgrade. I think there’s a strong case for it to be a BB,” he says.

Morgan Stanley’s fixed income research team resumed coverage of the Dominican Republic after the exchange, with an ‘overweight’ recommendation (ie. that total returns on the bonds would be “expected to exceed the average total return of the relevant benchmark… on a risk adjusted basis”) and argued that, although the country was not immune to the possibility of a new liquidity crisis, “life after the debt exchange shifts the discussion to a completely different stage”.

To date, nothing has occurred that might dislodge an August 2005 prediction that the administration would continue to ensure stable fundamentals and pursue structural reform at a manageable, if moderate, pace.

Show of faith

The IMF, one of the government’s other major creditors, appears to share that faith. At the beginning of 2005, it approved a 28-month, $665.2m stand-by arrangement for the Dominican Republic to support the economic programme through May 2007 and approved the authorities’ request for an extension of repayment expectations that were due to arise in December 2005.

In October 2005, the republic came to an agreement with the Paris Club, consolidating about $137m of maturities falling due in 2005. Rescheduling is expected to reduce debt service due to the Paris Club from $357m to $222m.

The first corporate debt issue came out of the Dominican Republic last year, too. Power sector player AES Dominicana issued a $106m, 10-year bond with an 11% yield on the Luxembourg stock exchange. Despite the republic’s recent travails – or arguably as a result of the proven vigour of its bounce back – the B-rated bond was two times oversubscribed and took orders from more than 50 accounts before pricing at 11%.

Perhaps unsurprisingly, given regional hopes for the Dominican Republic-Central America Free Trade Agreement (DR-CAFTA), more than 80% of investors were in the US. Pablo Venturino, head of LatAm fixed-income origination at bookrunner ABN AMRO, told The Banker: “As the first Dominican corporate bond since 1997 – and the first issue since the crisis – it proved to be quite a challenge because it was really testing the market.”

There was another challenge to overcome. AES Dominicana is one of the only private participants in a power sector that is long overdue for comprehensive restructuring and overhaul. That is not insurmountable, says Mr Venturino. “It’s a difficult sector. But it’s one that the country is trying to support with the assistance of the IMF and collection rates are definitely improving.”

The bond will be “entirely used to refinance outstanding debt – replacing short-term with long-term debt”, he says.

Good time to issue

For the moment, the Dominican Republic is having its spell in the sun. This might encourage other potential issuers to come to the market. One banker supports this view: “We are certainly keeping tabs both on companies and the government. This is definitely the time to come to the market, and there’s certainly going to be an appetite for any structure geared to international investors.”

One analyst suggests that a spate of infrastructure developments, including a large artificial island that is scheduled to be built just off the coast by the capital, Santo Domingo, could be the driver for more ambitious attempts to cash in on that appetite. The next step, he suggests, would be the development of sophisticated local offerings. “Right now, investors have hardly anywhere to put their money other than Certificates of Deposits (CDs). Liberalisation of the capital markets has to be around the corner.”

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