BEARING in mind the overall exposure of bank of Nova Scotia to Jamaica’s sovereign debt, it is appropriate that the first international analyst to respond to Jamaica’s proposed debt deal was Scotia Capital’s New York based Joe Kogan, who sent out his response only one hour after the end of the PM’s speech on Wednesday night.

Kogan correctly states that although Golding had portrayed the swap as voluntary, the government could take a number of actions to coerce bondholders into accepting the deal, the most obvious being to call the bonds for those investors who do not tender them, leaving those investors uncertain with regard to the interest rates at which they could re-invest the principal.

He adds “More extreme measures could include the previously discussed tax on high interest rate debt service and a change in the type of assets that can be used to meet reserve requirements. We expect the major financial institutions to participate. They are aware of the debt problem, have been involved in discussions with the government recently, and have sufficient reserves to accommodate the losses”.

Kogan notes that for external bond holders, the announcement is mostly good news.

He reminds us that he correctly predicted in November last year (as reported in the Observer) that the liability management programme would not affect the external bonds at all.

“Furthermore, the government did not ask for a haircut on the domestic debt, and has made good on their repeated assurances that they will honour their obligations. The government is not defaulting on their debt and will remain current on all outstanding obligations. In this way, their actions remain legal under the Jamaican constitution which gives priority in government spending to debt service.”

Kogan observes that, under Standard and Poor’s methodology, the offer is a distressed exchange whereby the government “tenders an exchange offer of new debt with less-favourable terms than the original issue”, and that it was therefore always likely to trigger a selective default rating.

He argues this methodology is reasonable in that when an issuer is near default, a “voluntary” debt exchange is not really voluntary.

“We had hoped the government would implement the swap by exercising the call option in the bonds in order to avoid an SD rating but apparently that proved too complex.”

Whilst acknowledging the headline risk of a restructuring and especially a SD rating could be “shocking”, Kogan argues that for those investors who feared a more severe restructuring, the announcement should provide relief, particularly in view of the fact that S&P already had a negative outlook on its CCC rating for Jamaica, so there was not much of a negative surprise from any ratings actions going forward.

Whilst acknowledging the importance of local investors response, “as they, after all, are the ones who hold most of the debt”, Kogan doubts they will panic.

“Most large financial institutions in Jamaica never marked down their holdings of Jamaican debt; it was decided that due to the financial crisis after the Lehman Brother’s collapse, market prices were not representative and as a result the bonds remain on the books at market prices from August 2008. If these institutions were to sell the external debt now, they would have to recognise these losses, in addition to the losses they will soon incur on the local debt. These institutions prefer to hold the bonds to maturity.”

He sums up by arguing “If the debt exchange is successful and the financial system remains stable, external bond prices should benefit substantially in the medium term.”

Moody’s

Moody’s has also now joined its sister rating agencies, Fitch and S&P, in declaring the Jamaica Debt Exchange to be an event of default, although they have not changed their rating.

They note that with their current sovereign ratings of Caa1, with a negative outlook, on both domestic and foreign currency debt, Moody’s had anticipated that Jamaica’s long-standing commitment to honour its obligations in full and on schedule might finally break this year.

Moody’s policy is to assign a rating that reflects the expected losses to investors relative to the original promise to pay, as well as a measure of the uncertainty around that expectation, according to the following guidelines: recovery rate of 90 per cent – 95 per cent – rating of Caa1; 80 per cent – 90 per cent – Caa2; 65 per cent-80 per cent – Caa3; 35 per cent – 65 per cent – Ca; and below 35 per cent – C.

They state that once there is more clarity on investor losses, it is likely they will make a technical adjustment to the rating in the near future.

Encouragingly, like S&P, Moody’s state that Jamaica’s rating could be upgraded once the debt exchange is completed, if it proceeds as expected and if multilateral financing is secured, and that in their judgment the exchange is likely to be relatively orderly.

Moreover, they observe domestic debt restructuring was a precondition for the nation to receive a large combination of multilateral loans over the next two years, the equivalent of around 20 per cent of GDP, and that “Such assistance could significantly alleviate the country’s liquidity constraint over the medium term.”

They view the risk of a low participation rate in the exchange as small because the government and local creditors have been in discussions for some time in an effort to coordinate an orderly restructuring.

Whilst observing that there is a risk that the exchange could trigger a general loss of market confidence – which in turn could lead to pressure on the exchange rate and possibly even a run on bank deposits and already-low foreign exchange reserves, Moody’s state that they do “not expect this to materialise, however.”

JP Morgan

Neeraj Arora, the Jamaica analyst for international investment bank JP Morgan, who have been positive on Jamaican debt for several months, comments that although ” rating actions are of less importance at this point”, the rating agencies have acknowledged that “the exchange will be positive for Jamaica in the long run, and Jamaica’s sovereign rating is expected to be raised several notches after the exchange.”

He adds “We believe successful completion of the domestic debt swap, which is expected to reduce government interest expense by 3.3 per cent of GDP and unlock US$2.4 billion (18 per cent of GDP) in multilateral funding, is positive for external bond holders and stay Overweight Jamaica in our model portfolio.”