The Big Idea
Ecuador | Possible blue bond launch
Siobhan Morden | April 28, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Ecuador’s debt buyback headline comes as a huge surprise. The timing is odd with the current administration fighting for political survival through impeachment. There is also no extra cash for buybacks under the current budget, with a structural deficit and limited financing options. The amount and logistics of the buyback suggest this could represent the long-awaited blue bond transaction. The loan should be a one-off event and not a recurrent source for future buybacks. This transaction could set a higher floor on bond prices through May 4 expiration but does not represent a game changer from my current fair value recommendation. This single transaction should not resolve the many medium-term uncertainties about Ecuador’s willingness and ability to pay that trap bond prices at low levels.
Credit Suisse just launched a buyback of three of the four of Ecuador’s bonds, excluding what now looks like an orphaned zero coupon 2030 bond. The other bonds quickly adjusted 2.0 to 2.5 points higher towards the buyback levels with near-term technical support. This operation comes as a total surprise with unusual access to an $800 million loan at a moment of intense political uncertainty with the Lasso administration under threat of impeachment or snap elections and default level bond prices restricting access to credit. These unusual circumstances and the logistics of the tender offer suggest that this buyback could represent the official launch of the blue bond transaction.
There has been much discussion of this transaction since last year and the now heavily discounted bond prices would maximize the savings for marine conservation projects. There is no official confirmation; however, the circumstances and the logistics of the transaction would suggest that the much-delayed blue bond buyback has now launched. The only reference was “The Offeror is making the Offer (subject to the New Financing Condition (as defined below)) as part of a broader refinancing operation to channel savings and promote certain conservation and sustainability efforts of the Issuer.” Belize sets the regional precedent after having successfully repurchased their bonds with a loan from the Nature Conservancy’s blue-bond ocean conservation program last year. Minister Arosemena suggested something similar for Ecuador since last year that would seek to improve medium-term debt solvency and allocate the cashflow savings towards marine conservancy in the Galapagos reserve.
There is significant firepower on the $800 million against default level bond prices of 32 to 50. The 2035s and 2040s are still trading below the maximum offer price offer of the transaction and are attractive relative to the 2030s. There is rationale to equally target the higher coupon bonds as well as the lower coupon bonds on both near-term liquidity and medium-term solvency relief. The cumulative future cashflow debt service savings could be sizable at $3.5 billion from 2023 through 2040; however, the annual savings would represent around $200 million or less than 0.2% of GDP a year from around 1.6% of GDP a year to around 1.4% of GDP and year and reduce the overall debt stock by 13% (on equal distribution across the curve). This wouldn’t transform the already low liquidity or rollover risks. The calendar of payments was already restructured such that total Eurobond payments wouldn’t exceed more than 2% of GDP a year.
The repayment risk isn’t so much a function of the debt burden but rather the scarce resources to finance a structural fiscal deficit and heavy competing amortization to China loans and IMF exceptional access loans with minimal if any financing resources beyond 2025. The latest political turmoil shows a reluctance amongst the political and social sectors to either tackle a high structural fiscal deficit or reform an uncompetitive economy with low growth prospects and low foreign direct investment. The ability/willingness to pay still remains under the heavy constraint of competing USD liabilities (including now higher marine conservation spending) and few USD resources.
This debt buyback in itself is only piecemeal without a credible medium-term economic program and high risks ahead of a political transition. The challenge for medium-term cashflow management is 1.) shifting the structural central government deficit to surplus and 2.) lowering the gross financing needs. How will the next administration manage the budgetary pressures on prospects of lower oil prices, still higher debt service and limited sources of financing? There is also the competition on diverting those cashflow savings towards higher spending for blue program conservation.
This doesn’t alter my current fair value recommendation with the benefit of a short-term bounce but still amidst fluid political and policy risks that heavily discounts the medium-term payments and will likely trap bond prices at these low levels. The investor positioning is probably still quite heavy with a bias to sell into this strength and to tender into the buyback transaction. The success of the transaction to sell bonds at heavily discounted prices would perversely invite rating downgrades (distressed exchange) and reaffirm the high implied default risk. There are the ESG-related benefits of the blue funding initiatives to the broader economy, especially on tourism and exports. However, the $800 million funding doesn’t seem transformational for medium-term debt dynamics.