December 13, 2004
As the holiday season is upon us, the thoughts of the fortunate among us must turn to the travails of the people of Iraq and the coalition forces struggling to bring peace to a troubled land. Oh, except for those fortunate people who are distressed debt traders and investors. Their thoughts turn to what’s in the troubled land for them and how quickly they can get their hands on it. Iraq has about $16 billion to $22 billion of commercial debt outstanding, although that total may rise as more claimants come forward.
The official creditors of Iraq among the developed countries agreed back in mid-November to write off about 80 per cent of their $39 billion in claims on the country, with the write-off to come in stages as Iraq completes a series of programmes agreed with the International Monetary Fund. The “Paris Club,” as the big official creditors call themselves, insist, as is usual in these cases, that the private creditors receive “comparable treatment,” or similar write-offs and payment delays.
One hears a lot of complaints from overcapitalised hedge fund operators about how few promising distressed assets there are on offer these days. Given that, you would think there was a lot of activity in trading Iraq, with the price bouncing up for each victory announcement from the coalition commanders, and down for every insurgent attack.
Not so. “This stuff has been the Pet Rock of emerging market credits,” says Saleh Daher of Boston’s Turan, a big dealer in EM toxic waste. “It just sits there and does nothing.”
The key problem in buying or selling this stuff is getting even a vague sense of what it is worth. The optimists would seem to include Exotix, the London-based distressed EM debt firm that is probably the most active dealer in the paper. Richard Segal of Exotix says: “The trade claims in particular have been difficult to price but claims that are clearly valid on their face could have an indicated value of 17 to 20 cents on the dollar of their principal amount.” That may be the case but there have not been transactions carried out at those levels.
According to Robert Smith, Mr Daher’s partner at Turan: “If you wanted to sell something quickly, like within a week, you would be looking at the high single-digit percentages of principal value, or maybe even as much as 10 cents on the dollar.”
A slight difference of opinion there. A difference, I might add, that will pale in comparison to the arguments over “reconciliation.” Reconciliation is the process through which the Iraqi authorities accept that your piece of paper really is a claim on the state-owned Rafidain Bank, say.
According to one adviser to the Iraqi government, “Ernst & Young will be putting a solicitation for claims on the internet in December. Then you have to remember that the elections come up at the end of January, so it won’t be possible for the government to take any real action until that’s all over. The central bank governor will stay in place, so that will provide some continuity, but we don’t know who the minister of finance will be.
“Realistically, the earliest substantive questions can be addressed is February. More likely, negotiations with the private creditors will start in March. Even so, I think it will be possible to have a rolling series of deal closings with the private creditors over the course of 2005.”
One reason why negotiations will go fairly quickly is that the private creditors have virtually no leverage over the Iraqi government. Iraq has no significant overseas assets and in any event the standstill agreement among all United Nations members means any past judgments are effectively uncollectable. The oil revenue is also ring-fenced from private claims. So creditors can leave their litigators at home.
What are the chances that this paper will be worth even the written-off value agreed at the end of next year’s negotiations? After all, the Paris Club paper, our guide to the value of the private stuff, has a three-year period during which no principal is paid and interest is capitalised, followed by another three-year period of grace on principal payments, followed by a payment schedule stretching out for another 20 years.
Well, even my appallingly cynical friends on the ground in Iraq are optimistic about the commercial prospects for the country. The coalition forces fighting the larger concentrations of insurgents, along with the less publicised Kurdish and Shia death squads, will eventually crush the armed revolt. The brutality with which this will be accomplished will not be forgotten, particularly by the Sunni Iraqis, who are the principal supporters of the insurgents.
However, to answer the question of whether there will be a relatively secure, functioning government that is in control of sufficient cash flow to pay for necessary imports, support development and service Iraq’s rescheduled foreign debt, yes, there will be.