Owned and operated by one of Brazil’s most successful family dynasties, the Papel e Celulose Catarinense (PCC) SA paper mill has long been Latin America’s most profitable pulp producer. But last May the controlling Klabin family, which owns 71 per cent of the mill, suddenly had two foreign banks as shareholders. One of PCC’s creditors, the World Bank’s International Finance Corp. (IFC), sold its $33million loan, which was converted into a 28.7-per-cent share in the company, to two banks that had troublesome loans out to the Brazilian government. After the IFC discounted the face value of its loan by 50 per cent, it offered the Bank of Scotland and Norwest Bank of Minneapolis, Minn., each a 14.3-percent stake in the mill in return for a total of $16.45 million. Said John Jones, vice-president of Norwest’s international department, which has $279 million in loans in default to Brazil: “The swap gives us a glimmer of hope that we might recoup some of our investment.”
As the growing crisis over the $1.4 trillion in Third World debt continues to dominate global economic discus-
sion, creditors appear to have lost faith in the debtor nations’ ability to repay their loans. At last week’s International Monetary Fund meeting in Washington, bankers once more expressed their pessimism. And since May 61 American banks have set aside more than $24 billion in new loan-loss reserves to improve their ability to absorb potential losses on Latin-American loans. Canada’s major banks, which have loaned $27.5 billion to financially struggling Latin - American and Caribbean nations, have been increasing their reserves since 1984. One solution is a small but growing practice of converting heavily discounted Latin-American loans into shareholding positions in such promising businesses as paper mills and coal mines. The premise is that the Latin-American loans currently on the books of commercial banks can be packaged and sold to investors as high-yield, highrisk securities. But recently an extension of that program has created a security that a holder can actually trade in the marketplace. It works by creating an asset-backed bond, the repayment of which is secured by the income from the coal mine or paper mill.
Still, what makes the so-called “loan swaps” so appealing to investors in the first place are the huge write-downs that commercial banks are willing to take in order to sell them. For the banks, it is a chance to gain ownership positions in profitable local businesses for a fraction of the price of a comparable stake in a North American operation.
Discounts vary from country to country depending on their economic health. In Argentina banks have written down the value of loans by 63 per cent, in Mexico by 52.5 per cent and in Chile by 44 per cent. Since the first swap in 1982, American banks have converted about $6 billion in Third World debt to equity. And in April the first Canadian bank jumped into the market when the Bank of Montreal announced that it planned to swap $100 million of its total $5.6 billion in Third World Loans.
American banks, which account for 35 per cent of the loans outstanding in Latin America, have taken a more aggressive stand. John Reed, chairman of New York-based Citicorp, which recently added $4 billion to its loan-loss reserves, said that debt-equity swaps
would play a crucial role in helping the bank unload up to $5 billion in loans to developing countries over the next three years. For its part, Bankers Trust of New York has been particularly eager to take equity positions. The bank has converted $107 million of its Chilean loans into local investment. The conversion has included trading $28 million in loans for a stake in a recently privatized hydroelectric plant.
For the debtor nations, the swaps promise to attract foreign investment to under-financed areas of their economies. The Mexican government, for one, has approved nearly 200 swaps, worth $2.3 billion, since last year. The country, which has a $132-billion foreign debt burden, has the largest debtequity plan in Latin America. For its part, Chile has retired $555 million of its $28.2-billion foreign debt as a result of swaps since 1985. Said Juan Andres Fontaine, director of studies at Chile’s Central Bank: “We had no idea of the wonders the program was going to do for the country’s image.”
But not all of the investment has made its way to financially troubled industries. Tourism and the automobile sectors have been the major benefactors in Mexico’s debt-equity program-two industries that have traditionally been strong in the country. Both account for more than half of Mexico’s swap activity, with more than 90 per cent of the investment being placed into productive operations.
Last year Japanese carmaker Nissan exchanged $71 million in debt. And last month the hotel group Posadas de Mexico, which includes the Holiday Inn franchise, completed a deal with four international banks, including Citibank, that will convert $329 million in loans to build 18 hotels in Cancún, Acapulco and Puerto Vallarta.
As a result, some Latin-American countries have been wary of debt-equity swaps, concerned that they will result in nothing more than increasing foreign ownership of their assets. Brazil, which is the largest Third World debtor—it owes $145 billion—has still not established a uniform conversion program because the business community is opposed to any plan that would increase the country’s already high degree of foreign ownership. Similarly, in Venezuela government officials are cautious about conversion programs that would erase some of the country’s $44.8-billion foreign debt because potential foreign investors are interested primarily in the country’s vital industries, particularly energy and petrochemicals.
But for foreigners, only the healthy businesses offer any chance of recovery of their investments. Said Joel Korn, senior vice-president for Bank of
America’s Brazil operations: “There is more debt to be converted than there are good projects to attract foreign investment.” Added Antonio Boralli, head of Citicorp’s local investment banking unit in Säo Paulo: “In the long term, we want a diversified portfolio representing the most promising sectors of the economy. We want return on capital, it’s as simple as that.”
Still, the banks and international monetary agencies are divided over whether swaps will make a significant dent in debt levels. Some bankers say that conversion is not a solution to the
international debt crisis because host countries do not really want to retire their debt, but are anxious to attract more foreign investment. Declared Susan de Stein, a spokesman for TorontoDominion Bank: “We have some reservations about this approach. The value of a direct claim on the government is greater than the claim on an equity position.” But for Latin America’s lenders, it may be a choice of a little or nothing at all.
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