Developers Get Bargains ‘Buying’ Third World Debt

The Mexican government’s plan to lure American investors into the development of San Jose del Cabo and Loreto may fuel the use of so-called “debt-equity swaps,” a financing tool that can drastically reduce a developer’s cost of building.

Such swaps are also being performed by Chile, Brazil, Bolivia and other Third World countries trying to pay off billions of dollars in debt to foreign banks. And it is particularly appealing to Mexico, which owes about $100 billion to banks in the United States and other nations.

A typical debt-equity swap might work like this: The Mexican government owes an American bank $10 million and is having trouble paying the money back. An American hotel firm that wants to build in Mexico could go to the bank stuck with the bad debt, and--at current rates--could purchase the $10 million loan for $6 million cash. The bank would take a $4 million loss, but at least it would recover some of its money.

The hotel company would then take the $10 million debt and exchange it, at current rates, for roughly $9.2 million in Mexican pesos. The pesos would then be invested in a development entity doing business in San Jose del Cabo or Loreto.

The Mexican government thus encourages further investment in its economy, creates jobs and gets to wipe the $10 million it owes to the American bank off of its debt sheet.

The hotel company gets $9.2 million in pesos for just $6 million in greenbacks--and effectively builds the project at a 32% discount.

More than 250 projects--ranging from hotels to automobile plants--have been approved through debt-equity swaps since the Mexican government launched its swap program 15 months ago. The deals have helped reduce its foreign debt by nearly $2 billion.