A Primer on Selling Foreign Debt
Banks use three basic methods to reduce LDC debt. They sell the loans at a discount, write them off as losses or exchange them for an ownership interest in a business in the debtor country.
In addition, banks restructure their LDC portfolios by swapping debt for debt with U.S. and foreign banks, getting out of some countries and concentrating on others, according to Jay H. Newman, a senior vice president at Shearson Lehman Hutton in New York, which brokers LDC debt.
The loan sales and debt-for-debt swaps occur on a growing secondary market for foreign debt that is operated through brokerages and banks.
Discount rates on the loan sales vary from country to country and week to week. Mexican debt has been selling for about 51 cents on the dollar, while Argentine debt has slipped as low as 26 cents.
The principal buyers are multinational corporations doing business in the debtor country. The companies convert the debt to local currency for their local operations through programs set up by the foreign governments. Active companies include Ford, General Motors and Nissan. Some banks with foreign affiliates buy loans to convert to capital for their local bank.
Mexico also has been buying back some of its own debt to benefit from the steep discount rate. It is sort of like paying $1,000 to cancel a $2,000 debt on your credit card. Most of the loans, however, prohibit countries from buying them back at a discount. Newman said there is little speculative buying of LDC paper by investors because of the difficulty in trading or reselling the debt. However, some restructured Mexican loans are traded actively by institutional investors, including foreign banks.
In some cases, banks exchange loans for an ownership interest in a business in the debtor country, such as part ownership in a hotel or factory. These so-called debt-for-equity swaps require government programs, and the most successful has been in Chile. Brazil and Argentina have less active programs, and Mexico and Venezuela have inactive programs.
In the short term, a swap means that the bank does not have to record a substantial loss on the loan because swaps are done at a higher ratio than an outright sale--for instance, a $100-million loan might be exchanged for a $95-million equity interest in a hotel. But the new ownership interest leaves the bank exposed to some of the economic uncertainties of the LDCs.
In some cases, banks write off LDC debt as total losses. Writeoffs usually occur when there is a tax advantage to the bank that outweighs the benefits of selling the loan at a discount.
Banks with stronger loan reserves are better positioned to sell discounted loans or write them off because they have the cash set aside to make up for the loss on their books.
Banks with weak reserves cannot afford to book the losses, which is one reason that institutions such as BankAmerica in San Francisco and Manufacturers Hanover in New York have been less active than stronger banks in reducing their LDC debt.
