1. Irwin/McGraw-Hill 1 Sovereign Risk Chapter 16 Financial Institutions Management, 3/e By Anthony Saunders

2. Irwin/McGraw-Hill 2 Introduction n In 1970s: Expansion of loans to Eastern bloc, Latin America and other LDCs. n Beginning of 1980s: Poland and Eastern bloc repayment problems. Debt moratoria announced by Brazil and Mexico.

3. Irwin/McGraw-Hill 3 Introduction (continued) n Late 1980s and early 1990s: Expanding investments in emerging markets. Peso devaluation. n More recently: Asian crises. MYRAs Brady Bonds.

4. Irwin/McGraw-Hill 4 Credit Risk versus Sovereign Risk n Governments can impose restrictions on debt repayments to outside creditors. Loan may be forced into default even though borrower had a strong credit rating at origination of loan. Legal remedies are very limited.

5. Irwin/McGraw-Hill 5 Sovereign Risk n Debt repudiation Since WW II, only China, Cuba and North Korea have repudiated debt. n Rescheduling Most common form of sovereign risk. South Korea, 1998.

6. Irwin/McGraw-Hill 6 Country Risk Evaluation n Outside evaluation models: The Euromoney Index Institutional Investor Index n Internal Evaluation Models Statistical models: country risk-scoring models based on economic ratios.

7. Irwin/McGraw-Hill 7 Statistical Models n Commonly used economic ratios: Debt service ratio: (Interest + amortization on debt)/Exports Import ratio: Total imports / Total FX reserves Investment ratio: Real investment / GNP Variance of export revenue Domestic money supply growth

8. Irwin/McGraw-Hill 8 Problems with Statistical CRA Models Measurements of key variables. Population groups »Finer distinction than reschedulers and nonreschedulers may be required. Political risk factors »Strikes, corruption, elections, revolution. Portfolio aspects

9. Irwin/McGraw-Hill 9 Problems with Statistical CRA Models (continued) n Incentive aspects of rescheduling: Borrowers and Lenders: »Benefits »Costs Stability »Model likely to require frequent updating.

10. Irwin/McGraw-Hill 10 Using Market Data to Measure Risk n Secondary market for LDC debt: Sellers and buyers n Market segments Brady Bonds Sovereign Bonds Performing LDC loans Nonperforming LDC loans

11. Irwin/McGraw-Hill 11 Key Variables Affecting LDC Loan Prices n Most significant variables: Debt service ratios Import ratio Accumulated debt arrears Amount of loan loss provisions

12. Irwin/McGraw-Hill 12 *Mechanisms for Dealing with Sovereign Risk Exposure n Debt-equity swaps Example: »Citibank sells $100 million Chilean loan to Salomon Brothers for $91 million. »Salomon (market maker) sells to IBM at $93 million. »Chilean government allows IBM to convert the $100 million face value loan into pesos at a discounted rate to finance investments in Chile.

13. Irwin/McGraw-Hill 13 *MYRAs n Aspects of MYRAs: Fee charged by bank for restructuring Interest rate charged Grace period Maturity of loan Option features n Concessionality

14. Irwin/McGraw-Hill 14 *Other Mechanisms n Loan sales n Debt for debt swaps (Brady bonds) Transform LDC loan into marketable liquid instrument. Usually senior to remaining loans of that country.