The recent announcement of the debt for climate swap initiative has been characterised as “a pioneering step in debt management and climate action that also positions Barbados as a leader in innovative financing within the region, if not the world”. (Barbados TODAY, Nov 23, 2024). Many have spoken eloquently and fervently about the rationale for the operation and its innovativeness in creating fiscal space to address climate issues. Given the complex financial engineering underpinning the operation, the merits and demerits of this characterisation are not the subject of this analysis. An examination of the transaction indicates that there are many stakeholders involved in the structuring of this deal. Therefore, any analysis of the benefits of undertaking this transaction should assess its impact on the borrower (Government of Barbados), the investors, lending institutions, guarantors, taxpayers, the financial institutions responsible for structuring the deal and on key socio-economic indicators. This analysis specifically looks at the impact of the debt buyback from the perspective of the investors in the government-restructured debt.
Last week, the Parliament considered and approved a resolution to borrow the sum of approximately $600 million for 20 years at a rate of 3.25 per cent from CIBC Caribbean Bank (Barbados) Limited, Scotiabank (Barbados) Limited and RBC Royal Bank (Barbados) Limited via what is being referred to as a Sustainability-Linked Loan Syndicated Facility (Barbados Parliament Bills Archive | Resolution re: Sustainability Linked Loan Syndicated Facility under Special Loans 2 Act Cap. 105). The loan has a grace period of five years, three months. The proceeds of this loan are to be used to repurchase $600 million worth of higher-cost restructured domestic debt which is expected to result in significant savings in interest payment.
The operation is underpinned by a policy-based guarantee from the Inter-American Development Bank (IDB) and the European Investment Bank for US$150 million each, which is then counter-guaranteed by the Government of Barbados. These savings will be used for investment in climate-related projects, including the South Coast Waste Water Reclamation Project and Reuse Facility, which is also being funded by the IDB and the Green Climate Fund.
A debt buyback usually involves a loss of value for investors/creditors. A debt buyback can be advantageous to investors in one of two circumstances: firstly, if the investor is facing a liquidity crunch, that is, in need of access to ready cash, and is offered a better repurchase rate than available on the market/stock exchange. Secondly, if the lender has lost confidence in, or has concerns about, the borrower’s ability to meet its obligations in the future, then the offer to repurchase may be seen as a “bird in the hand is worth two in the bush”. Bondholders generally do not like a debt buyback because it could entail a significant loss of the interest income that would have been earned on the debt if held to maturity, as well as it may also involve a reduction in the face value of the amount invested/loaned when the debt is repurchased at a discount. Further, unless investors can find an alternative investment that pays a similar or a higher rate of return to place the returned funds, the investor will be forced to invest in lower-yielding assets.
In situations where the instrument being repurchased is paying a much higher rate than is available in the market, to encourage the lender to participate, the debt is usually repurchased at a premium, for example for every $100, an amount greater than this is offered. Debt buyback also disrupts the creditor/investor investment plans.
Since debt buyback involves a loss of value for the holders of the debt, one also needs to be concerned about who is bearing this loss, the size of this loss and the possible impact on the investors’ activities or operations. Minister in the Ministry of Finance Ryan Straughn explained that the intention was to repurchase $400 million of Series E Bonds, and $100 million each of Series B and D bonds (Down to Brasstacks on VOB on November 22, 2024). Series E bonds are to be repurchased at par (face value) and the other two series by reverse auction which was due to close last Friday. Series B bonds are held by individuals and institutions, Series D by institutions and Series E bonds are held by one investor, the National Insurance and Social Security Service (NISSS). According to the Estimates of Revenue and Expenditure 2024-2025, $2.72 billion Series B, $1.22 billion Series D and $2.05 billion Series E bonds were outstanding at the end of 2023. The interest rate on these bonds is currently 3.75 per cent, 4.25 per cent and 8 per cent respectively.
Based on publicly available information, the debt buyback is expected to result in an overall reduction of $442 million in interest payment to bondholders; with Series E suffering losses of around $300 million; Series D, $121 million and Series B, $19 million.
This reduction in interest payment to bondholders, which is equivalent to the gross interest savings accruing to the government, is the difference between the total interest that the Government of Barbados would have had to pay if the debt was held to maturity less the accumulated interest paid at the time of the buyback. Depending on the price at which Series B and D are repurchased, the holders of these bonds can see additional losses of between $25 million to $40 million in principal. At present, it will be difficult to find alternative investment opportunities that will allow bondholders to recoup these losses.
Series E bonds were also the target of the 2022 debt buyback which resulted in estimated losses of $127 million in interest income for the NISSS. This was approximately 75 per cent of the gross interest payment avoided by the Government of Barbados due to this operation. The two debt buyback operations would therefore result in overall losses of approximately $428 million in interest income for the NISSS compounding the losses incurred in the 2018 debt restructuring. At the time of the 2018 restructuring, GOB liabilities with the NISS stood at $4.4 billion, with contribution arrears amounting to $468 million. The NISSS lost $1.46 billion in the nominal value of this debt due to the restructuring (NIS 17th Actuarial Review). This does not account for the loss of interest income due to this transaction. Approximately $3.5 billion of this debt was restructured into Series E bond with a 37.5 per cent ($1.3 billion) reduction in the face value. Overall, the NISSS could see an erosion of $1.7 billion in the value of its investment in Series E Bonds across all three debt operations. The NISSS also has holdings of Series B ($324 million) and Series D ($89 million) bonds, and if these are part of the repurchase auction this will add to the NISSS losses. The holders of Series D and Series B bonds (except the University of the West Indies) suffered no reduction in the face value of their debt, but because of the lengthening of the maturity period and a reduction in interest rate, they would have endured the loss of interest income due to the 2018 debt restructuring.
Since 2018, the government has completed two debt operations and is in the process of implementing a third, the debt for climate swap. These three operations, while they have impacted the debt metrics positively and have created fiscal space for the government, have resulted in significant erosion of the value of domestic bondholders’ assets and could weaken the financial position of the affected parties. It appears that the NISSS has been bearing an unequal share of the burden of the government’s debt management strategy. In all three debt operations, the reduction in debt and savings in interest payment have been absorbed primarily by the NISS.
Debt buyback can be an effective tool as part of the government’s debt management strategy to create fiscal space to pursue priority development objectives in a resource-constrained environment, but it must be fair to the debtor as well as to all creditors and should not compromise the financial viability of the creditors/investors and their ability to deliver on their mandate. Persons responsible for investment decisions and for the financial health of organisations affected by debt buyback therefore need to be alert and diligent in exercising their fiduciary responsibilities.
Dr Juliet Melville is a former Director of the Economics Department at the Caribbean Development Bank and a former lecturer at The University of the West Indies, St Augustine campus.
