Upon announcement of an exchange for the Dominican Republic's bonds due 2006 and 2013, Fitch Ratings has
downgraded that country's foreign currency issuer rating as well as the ratings on the debt eligible for the exchange to 'C' from 'CCC+', with a Negative Rating Watch.
The aggregate principal amount of the bonds eligible for the exchange is US$1.1 billion. The exchange for new bonds with the same coupon but a longer maturity implies a distressed debt exchange, as do exit amendments to the eligible bonds that weaken their credit quality. Finally, the bond exchange is part of a broader restructuring of the government's external debt profile under the auspices of an IMF program that is necessary to avoid a disorderly default.
Upon completion of the exchange, scheduled for May 4, Fitch will place eligible bonds, as well as the Dominican Republic's foreign currency issuer rating, in a default category. The long-term local currency rating remains at 'CCC+', as local currency obligations are not included in the exchange. The short-term foreign currency rating also remains at 'C'.
The government of the Dominican Republic announced yesterday that it will exchange its foreign-currency-denominated bonds due in 2006 and 2013 for new bonds with maturities of five years longer. Although the 9.50% bonds due 2006 and the 9.04% bonds due 2013 will amortize on a semi-annual basis during the five-year extension period, the exchange imposes a loss for all bondholders in present value terms, all else being equal. Additionally,
bondholders that elect not to participate in the exchange will face unfavorable exit amendments including the elimination of event of default provisions triggered by cross-default, cross-acceleration, and/or unsatisfied or discharged judgments on their existing bonds, as well as the deletion of the negative pledge covenant in the existing bonds.
The Dominican Republic may also seek to de-list the existing bonds from the Luxembourg Stock Exchange. These changes to the original contract would appear to be permissible under existing bond contracts, given support from
the majority of holders tendering bonds for the exchange, but would nonetheless be harmful to 'holdout' investors. Furthermore, settlement of the exchange may be conditioned on a minimum participation rate of at least
85% in aggregate principal amount of all existing bonds. Finally, the government has stated that if the exchange fails, the Dominican Republic may not be able to continue to service its debt obligations, even during 2005, underscoring the government's financial distress.
Upon completion of the exchange, Fitch would lower the ratings on eligible bonds to a default category. In accordance with Fitch's practice in distressed debt exchanges, existing bonds would retain a default rating for at least 30 days. After 30 days, if the government is committed to continuing to pay principal and interest on any outstanding defaulted bonds according to their original terms, the ratings on these securities would be raised to a non-default rating to the extent that they are not fully extinguished through tenders.
New securities issued as part of the exchange would be assigned a non-default rating based on Fitch's assessment of the likelihood of timely and complete payment, potentially in the 'B' category, assuming that the new debt service burden resulting from the exchange is manageable in the context of a credible fiscal program, IMF financing
assurances, and the continuation of debt relief agreed with the Paris Club and that other negative developments do not obtain.
A comparatively orderly exchange undertaken with the support of the IMF and official bilateral creditors, while at the same time remaining current on its obligations to bondholders, signals the Dominican authorities' commitment to make best efforts to normalize relations with creditors, and also supports a post-exchange sovereign rating in the 'B' category. A final determination of the appropriate rating for the new bonds would be made when they are issued. If the government resumes payment on bonds eligible for tender and not fully extinguished, these bonds would likely be rated below the new issues on the expectation that the government would make a distinction in its willingness to pay new bonds before exchange-eligible bonds.
If the exchange is successful, the Dominican Republic's liquidity position could improve considerably. Scheduled amortizations through 2013 would be due to almost entirely official creditors. Assuming a 90% participation rate, most of the savings in 2005 would come from Paris Club debt relief (US$142 million) and the 100% capitalization of the remaining interest payments on the new bonds (US$46 million), as market amortizations, which amount to US$20 million, would remain unchanged as a result of the exchange.
In 2006, the most significant savings would come from the five-year extension of the US$500 million maturity on the existing bonds. Total debt service would be reduced, declining to an estimated 2.7% of GDP in 2005 from 3.6% in 2004 (equivalent to 15.4% of revenues in 2005 from 22.2% of revenues in 2004). As the new bonds begin to amortize in 2007, market amortizations would increase to US$130 million from US$20 million pre-exchange.