The Risk Vulture Funds Face

by: Felix Salmon

Liberia, with the aid of the World Bank, has been negotiating with vulture funds holding $1.2 billion of its debt. You know what vulture funds are, right? They’re evil hedge-fund types who buy up debt at pennies on the dollar, and then sue for repayment in full, with interest and penalties and everything.

Just look at the deal they drove in this case! Liberia, one of the poorest countries in the world, is going to have to pay them, er, nothing at all. The World Bank is kicking in $19 million, a few rich countries are matching that sum, and the vultures are walking away with a not-very-princely-at-all $38 million, or just 3 cents on the dollar. Which probably barely covers their legal fees, let alone the amount they paid for the debt in the first place.

Meanwhile, Ecuador has come out with its own offer to bondholders: 30 cents on the dollar, which is either a “minimum price” (Bloomberg) or else just a starting price which the finance minister expects to fall in a “modified Dutch auction” (Reuters). Dow Jones says it’s a modified Dutch auction with a minimum price of 30 cents on the dollar; in any case, what’s clear is that no one is going to pay much attention to the technicalities until the current government is re-elected next week and all the electoral noise is in the past.

There are many more questions than answers right now on the Ecuador front. For instance, if the bondholders do accept the offer, where will the money come from? How will the auction work? What’s the minimum number of bondholder acceptances needed for the offer to go ahead? If the offer fails, will the Ecuadoreans continue making the coupon payments on their 2015 bonds in full? And since the secondary-market price of the defaulted bonds seems to refuse to fall below the 30-cent level, why would anybody take the government’s offer rather than just sell in the secondary market?

But still, the Liberian precedent will be sobering for anybody thinking about a vulture-like holdout strategy. Sometimes, holding out can pay handsomely: after the last distressed Ecuadorean bond exchange, the small number of holdouts was paid off in full. But as the Liberian example shows, it’s a very high-risk gamble, and it can end up in utter failure.