Making Money off of Fallen Countries

I recommend first looking into my previous article about the Ukraine before this in order to understand the strategic scope of a crisis, plotting it over-time, and how it can be alleviated for the sake of us, the financial observers.

What's below acts more as a guide than a real blog post.

When I worked at the World Bank

Before I went up the mid-sized fund I work at now, which primarily focuses on distressed credit, I worked for this peculiar portiere of development-aristocrat speak known as “The Bank”, or in wikipedia-speak The World Bank, or The Evil Bank if you're the former Chief Economist (Bill Easterly).

At The Bank, I worked on its post-war frontiers team and found myself working in Afghanistan and Yemen for a time.

It's an important institution to track though.

No matter if you think they're right or wrong, indeed the most important part of the World Bank is that it has a near monopoly on international donor money, half of the world's loan guarantees, one quarter of the world's frontier-market bond purchases, its coordination with the powerful sister institution in the form of the International Monetary Fund (IMF), it's work at emergency funding, plus addressing a backlog of bond disputes between debtors and credits during sovereign default, has created a decades-old number of relatively unknown fixed income products that are, nonetheless, highly lucrative if you have either no principles (like me, as I lost those in Kandahar) or just have no idealism left in your soul.

Another note: It's not all bad... the headquartered European Investment Bank(EIB) and Asian Development Bank (ADB) deserve a few nods too for not having lost their idealism years ago, but still keep at it. GIZ, NORAD, and the Danish one get a nod to for actually doing good work without real salary remuneration.

Investors can find a lot of value that goes unnoticed if you think a bit beyond normal fixed-income investment terms and criteria.

The last few countries that I have seen fade into this area, i.e. oscillating between war to peace, from peace to being coddled into seclusion and into the corner of a weird international, are frontier-market bonds market with the likes of (and in no particular order) Sierra Leone, Iraq, Afghanistan, Bosnia, Zimbabwe, South Sudan, Yemen, and soon to be on the list too: Syria.

Zimbabwe Example

In brief, as in the case of this failed state, us one very minor example to show you the lower spectrum of this business. Their recent five-year note was chump-change at just 1.2 million dollar note raised from assets totally $6.2 million in the Investor Protection Levy which is administered by the Securities and Exchange Commission of Zimbabwe (SECZ) and given, and guaranteed, by various international donors.

It is the only trusted institution in the country, to many's surprise. But, you have to understand, in a basket full of bad apples there are always groups of gems that do what they say.

In essence, the bond was also guaranteed money because the SECZ was paid out, not by Zimbabwe' s non-existent governance system, but the very international donor organizations who paid into it.

However, this was a bit obvious at the time. Anyone could tried to get into it did so.

Iraq Example

Scaling it upwards in the case of an oil-rich country, Iraq, there is ShaMaran (a Kurdish company) which obtained a US $150 Million senior secured bond issue with a five year maturity, without amortization, and carries a great 11.5% fixed semi-annual coupon. ShaMaran is the Kurdish Authority's equivalent to Putin's Gazprom, Malaysia's Petronas, it is their British BP, all in one package.

In the case of ShaMaran, you have to look at the fine print. The Iraqi Budget of 2013, which would be much scarier if the Kurdish authority didn't have separate drawing rights into a stash of IMF funds, was a good deal for an investor investing in Erbil and not in Bagdad.

The Iraqi budget "authorizes the Federal Minister of Finance the power to continue to borrow from the International Monetary Fund (IMF), complementing the sum (4.5) billion dollars (four billion five hundred million) and the World Bank complements the $ (2) billion dollars (two billion dollars) during the year 2013 and using Special Drawing Rights SDR Limits (1.8) billion dollars (one billion, eight hundred million) to cover the projected shortfall in the federal budget".

But, the federal budget, however,is a misnomer, because Kurdistan has basically what we would refer to as "Home-Rule" in Britain or something more like Puerto-Rico (but much more independent fiscally) in the U.S..

Fortunately for me, most of the international financial market was too into Asian developing market debt (even Ukrainian debt) and glossed over this despite Kurdistan's promotion of this glaring fact up to the auction.

Additionally, the competently managed Erbil government can sell oil to other countries without the permission of the Federal government itself. This means that with the number of crises in the region, they could still (as some people believe they are) sell it to Iran or Turkey (which is funny because the two are in a state of undeclared war), and thus proving how flexible the regional government, and willing, they are to make the payments.

But, let's say there will be a short-fall either due to price fluctuations or supply issues, i.e. terrorists-takeovers of pipelines or more violence, and perhaps more war full-on civil war, the IMF and World Bank will leap to save it with a rate of about 80% of the time. They don't want their pet projects sinking away, that would make them, international donors, look very bad given it would look like had then wasted billions of dollars.

Another example are countries that have just emerged from a war, let's say one or two decades ago, and do have good access to international financial markets.

Yugoslavia Example

The former Yugoslavia is another, more average, example. Although mostly a mix of ex-communist Mafia-states like Bosnia, where one minister claimed recently that "we are not the government! Please understand, they (the opposition in the Serbian area) are the government! Stop telling us we're the government!" It can, thus, be obviously difficult to trust a country like this to go to the bond market and begin buying, and more importantly, begin repaying if there's no one authority that's supposed to do it.

The lack of a definite financial track record shouldn't deter people interested in post-war frontier markets. Track record is as good as a large white-water wave breaking, washing all the good stones to the stop of the sediment, and everyone looks at them while the really worthwhile ones are the stones in the rough.

Bosnia, has issues. Bosnia, however, still has a a large-enough international presence that should it try defaulting on its debt payments for domestic political reasons, and unknown to many, the residual effects of the Dayton Agreement still allow a totally undemocratic, international observer, to basically kick out or mediate a dispute between various "government" parties.

Macedonia Example

Another one is Macedonia, between Albania, Kosovo, Greece, and Bulgaria.

Unlike Bosnia, Macedonia did have good access to European financial markets. It also has a real government. It had built up a few year of a track record before 2008. After that, all went to hell. Without the European markets that it supported itself on, not a single neighboring country was willing to lend to it (i.e. Greece or Bulgaria, the ones I mentioned who, for various reasons, despise its sovereignty), and creating good value for vulture investors.

However, the government promoted pretty decent "governance" in the sense that I have personally gotten drinks with the former and current Minister charged with foreign investment. You find that in certain countries, many of them are western-educated, if not western-born, and are slightly more trustworthy than, let's say, Sudan.

Moreover, after getting a feel of who they are, who they represent, their short-track record, you see what they're offering. In the case of Macedonia, and this was a closed auction so I'll have to keep the details from you, it was in the two-digits, it was short-term duration, and it had World Bank loan guarantees so that for every 20 million Macedonia received, the World Bank would pitch in 20 million more.

So if Macedonia defaults, most likely it won't burn up all of its cash in one go, it still has more guaranteed money coming in.

The conclusion is, for a number of reasons that require some research or a sit-down and drink with one of their random ministers, countries that look like total losers can often be hugely rewarding to those fixed-income investors, that understand the risks properly, who understand long-shots can often be cheap-shots too.