Insights | October 31, 2017

The International Bank of Azerbaijan

Executive Summary

Quasi-sovereign defaults, particularly when independent of the sovereign, are rare. In this report I examine the curious case of the International Bank of Azerbaijan (IBA), the latest quasi-sovereign idiosyncratic defaulter.1 IBA, a 91% government-owned bank, in May forced a “voluntary” restructuring upon creditors and its own sovereign wealth fund even as its BB+ rated sovereign continued servicing its own debt. The case carries some similarities to that of BTA Bank, a Kazakh bank, in the way it engineered a similar restructuring via the same financial advisors in 2014. So, while surprising to us as Boston-based bond investors, we imagine it was more surprising still for the Development Bank of Kazakhstan, an investor in the IBA bonds, which found itself crammed down alongside us. When these rare events happen, it’s useful to review the event through the lens of our investment process. We make two observations from which we derive two conclusions:

Observation 1

We had incorrectly estimated Azeri decision makers’ utility function, placing insufficient weight on non-financial, perhaps political factors.

Conclusion 1

We need to remain vigilant and maintain a healthy cynicism in assessing policymakers’ utility function, being wary of agendas that may portend losses for current creditors, and apply additional hurdle rates for such investment uncertainty. We add the Azeri government and its related quasis to our high uncertainty bucket.

Observation 2

The cross-border bankruptcy method used to “voluntarily” cram down foreign currency creditors calls into question the assumption that US and UK law bond documentation can be relied upon to deliver “expected” outcomes (e.g., collective action clause thresholds, respect for seniority of claims).

Conclusion 2

Until international courts and legal systems devise counter-methods for dealing with such bad-faith loopholes, investors such as ourselves should assume the worst outcome. We are watching IBA’s ongoing legal proceeding with interest.

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1 Of the nearly 350 corporate defaults in the emerging markets since 1999, 15 were quasi-sovereign defaults, 5 of which defaulted independently of their governments. Even rarer, IBA becomes only the second quasi-sovereign ever to default idiosyncratically while other quasi-sovereigns from the same country remained current on their debt.

Disclaimer: The views expressed are the views and understanding of Mustafa Ulukan through the period ending October 2017, and are subject to change at any time based on market and other conditions. While all reasonable effort has been taken to insure accuracy, no representation or warranty for accuracy is provided nor should be assumed. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.