Gabon Coup Tests Two-Week-Old $500 Million BofA Debt Swap

The coup in Gabon sent investors scrambling to assess its impact on a new ESG debt contract that’s attracted investment-grade creditors to the junk issuer’s bond market.

(Bloomberg) — The coup in Gabon sent investors scrambling to assess its impact on a new ESG debt contract that’s attracted investment-grade creditors to the junk issuer’s bond market.

The deal in question is a $500 million debt-for-nature swap, completed by Bank of America Corp. just two weeks ago. Under terms of the deal, Gabon refinanced a portion of its bonds at more favorable terms in exchange for a marine conservation pledge.

A key feature of the swap is a political risk insurance contract from US International Development Finance Corp. (DFC), which creditors can fall back on if there’s a default, subject to arbitration. That could include Gabon’s failure to repay its debt or meet conservation pledges. It’s the main reason that investors who normally wouldn’t venture into emerging markets were drawn to the deal. And while such insurance contracts aren’t new, they’ve not yet been activated in the context of a debt-for-nature swap.

“It’s untested,” said Thys Louw, emerging market debt portfolio manager at Ninety One, which invested in the bond. The Gabon coup “throws up a lot of uncertainties,” he said in an interview. 

Stakeholders on both sides of the deal spent Wednesday hitting the phones in an effort to get more information on the ramifications of the coup, according to a person close to the situation who asked not to be identified discussing behind-the-scenes movements.

Soldiers seized power in Gabon this week, four days after the central African nation held disputed presidential elections. The coup triggered a record slump in Gabon’s mostly junk-rated international bonds. 

But the bonds tied to its debt-for-nature swap, which are rated Aa2 by Moody’s Investors Service, fared better. That’s despite uncertainty surrounding not only repayment, but also the issuer’s ability to live up to its commitment to protect the environment.

‘Too Early to Call’

It’s “still too early to call how this will pan out,” said Søren Mørch, head of emerging market debt at Danske Bank Asset Management, another investor in the debt-for-nature-swap bonds.

A spokesperson for BofA declined to comment. Gabon’s environment minister under deposed President Ali bongo, Lee White, hasn’t responded to a request for comment. The soldiers who seized power said in a state television broadcast Wednesday that all international agreements would be respected, without providing details.

Bianca Shead, a spokesperson for The Nature Conservancy, which is managing the conservation projects being partially funded by the bonds, said by email that it’s closely monitoring the situation in Gabon.

“Gabon is a critically important ecosystem, and TNC remains committed to work that supports the well-being of people and economies in ways that help countries reach their conservation and climate goals,” she said.

Before the Gabon deal, the debt-for-nature swap market had been dominated by Credit Suisse Group AG. Since its takeover by UBS Group AG, a number of global banks have signaled their interest in entering the market, including HSBC Holdings Plc, Citigroup Inc. and Standard Chartered Plc. Analysts at Barclays Plc estimate the market has the potential to reach about $800 billion.

Controversial Deals

Such debt-swap deals are already controversial, with Barclays analysts questioning whether the marine conservation component satisfies the bonds’ “blue” label. And in the case of the BofA deal for Gabon, Nuveen LLC said in early August it found the financial terms so unappealing that it opted to stay away, after having bought into previous debt swaps.

BofA, which rushed to get the deal over the line before Gabon’s fateful election, also had to contend with external shocks. There was the fallout across bond markets of the Fitch Ratings decision to strip the US of its AAA credit rating, as well as the volatility that often hits markets in summer months when liquidity is low. 

This week’s coup arguably makes the Gabon debt swap the most troubled in the short history of that nascent market.

Sebastian Espinosa, managing director at White Oak Advisory, which helped Barbados arrange a debt-for-nature swap earlier this year, said the coup in Gabon is a wake-up call.

“Countries with poor economic or political fundamentals, or with a history of distress, may not necessarily make the best counterparts for long-term environmental commitments,” Espinosa said.

Gabon’s first coupon payment is due Feb. 1, with a 30-day grace period. If that’s missed, a legal process could then be initiated to activate the DFC insurance, said Louw at Ninety One. The insurance could cover a full repayment in the event of default, subject to an arbitration.

Base Case

“The base case would be that unless we see significant sanctions after the storm settles, it will be business as usual with the new regime looking to limit economic fallout given its own financial interests,” Louw said.

According to the Gabon bond prospectus, the DFC “will insure 100% of a loss for up to, in aggregate, $522,789,905, which shall include the full amount of principal and seven months’ interest.”

Since 1971, the DFC has settled a total of 306 insurance claims worth just over $1 billion, covering expropriation, political violence, war damage and inconvertibility.

A spokesperson for DFC, which has provided similar insurance for about $1.5 billion in bonds tied to debt-for-nature swaps in markets spanning Ecuador to Belize, said the agency is monitoring the situation closely.

“There is a tendency for people to think that these deals are done at close,” Espinosa said. “But the truth is they play out over a 12 to 15-year horizon,” he said. 

–With assistance from Yinka Ibukun.

(Adds comment from DFC spokesperson in second to last paragraph.)

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