Metalastan is a little-known former Soviet republic located near Russia and Kazakhstan. One of its major privatized companies, CopperCo, prospered in the new millennium as demand for copper increased worldwide. The company was rated BB+ and aggressively borrowed in dollars to make acquisitions in many countries outside of Metalastan to become the world's 3rd largest copper producer. Yet many of these acquisitions were at the top of market prices. When commodity crisis ensued in 2010-2014, copper prices plummeted 70%, forcing the company to cease interest payments on $5 billion of bonds due in 2014. CopperCo is one of the country's largest employers, and Metalastan wants the company to survive. Cash strapped, the government of Metalastan made a senior loan to CopperCo, with warrants to buy up to 20% of the company's equity. Credit spreads on Metalastan sovereign debt (rated BB+, viewed as "stable" by the rating agencies), which had been as low as 240 bps. above US Treasuries in early 2007, had soared to 800 bps. during the credit crisis in 2009 but has now come down to 490 bps. above US Treasuries. (FOR REFERENCE, SEE TABLE OF COUNTRY MARKET SPREADS AND RATINGS ON NEXT PAGE).
Creditor committees formed to work on a debt restructuring in early 2014 and the World Bank was also asked by the Metalastan government for some assistance. Final details were just released this week to settle the outstanding bond claims.
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Interest Arrears:
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INTEREST ARREARS BOND: $1 of interest arrears converts into $1 of new 10-year bonds with a "step-up" coupon of 1% for first 3 years, 2% for the next 3 years, and 3% for final 4 years. The Metalastan government will guarantee all interest and principal payments, although no additional company collateral or assets will be pledged.
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Principal:
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PAR BOND: $1 of old bond converts into $1 of new 30-year bonds with a 1.25% coupon. 30-year principal maturity backed by US Zero Coupon (with the money to buy such collateral coming from the World Bank). The Metalastan government will guarantee all coupon payments, and no additional company collateral or assets will be pledged.
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Copper Warrant Details:
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Each $1 million of new Par Bonds carries 3000 warrants. The warrants pay per annum, dollar-for-dollar difference between average annual contract prices of $90 and $95 (when the market is above $90). It is capped at $5 per warrant. This payment, paid annually with the 1.25% coupon, is a bonus provision in case copper prices rise to pre-crisis levels - they are currently at $50 per contract). The warrant is not detachable and valid for thirty years.
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Note for calculation purposes, all bond coupons are paid annually.
You are a Managing Director at the Wall Street investment bank Dewey Cheatum & Howe (DCH), in charge of trading strategies for emerging market debt. In July 2016, DCH bought $1 million of CopperCo's pre-conversion bonds at 50% of face value for principal, and 10% of accrued interest arrears comes for free (that is, $1 million bonds plus $100,000 of accrued interest cost DCH $500,000). The $100,000 of accrued interest, which will be converted into Interest Arrears Bonds, is now being bid in the market separately at 60% of face value ($100,000 * 60% = $60,000).
Based upon the current price of 60% of face value, calculate Yield to Maturity for Interest Arrears Bonds (use IRR functions on Excel for all subsequent yield calculations). Current reference US Treasury rate for 10-year bonds is 2.00%.
If the Par Bonds are trading 55% of face value, calculate Blended Yield to Maturity, Stripped Yield, and Default Yield. Note the current reference US Treasury rate for 30-year bonds is 3.00%, and market price for US Zero Coupon collateral of the Par Bond is 41.20% of face ($412,000 per $1 million).
Calculate the extra per annum income from 3000 copper warrants based upon the following annual average contract prices:
$85_________
$90__________
$91_________
$94_________
$100_________
If DCH sells the Par Bonds at 55% of face value and the Interest Arrears Bonds at 60%, how much profit or loss will be made based on their purchase price of $500,000?
Based on comparable country spreads and ratings in the marketplace (see below), do you think these new CopperCo bonds are cheap, expensive, or fairly valued at these current market prices? Which countries are most comparable? Do you anticipate any price trends for these CopperCo bonds over time? Again, note as reference rates, the US Treasury 10-year bond yields 2.00% and 30-year yields 3.00%.