Views on the quality of Cuban-backed credit obligations often fall into two very different camps. There are those who consider anything to do with the tropical island is basically junk while others argue that in fact Cuba is an under-rated highly performing niche market. The former will point out that the Cuban State has not met any of its Paris Club obligations since 1986, that the country is rated by international rating agencies on a par with Haiti, Liberia and Sierra Leone and that the Cuban State introduces an element of political risk into transactions which is impossible to gauge. The latter will emphasize that all Cuban obligations are not the same and that since 1996 state owned commercial Cuban banks have a zero default record. Furthermore, they will point out that there are several overseas institutions which have consistently made returns of 13-18% per annum while maintaining extremely low default rates. This article will seek to place Cuban credit in context, and will then explain the apparent anomaly in perceptions of the quality of financial instruments available. It will then assess the real level of risk faced in the market today and the factors which may change this. Introduction & backgroundto the Cuban financial sector In 1986, Banco Nacional de Cuba (BNC, the former Central Bank) ceased payments on its external debt. Although a part of this debt has subsequently been rescheduled, the greater part remains frozen today. In the decade following this decision, the Cuban financial system was re-organized with several new (state owned) financial institutions established and the different functions of the old central bank effectively hived off. This included the establishment of a new slimmer central bank, Banco Central de Cuba (BCC) and commercial banks including Banco Financiero Internacional (BFI), Banco International de Comercio S.A. (BICSA), Banco Exterior de Cuba (BEC), Banco Metropolitano, and Banco de Inversiones (BIS). While all of these new banks are 100% state owned, they were established with a certain amount of legal and operational independence and were (generally) both well capitalized and free from the obligations incurred by the old Central Bank (BNC). Each bank performs a certain role which complements the financial system as a whole. BEC focuses on facilitating overseas trade finance, Banco Metropilitano is the bank of choice for individuals in hard currency, BIS is the vehicle which promotes investment banking type transactions and BICSA and BFI are corporate banks which lend primarily to Cuban companies. The other main Cuban bank is Banco Popular d’Ahorro (BPA) which operates mainly in local non-convertible currency and which is the retail savings bank for the population. The decentralization of the financial system was pushed further during the mid 1990s with the establishment of a number of non-banking financial institutions which were termed “casa financieras.” These may be seen as in-house treasuries to particular companies and/or sectors. They were intended to improve both accountability and financial management. At one point there were more than 20 of these institutions with the largest entities including FINTUR and FINATUR (tourism), Rafin (army), Finagri (agriculture), ARCAZ (sugar), Fincopex (Copextel), Fincimex (Cimex) and so on. As part of the re-centralization of the banking system, since 2002 many of these non banking financial institutions have been (re) integrated into one of the main Cuban commercial banks. This has contributed to a significant increase in the size of the balance sheet of BICSA and BEC which have also seen strong organic growth. International providers of finance to Cuba The latest figures supplied by the Cuban Central Bank (BCC) suggest that, as at the end of 2006, Cuba had a total of US$ 7.8bn in performing and US$ 7.6bn in non-performing loans (US$ 15.4bn in total). This represents a large increase over previous years and implies that Cuba has been successful in both securing new medium term finance and in restructuring several non-performing facilities. While sovereign debt is an important issue, even taking a higher debt figure of US$ 16.6bn (estimated by the EIU) it still only represents 37% of GDP and, once accumulated interest is excluded, falls further. Furthermore, a significant chunk has been sold on the secondary market where it trades at between 10-15 cents on the dollar. State credits to Cuba (friends of Cuba) Cuba has negotiated various financing facilities with countries including China, Russia, Venezuela (financing is also routed via ALBA- the fair trade group of the Americas championed by Venezuela), Iran and Brazil where there is considered an element of political support as well as commercial interest. This is most apparent with the Venezuelan oil & gas company, (PDVSA) which provides oil to Cuba under the terms of the Petro-Caribe agreements which allows 40% of the total value to be paid over 50 years. China is also understood to provide significant export finance which helped facilitate a record US$ 1.8bn in exports of goods to Cuba in 2006. Iran is reported to have extended a US$ 300 line (although this is little utilized) and agreements have been reported between Cuba and Russia to both settle old outstanding debts and to agree new commercial credit which has enabled Cuba to recently purchase several passenger jets from Russia (+US$ 300 million). Other Export credit agencies (ECA’s) Of the defaulted debt the largest part is held with Export Credit Agencies (ECA’s). Collectively amounts due are in excess of US$ 2bn today with the largest amounts due to Cesce (Spain) and Coface (France). In recent years amounts due to ECA’s from Canada, Germany and Japan have all been renegotiated and are now functioning. Private international commercial banks The involvement of private international commercial banks can be broadly split into three separate parts: Structured finance Since the early 1990’s several structured facilities of US$ 100m plus have been arranged by large Dutch, French, Canadian and other international banks. These amounts have used a variety of securities including the airport departure tax, sugar receipts, tourist receivables and credit card payments and have played an important role in financing infrastructural development. Credit lines made to Cuban commercial banks A number of (mostly) Canadian, German, French and Spanish banks have established ongoing relationships with Cuban commercial banks to both facilitate trade transactions on a correspondent basis and to extend lines of credit on a primary basis to those banks in support of trade transactions. Trade finance made directly to Cubanentities and/or foreign traders The secondary market for Cuban trade finance, (generally structured around discounted bills of exchange) is something of an ongoing anomaly in the market. Several (mainly) small financial institutions and funds have generated excellent returns (+13%) for over 10 years with a very low default rate as evidenced in their audited financial statements. The question of why rates have remained so high is a vexing one for the Central Bank and some businessmen would argue that it represents predatory pricing, or simply pricing at the margin falls off a cliff. The simplest explanation is that the high rates are merely a function of supply and demand. The latter is restricted due to the reluctance of many international financial institutions to antagonize the US Treasury for a relatively small market and the general complexity and time necessary to develop a successful business in Cuba. To understand why repayment is prioritized to providers of trade finance it is important to understand the role it plays in the Cuban economy which has an extensive and ongoing need for foreign products which is not suited to structured finance. This includes spare parts for machinery, chemicals, and small investments in infrastructure for the tourism, sugar, transport and other sectors. Non payment to a financial institution which has provided trade finance would further tarnish Cuba’s financial credibility and would make it practically very difficult for Cuba to purchase many of the necessary products it requires since traders are often disinclined to ship products n credit terms. Foreign financial institutions also emphasize that the instruments use afford them a strong level of legal assurance in the event of a default. Cuba’s credit rating As is clear from the table below, Cuba’s credit rating, as defined by various rating agencies, is extremely poor. This is driven principally by the sovereign debt default dating from 1986 as well as the defaults to ECAs in the 1990s. There are also various anecdotal stories of individual companies/traders who have suffered payment issues. In contrast to this pessimistic view most country managers of institutions with Cuban exposure consider that the risk of their own particular exposure is much lower and is not accurately reflected in the ratings detailed below:
Factors which may reduce Cuba risk Cuba’s ability to generate hard currency has significantly increased over the past five years, largely due to higher nickel prices internationally and service income from Venezuela for Cuban doctors and other professional services agreements. The defeat of Chávez in the recent Venezuelan referendum highlights the risk from a cooling of the bi-lateral relationship with Venezuela but does not suggest any imminent change. The centralization of the banking system in recent years has given some assurance to providers of finance to Cuba. In particular the use of the cuenta unica (single hard currency account through which all transactions are funneled) and the need to obtain Central Bank approval (for purchases by Cuban entities in hard currency) gives an implicit Central Bank guarantee to most transactions and ensures that the repayment has been put in the appropriate budget. The Central Bank President, Francisco Soberón, is widely respected and has placed his own credibility on ensuring the efficiency of the banking system which includes ending what he termed a culture of non-payment. On a structural level the corporate restrictions on the establishment of new companies, the opening of multiple bank accounts and the extremely limited use of complex financial instruments reduce the risk that corporate fraud might strip out productive assets from an entity leaving a shell to be picked over by creditors in the event of a default. While Cuban institutions clearly have no sub-prime exposure the effect of the ongoing turbulence in the international markets may have the effect of reducing the appetite for Cuba risk from foreign institutions. Already there has been a re-pricing in certain developing markets and given that Cuba is seen as an exotic risk this may reduce appetite from institutions focused on maintaining core business and dealing with issues closer to home. It is also of note that the financial sector as a whole is being used to impart discipline and rigor to the rest of the economy. In the past the Ministry of Economy & Planning was far more involved in allocation decisions. Implicitly and explicitly the financial systems through credit decisions made at an individual bank level have played an increasingly important role over the past few years.
Risk of default As detailed above the rating agencies appear overly pessimistic of Cuban financial risk and not to take into account the real and tangible improvements which have taken place both within and outside of the Cuban financial system. A myopic view of old defaults places Cuba in ill fitting company (Haiti, Sierra Leone). At the other extreme the Cuban Central Bank (BCC) appears overly optimistic regarding the risk premium which international institutions ought to attach to obligations associated with Cuba. This was reflected in the pricing of the recent London bond issue, which at 8% was widely perceived as being under-priced relative to market expectations. There is also still, fairly or not, a certain amount of political risk associated with Cuba and the ongoing and unrelenting hostility of the US administration means that Cuba does not have access to any of the international shock absorbers (IMF emergency bridging loans etc) in the event of a severe shock to the economy. From a lender’s perspective there is also the risk of political interference in a transaction given that, whatever the precise legal or operational independence of Cuban state owned institutions, they operate for the ultimate benefit of the state which could in a crisis prioritize for example maintaining a social safety net over meeting repayments. During the last few years a number of international financial institutions have stopped doing business with Cuba, reportedly due to Concern about extra-territorial reach of the US embargo against Cuba [it is of note that these institutions were worried more by US compliance risk than Cuban financial risk]. This encouraged some speculation that Cuba would struggle to maintain banking relations with the rest of the world in turn placing a serious strain on its economy. In any event, the effect of the withdrawal of several market participants has been more of a damp squib than a tropical storm. Business has continued much as before with market share being absorbed by existing participants. It is of note, however, that rates have risen and there appears to have been something of a slowdown in purchasing in mid 2007 which suggests a continuing financial constraint. In conclusion, Cuban risk is likely to remain perceived for some time by the mainstream financial community as a dangerous and exotic-sounding cocktail. At the margin, however, there is an increasing recognition that all Cuban risk is not the same and that several steps have been taken to ensure real financial disciple. The likelihood of a general Cuban default linked to some doomsday scenario may therefore be considered as analogous (but uncorrelated) to a general worldwide financial meltdown. While theoretically possible, neither is terribly likely. A final irony is that the very shortage of finance providers has meant that the institutions who are prepared to take onboard Cuban risk find this is a sector which is very much open to business. |
