S&P Downgrades El Salvador To 'SD' On Pension Debt Exchange; Distressed Exchange Subsequently Cured
Overview
• | El Salvador conducted a pension debt exchange on April 28, offering private pension funds a mix of new certificates to replace earlier sovereign financial obligations that had been partly issued after a debt exchange conducted in 2017. |
• | According to our criteria, we consider this transaction distressed based on the likelihood of a conventional default absent the participation of the two pension funds, given the sovereign's pronounced macroeconomic vulnerabilities and very limited financing alternatives. |
• | A distressed debt exchange under our criteria is tantamount to default. We lowered our sovereign credit ratings on El Salvador to 'SD/SD' from 'CCC+/C'. |
• | The new terms for the pension debt became effective immediately. According to our policies, we will wait one business day and will raise the long-term sovereign credit ratings, most likely to 'CCC+'. |
Rating Action
On May 9, 2023, S&P Global Ratings lowered its sovereign credit ratings on El Salvador to 'SD/SD' from 'CCC+/C'. We also affirmed our 'CCC+' long-term issue ratings. Our transfer and convertibility (T&C) assessment remains at 'AAA'.
Rationale
We lowered our sovereign credit ratings on El Salvador to 'SD' following a pension debt exchange on April 28, which we view as distressed owing to the government's limited financing alternatives. Since the new terms became effective immediately, the default has already been cured. Therefore, we plan to raise the long-term and short-term ratings on May 10, most likely to 'CCC+' and 'C', respectively.
The government of El Salvador offered private pension funds a mix of three instruments with different maturities, interest rates, and capital repayment profiles. Two of the new instruments match the terms of the previously outstanding pension certificates, and the third instrument has a higher interest rate, longer maturity, and different repayment profile. The private pension funds decided to allocate 99% of their portfolio to the third certificate that pays a higher interest rate (7% instead of the 4.5% or 6% rate offered on the previous certificates) but has a longer maturity (50 years instead of 24 years or 44 years of outstanding maturities). The amortization profile of these certificates does not have capital or interest payments for the first four years. As a result, upon the exchange, the government will have fiscal relief of around $500 million annually over the next four years (about 1.5% of GDP annually).
In general, at such low ratings levels, we consider most exchanges as distressed and tantamount to a default. We had signaled, after the last two debt repurchases, that we would analyze any subsequent debt exchange at this rating level on a case-by-case basis and in the prevailing macroeconomic context. We indicated that we could classify such exchanges as distressed, indicating that, without the exchange, a conventional default could ensue. Amid limited financing options, in our view, the government is partly relying on the pension debt exchange to alleviate fiscal spending needs by lowering debt service payments for the next four years on pension-related financial debt. The fiscal relief provided by the previous pension reform of 2017 (which we considered a distressed exchange and tantamount to default) lasted for three to five years and has already expired.
We affirmed our long-term sovereign issue ratings at 'CCC+' because the government has remained current on its capital and interest payment on its Eurobonds. The government paid a sizable bullet bond amortization in January 2023 for $604 million by getting financing from multilateral lending institutions and following two debt repurchases in 2022, which reduced the bullet bond amortization (originally $800 million). However, the ratings remain constrained by limited financing alternatives, heavy reliance on short-term debt, high debt, and hefty debt service payments, amid a weak payment culture. Dollarization also limits monetary flexibility.
Related Criteria
Related Research
In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.
After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.
The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.
The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').
Ratings List
Downgraded; CreditWatch/Outlook Action | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
To | From | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Sovereign Credit Rating | SD/SD | CCC+/Negative/C | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Ratings Affirmed | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Transfer & Convertibility Assessment | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Local Currency | AAA | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Senior Unsecured | CCC+ |
Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column.
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