As the United States prepares to hoist its flag at an embassy in Cuba for the first time since the late 1950s, a small group of investors lies in wait, hoping to finally get paid after holding defaulted Cuban debt for as long as 15 years.
Julian Adams, of London-based Adelante Asset Management, is one of those investors—a small group of mostly British risk-takers who bought the debt a decade ago or longer and are now watching political developments on the communist-run island closely. Adams wouldn't disclose how much he owns, but with the debt trading at between 8 and 10 cents on the dollar for more than a 10 years, he owns a lot.
He likens it to a penny stock: "It trades around 10 cents on the dollar for a very long time. And then when one has the event, which in this case would be the lifting of the embargo, the debt restructuring, the economic reforms, then you get a pop in the value of the old debt."
Adams believes the debt, which Cuba stopped paying in 1986, could be settled for anywhere between 27 cents and 49 cents on the dollar, depending on the methodology used in a final settlement. For a brief period during the Clinton administration, when it looked as if relations were improving, it traded as high 35 cents on the dollar.
Getting paid on very old, defaulted debt isn't without precedent. Iraqi debt traded for between 8 and 10 cents on the dollar for a decade, and then settled for roughly 32 cents on the dollar after the U.S. invasion in 2003. Liberian debt traded for 3 cents on the dollar in the 1990s—creditors received 21 cents on the dollar for it in a 2008 buyback.
The portion of Cuba's total debt owned by Adams and hedge fund investors is impossible to pin down, because it's difficult to ascertain how much Cuban debt exists in the first place. It comes in many varieties, and its issuance and payment have sometimes been managed in ways that are financially unconventional.
Moody's estimated in a June report that Cuba's total external debt exceeds $20 billion, or 24 percent of the ratings agency's estimate for Cuban gross domestic product.
"There's a lot of different types of debt. You can buy 25 to 50 different loan agreements all with different jurisdictions and covenants," said emerging market debt specialist Peter Bartlett, who estimates that he paid 5 to 10 cents on the dollar for Cuban debt he's owned for more than 10 years. "It's like buying fine wine or vintage cars—you need to know the specific features of each asset well."
Another holder of the debt, Nicholas Berry of London-based Stancroft Trust, said he owns roughly $140 million in face value, which he started accumulating 15 "long" years ago. There could be as many as five significant holders, most of them in London because U.S. investors and firms are prohibited from trading in the debt due to the U.S. embargo against Cuba.
Berry put the total outstanding face value on Cuba's defaulted debt from the 1980s at around $1 billion. It's estimated that when past-due interest is included, the amount could rise to as much as $5 billion. Complicating that calculation is that some of the debt is denominated in a currency that don't exist any more—the Deutschemark.
Generally what happens in the case of such debt is the actual principal is written down sharply—in the case of Iraq, it was slashed by 80 percent—and then investors make money on the accumulated past-due interest, or what's known in the restructuring world as PDI.
They would not necessarily receive cash. There's precedent for payment in the form of a financial instrument that "isn't worth a lot right now but can be extremely valuable in the future," Berry said. For example, what are known as GDP warrants have been used in other debt restructuring deals—those are instruments that pay more as the GDP grows. Another option is a "debt for equity swap," an arrangement under which debt holders receive equity in some kind of infrastructure or investment project that they believe will grow in value.
Cuba will want to settle the debt some day, Adams said, because "once they do that, they regain access to capital markets, which allows them to issue new debt very cheaply. Their overall cost of financing goes down drastically, as well for trade finance and other credits."
Both he and Berry see themselves not as vulture investors, but as investors who are interested in capitalizing on a slow-going reform process on the island.
"We get asked when we go to Havana: 'Why do you invest in our debt?' Because they don't like it, really—they try to forget about it," Adams said. "And we say, 'Because there's nothing else. There's no stock market, there's no bonds.' " So this is the only way of doing it—of getting that clear portfolio exposure."