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REFILE-ANALYSIS-Iraqi sovereign debt holders see value
Updated: 8:36 a.m. PT Feb 28, 2007
LONDON - Iraq's daily carnage and factional violence may prompt the question whether a post-Saddam era government will ever repay its debts, but many holders of the country's sovereign bonds say they are still worth the risk.

Investors reckon the debt, due to be repaid in full in 20 years, still offers value despite Iraq's struggle to avoid an all-out civil war between Sunni Arabs and Shi'ites and the attendant threat to the country's future as a single entity.

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Iraq's 2028 sovereign bond has an enticing double digit yield contrasting favourably with major international market returns of four to five percent, they point out.

Investor logic for holding debt in as precarious a state as Iraq is backed by the third largest proven oil reserves, U.S. backing and precedent in international sovereign markets for repayment of debt after a national split.

After the break-up of Yugoslavia, its sovereign debt was split amongst the successor nations and is being repaid to investors.

"Of course you should own bonds you think are going to default, because you don't know for sure if they are going to default and in the meantime you get to eat while you wait," said Tom Cooper, portfolio manager at Boston-based GMO who runs the $2.9 billion Emerging Country Debt fund.

Iraq's $2.7 billion worth of sovereign bonds mature in 2028 and do not start to pay principal until 2020.

But because the bonds trade at about 65 cents on the dollar -- around where many investors bought the paper -- and Iraq continues to honour an annual 5.8 percent coupon payment, they yield an effective 10.185 percent on that investment.

That is a hefty 545.3 basis point spread over the 30-year U.S. Treasury bond.

"Ecuador is more risky," said Cooper, whose fund is the third largest holder of Iraqi debt among portfolio investors according to the eMAXX database. eMAXX is own by Lipper, a Reuters company.

Ecuador offers a 777.6 basis point spread over the 30-year Treasury, but its new president has made a debt restructuring the corner stone of his election campaign.


POST-SADDAM

Iraq's restructured $14 billion worth of commercial claims against the former regime of Saddam Hussein in January 2006.

When the bonds began trading on Jan. 19, 2006, the price was 69 cents on the dollar and quickly reached a high of 74 cents on Jan. 24 but have trended lower ever since <XS0240295575=R>.

Investment portfolios hold 4.5 percent of the outstanding par amount of Iraq bonds, spread through 16 firms and worth $121.6 million, according to the latest eMAXX data. For table of top holders, click on [ID:nL2821751].

Investors' argument is that Iraq ultimately has the means to service this debt because of its oil reserves, and that current prices are secondary to the fat yield.

"It is mostly a yield play, but of course the dollar price at 65 cents provides a cushion if it should become a default play," said Bart van der Made, senior investment manager at ING Investment Management in the Hague.

"The drop that you would expect (in default) would be from 65 to about 30 or 35 cents on the dollar," said van der Made, adding "If you make that drop from 65 cents that is a different percentage loss than when you are making it from 100 percent. In that sense it is a cushion." ING is the largest portfolio holder of Iraqi debt with 1.7 percent of par bonds outstanding.


SPLIT AND WITHDRAW

Iraq plans to convene a high-level meeting of its neighbours and the Group of Eight countries as early as April to help stabilise the country.

Anger over the Iraq war -- which has left tens of thousands of Iraqis and some 3,100 U.S. troops dead -- helped Democrats take control of both houses of the U.S. Congress in November.

Republican U.S. President George W. Bush wants to send more troops while Democrats are aiming to limit and/or redefine the U.S. role in Iraq and bring troops home, leading to speculation that a pullout before Baghdad is ready could split the country.

Kurds and Shi'ites to the north and south, respectively, would control the oil fields, leaving Sunni Arabs in the central and western regions without meaningful access to them.

One fund manager says even if U.S. troops reduce their role or the country splits up, paying back debt will continue.

Cathy Hepworth, portfolio manager and sovereign strategist at Prudential Investment Management Fixed Income in Newark, New Jersey, said that servicing the debt seemed to be "a pretty high priority" for whoever would ultimately be in charge of the country.

"In that regard, I think we feel comfortable. I know it seems like (a split) is almost an inevitability, but I just don't think that is going to happen," Hepworth said. Prudential is the fourth largest portfolio investor in Iraqi debt.

Another portfolio manager is not as confident.

"Such an event would trigger a sharp sell-off in Iraq bonds. It is always uncertain and the market doesn't like uncertainty. In that case we would have to think about selling our Iraq position," said Anton Houser, emerging markets debt portfolio manager at ERSTE-SPARINVEST in Vienna. The firm is the sixth largest holder of Iraqi debt.