NICARAGUA TRIES TO SUSPEND PAYMENT ON LOCAL BANK

C O N F I D E N T I A L SECTION 01 OF 04 MANAGUA 000443 SIPDIS SIPDIS STATE FOR WHA/CEN, WHA/AND, WHA/EPSC, INR/IAA, AND EEB/OMA STATE PASS TO OPIC AND USOAS DEPT PASS TO USAID/LAC FOR D BATTLE USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR E.O. 12958: DECL: 04/11/2018 TAGS: EFIN ECON PGOV NU SUBJECT: NICARAGUA TRIES TO SUSPEND PAYMENT ON LOCAL BANK BONDS REF: A. MANAGUA 373 ¶B. 07 MANAGUA 2564 ¶C. 07 MANAGUA 2539 ¶D. 07 MANAGUA 2185 ¶E. 07 MANAGUA 1719 ¶F. 06 MANAGUA 2611 Classified By: Ambassador Paul Trivelli for reasons 1.4 b&d. ¶1. (C) Summary: On April 4, a Criminal District Court judge issued a sequestration order for all of the remaining USD 190 million in Negotiable Investment Certificates (CENIs),in order to stop the Central Bank (BCN) from making a USD 20 million coupon payment on April 15. The CENIs have been a long standing source of tension between President Ortega's political and economic advisors. When President Ortega rejected a refinancing agreement between the BCN and the banks holding the CENIs, he told the banks to negotiate a new agreement with the Attorney General and Comptroller General, FSLN political hardliners. The banks declined, believing the negotiations would not be "voluntary." Despite the public legal and political pressures the GON is exerting on the banks holding the CENIs, the BCN staff view the bonds as legally binding obligations and absent a Supreme Court decision or a new refinancing deal, they continue to prepare to make the April 15 payment. The current political meddling in financial policy, if sustained, will do damage to the country's creditworthiness, the good operations of the banking system, and the prospects of creating a well functioning capital market. Post will present the CENIs history and political implications septel. End Summary. The CENIs hit the Headlines Again -------------- ¶2. (SBU) At 4:30pm on Friday, April 4, Assistant Prosecutor Ana Maria Guido requested that Criminal District Court Judge Julio Cesar Arias issue an order to sequester all of the USD 190 million in "Bonos Bancarios" (aka CENIs) still in circulation in order to legally suspend the USD 20 million coupon payment due April 15. The CENIs are held by two of Nicaragua's largest banks, BanPro, holding USD 150 million in CENIs with a capital base of USD 80.6 million, and Bancentro, holding USD 39 million in CENIs with a capital base of USD 65.8 million. (Note: In 2003 the original CENIs we refinanced and replaced with Bonos Bancarios. Although the GON and public still use the term CENIs, they are referring to the replacement instruments, Bonos Bancarios. We will use the same shorthand throughout this cable. End Note) A Deal Gets Done and Then Undone -------------- ¶3. (C) The CENIs have been a long standing source of tension between President Ortega's political and economic advisors. Back in January it seemed that Senior Economic Advisor Bayardo Arce and Central Bank (BCN) President Antenor Rosales had convinced Ortega of the importance of continuing to pay the CENIs and to negotiate their refinancing instead of going into default. In February, Rosales, Arce, and the banks agreed to replace the bonos bancarios with new 10-year instruments at a 1% point reduction in interest rate to an average of 7.3%. In net present value the agreement saved the GON USD 20 million; however, it increased nominal payments by USD 5 million over the bonds' ten-year life span. The BCN Board of Directors refused to sign off on the agreement for fear of judicial attacks as the refinancing is exactly the same operation for which opposition leader Eduardo Montealegre is being prosecuted. ¶4. (C) Rosales planned to sign the agreement himself instead using his authority as BCN President, but Ortega rejected the deal citing the increase in the nominal payments. Ortega created a new negotiation commission comprised of political hardliners, Comptroller General (CGR) Luis Angel Montenegro and Attorney General (PGR - Procurador General) Hernan Estrada, to try and negotiate "a better deal." However, the banks refused to come to the table feeling the negotiations would not be truly voluntary. The GON Goes on the Offensive -------------- ¶5. (C) In response to the banks' non-participation, the GON reverted to a tactic that has worked well in the energy sector: publicly and financially back the banks into a corner forcing them to come to the table and accept any agreement offered to them. The GON successfully used this tactic to force Esso to bring in Venezuelan crude in the fall of 2007 (Ref B). Supreme Court (CSJ) Vice President Rafael Solis (known as Ortega's legal right hand) confirmed this to the local media: "Since the banks did not want to sit down and negotiate with the new Commission (PGR and CGR),the Commission is now pressuring them using judicial means." The GON and banks now have until April 15, when the payment is due, to negotiate and agreement. (Note: The Banks can accept a grace period on payments as part of the refinancing, and the GON would get out of the April 15 payment. End Note.) ¶6. (U) The payment suspension has been in the works for several months. On February 13, in response to a request from Deputy Prosecutor Guido, Judge Arias issued an order to stop payment on the CENIs. On February 14, BCN President Rosales filed a request to nullify Arias' order because it violated the Capital Markets Law. The Capital Markets Law states that payment on bonds can only be suspended if the bonds and/or coupons are physically annotated to that effect. In response, Guido and Arias worked together to issue the April 5 sequestration order, allowing the court to physically annotate the bonds, thereby stopping the April 15 (and possibly the October 15) payment. On April 7, Arias denied Rosales' request for nullification, although that decision is more properly the purview of the CSJ. Continuing with the sequestration effort, Judge Arias spent two nights in the BanPro central offices trying to gain physical access to the bonds to annotate them. Late on April 9, BanPro had retrieved its CENIs and presented them to Arias. ¶7. (C) An observer present during an April 9 GON Financial Committee meeting (comprised of BCN and Ministry of Finance senior staff) views the media circus as an effort to play "good cop/bad cop" with the banks to force them to renegotiate the CENIs on terms more agreeable to the political arm of the FSLN. The BCN staff regard the CENIs as legally binding obligations of the GON and the rulings of a criminal district judge and the actions of a special prosecutor as non-binding. "The GON had the authority under the Constitution to issue the bonds and the BCN has the obligation to honor them, especially when provisions have been made in the budget to honor them." This view could change if the CSJ rules that the CENIs are unconstitutional. Though Supreme Court Vice President Solis has repeatedly said it is a decision that the CSJ is not yet ready to make. Therefore, absent a CSJ decision or a new refinancing deal, the BCN staff continues to prepare to make the April 15 payment. On April 9, the Finance Ministry stated that they will not pay the CENIs until Arias rescinds the court order. GON Motivations -------------- ¶8. (C) Both Comptroller General Montenegro and Attorney General Estrada have made clear their belief that the CENIs are illegal and are determined to use them for political revenge against former Finance Minister Eduardo Montealegre and anti-pacto Liberals. While they build their cases, Montenegro and Estrada also want to stop GON payments to "rich, corrupt bankers at the expense of the Nicaraguan people." According to Banking Superintendent Victor Urcuyo, FSLN party hardliners have been determined from the beginning to make no CENIs payments at all during the Ortega administration. Concentrating attention on payment also allows the FSLN hard-liners to divert attention away from questions about the role of several prominent Nicaraguans, including FSLN party members, in the initial bank failures that generated the CENIs. The Implications of the Sequestration -------------- ¶9. (C) Banking Superintendent Urcuyo does not believe the CENIs issue will destabilize Nicaragua's financial sector. In the event of non-payment, Urcuyo plans to allow both banks to write down the value of the bonds over the course of two years. There will be short term problems with BanPro's capitalization, but the Superintendency is determining additional ways to help the bank through this period. (Note: A back of the envelope calculation of BanPro's overall capital/asset ratio is less than 1%, Bancentro's is 8.7%. End Note.) As well, BAC and Banco Uno, the next largest banks in Nicaragua are now wholly U.S.-owned and do hold any CENIs. Therefore, the majority of Nicaragua's banking system is not exposed and should be able to weather any storms. Urcuyo does not expect any runs on BanPro or Bancentro as most Nicaraguans do not understand the connection between the payment of the bonds and the financial health of the institutions that hold their money. That said, the Superintendency and BCN are laying contingency plans in case a run does materialize. ¶10. (C) The GON is avoiding the word "default," claiming the sequestration and suspension is allowed by law. For international markets and bankers, however, will likely be viewed as default, no matter the vocabulary. Irrespective of whether the CENIs are paid or not, these political games have hurt Nicaragua's international credit rating and will make future borrowing more expensive. IMF lawyers are studying whether a domestic debt default would have the same implications as a foreign debt default for Nicaragua's standing with the IMF. Either way, both the World Bank and IMF have made it clear to the GON's fiscal and monetary authorities that they will withhold scheduled transfers if the GON defaults on the CENIs payments (Ref A). The World Bank has committed to USD 20 million in budget support payments in 2008, but has informed the GON it will not present the proposal to its Board if there is a CENIs default. ¶11. (SBU) The CENIs scandal has also hurt Nicaragua's nascent efforts to create a domestic debt market, assisted by a U.S. Treasury advisor (Ref E). The market is too young for Nicaragua's reputation as a debtor to recover soon. This is particularly bad news given that Nicaragua had finally resolved its commercial foreign debt problem and was now able to offer its instruments to the international financial community (Ref B). A default would also limit the GON's sources for budget deficit financing as the institutions willing to purchase the newly created Treasury Bonds will be limited. This will force the GON to revert to foreign borrowing again; an activity currently limited by the terms of the Highly Indebted Poor Country (HIPC) debt forgiveness deal. Comment -------------- ¶12. (C) At this point many of our contacts still hope that the more reasonable members of the GON will prevail and the CENIs coupons will be submitted to the BCN and the payment will be honored. Between now and then, however, there will be much political hay-making and hand-wringing, and BanPro and Bancentro will be roughly handled. The issue plays too well domestically for the GON not to try to get election mileage out of the case. The sad reality is that all of the FSLN political hardliners have no understanding of the damage they are doing to the country's creditworthiness, the good operations of the financial system, and the prospects of creating a well functioning capital market. ¶13. (C) This is the first serious case where FSLN political leaders have begun to meddle in economic policy and operations that have significant ramifications for the larger national economy. Previous FSLN/Ortega economic attacks have been against large foreign firms (e.g. Exxon/Esso and the Spanish energy firm Union Fenosa). These economic attacks have had little direct impact on the domestic private sector. However, this new action by Ortega proxies, including Estrada, Montenegro and judges, seeks to intentionally default on sovereign debt obligations and in the process severely damage the capital position of two major banks. We are concerned, as we noted after the 2006 election, that this is a severe lapse of the GON's responsibility (and Ortega's 2006 post-campaign promises) to adhere to fiscally responsible and sound macroeconomic policy (Ref F). TRIVELLI