|
The collapse in Argentine bond
prices year-to-date has validated our concern regarding the odds of
a negative outcome in the legal conflict between Argentina and
holdout creditors that threatens to hold performing bond markets
hostage. Last week we re-affirmed our underweight recommendation
for Argentine sovereign bonds twice; first, following the hearing
and second, following the subsequent Court's order seeking further
understanding of Argentina's proposed solution (* see footnote
below).
That said, valuations
have now reached a level that warrants exploring upside "tail risk"
scenarios. Our decision to maintain underweight recommendation
implies that we are not convinced that the odds favor embracing
expectations of a constructive solution at this stage but this does
not constrain us from exploring them.
At this stage, three
basic scenarios stand out, all of which imply second-guessing
judges, interpreting Argentina political rhetoric, and anticipating
holdout creditor responses:
-
Pari
passu with enforcement (our base case scenario):
The Court adopts the
Distric Court's payment formula and enjoins BNY. Two scenarios stem
from this one: either Argentina complies with the order (upside
surprise version) or falls into "technical default" by ignoring the
order and re-routing restructured debt service payments outside NY
(downside version, and effectiely our base case).
-
Pari
passu without enforcement (original upside scenario):
The Court adopts the
Distric Court's payment formula but does not enjoin BNY which
relieves restructured bondholders from the risk of a "technical
default."
-
Pari
passu in reverse (new upside "tail risk" scenario):
The Court adopts
Argentina's formula (2010 restructuring offer) and "crams down"
holdouts, which relieves restructured bondholders from the risk of
a "technical default."
Below we set aside the
base case scenario and the original alternative scenario and focus
on assessing the options faced by Argentina in the 3rd scneario
(new upside "tail risk" scenario). Argentina's "cram down" proposal
to the Court will be a function of the policy guidelines revealed
by Vice President Boudou and Minister of the Economy Lorenzino in
a
local newspaper interview published over the
weekend.
It's official:
Argentina will propose a "cram down" formula
The views from the Vice
President and the Econom Minister in that interview follow the
President's recent views regarding NY litigation. They make it
absolutely clear that the government intends to respond to the
Court's request with a proposal to "cram down" holdouts into the
2010 restructuring. The Minister's quote that provides the title to
the interview lays the government's litigating strategy bare: "We
are not convincing the vultures... we are convincing the
judges."
In her Congressional
inauguration speech last week President Kirchner reaffirmed that
Argentina will not pay holdout creditors (8% of private creditors)
any more than restructured bondholders (92% of private creditors).
The President justfied her position by pointing out that doing
otherwise would be illegal, economically unfeasible and unfair. The
President also appeared confident that judges would ultimately be
inclined to "cram down" holdout creditors because they would
realize that Argentina was a "leading case" for resolving future
sovereign restructurings - and therefore, a precedent central to
solving the debt overhang of developed economies (and not only
emerging economies).
We agree on the
relevance of many of these considerations for defining sovereign
public policy. However, our concern over the outcome of the
litigation reflects the understanding that the case will be
resolved in a NY Court by judges who may prove to be less
sympathetic to these guidelines and more to strict interpretation
of contractual law.
We fear that a
genuine "cram down" is not what the Court has in mind
Indeed, we fear that there is a
relevant disconnect between Argentina's perception of the
'pro rata'
formula that the Court may be
receptive to and what the Court is seriously willing to consider
when it unexpectedly put forth a request for a clarification from Argentina of its
proposal to pay holdouts 'pro
rata.'
First, a re-reading of
the October 26 partial ruling of the Appeals Court suggests judges
consider the policy arguments of the case (risk to future
restructurings, financial spill-over, etc) to have been settled in
favor of holdouts. We, and many market participants, are more
worried about the potential ramifications of the Argentine
precedent than the Court seems to be - but what matters here is
what Judges consider. If we are right in interpreting the October
26 partial ruling, the denial of NY certification and the denial of
panel rehearing then we would expect that the Court will base its
ruling on principal rather than on fear of potentially contributing
in some unknown way to financial instability.
Second, the Court's
recent order effectively signals that the panel of judges is
seeking compromise predicated on the belief that politics may not
be an impediment (Judge Pooler at the hearing: "politicans change
their mind, don't they?"). But it was also clear that the scope for
compromise is not unbound: we infer from the hearing that the Court
is unwilling to step outside the boundaries of contractual law
interpretation (Judge Raggi at the hearing: "we are here to enforce
contracts, not rewrite them").
Kirchner must deploy
"smoke screens" to obtain a "cram down"
We already addressed the developments
that might be considered supportive of the "upside risk" version of
the "pari passu with enforcement" scenario - that is, the one in
which in the face of an adverse and enforceable ruling Argentina
"blinks", pays holdouts in full and dispells "technical default"
risk (see **). We remain unconvinced of this scenario but
watchful.
In our opinion, the "new tail risk"
scenario involving a successful sovereign "cram down" that
determines upside risk to bond prices is also highly unlikely to
materialize. In order for this scenario to materialize President
Kirchner would need to deploy "smoke-screens" that either distract
NY Judges or betray the Argentine public opinion.
-
Option
1: A "smoke-screen" to distract NY judges: Argentina's 2005 debt restructuring
offered an option of Discount bonds and Par bonds (the 2010
restructuring did not, but we will leave this inconsisency aside
for a moment). Both the Discount and the Par bond options implied a
similar NPV hair-cut but the Par bond option did not require a
principal haircut (rather, it carried lower coupon interest and a
greater principal maturity extension). In proposing a "cram down"
President Kirchner might assume that Judges (like retail investors
in 2005) can be lured by the financial optics of the Par bond
option - which has to assume that Judges do not care to distinguish
between face value (FV) and net present value (NPV). We believe
that this "smoke screen" is unlikely to succeed because holdout
creditors have an interest in educating Judges that may not
distinguishing FV from NPV if left on their own. Note that a 2010
proposal (valued at spreads prior to the October 26 ruling) could
be worth more than 70% on an NPV basis but litigating holdouts have
specific claims that represent a 300% NPV claim value. Thus, the
Par bond "cram down" package is likely to be unsatisfactory to
holdouts and not the basis for re-defining the Court
ruling.
-
Option
2: A "smoke screen" to betray the Argentine public:
One of the key
parameters of the 2005 and 2010 restructuring deals is that
Argentina did not recognize past due interest claims (PDI) from
default date (Dec 2001) until issuance date (Dec 203) and
thereafter recognized it at new restructured coupon interst rates
(not the original, much higher, coupon interest rates). As
mentioned above, strictly respecting the 2010 proposal parameters,
including the constraint on "eligible claim" ratios (mostly
representing principle), provides a cram down proposal potentially
worth more than 70% to holdout creditors. We believe that holdouts
are pragmatic and if Argentina offers the 2010 swap terms on their
legal claims (rather than on the more constrained "eligible
claims") the holdouts might well signal to the Judges that their
receptiveness of the offer (after all, while falling short of 300%,
this deal would be potentially worth more than 210% - hardly what
one might define as a "cram down"). Off course, this "smoke screen"
would imply a deviation from the true terms of the 2010 swap and
requires that the President Kirchner would be betraying her promise
to Congress and Argentine citizens (i.e. that holdouts will not be
paid more than restructured bondholders). We discard this scenario
because we expect the President will keep her word.
A contrarian view of
the Argentine bond market today can be predicated on these
assumptions. However, we are skeptical that Kirchner's government
would succeed in imposing option 1 and are skeptical that Kirchner
would assume the political risk of deploying option 2. In the
absence of such "smoke screens" or "optical illusions" we consider
that the chances of a "genuine" sovereign "cram down" ruling from
the Court remain very slim. This draws from our belief that at this
stage policy considerations are settled and the Court's approach to
the case is dominated by the straightforward interpretation of
contractual obligations.
* Please refer to the
following for more details:
Subsequent to the
hearing we recommended fading the partial rebound in bond prices
resulting from a positive interpretation of the Court's latest
order requiring Argentina to present an alternative
'pro rata'
formula to pay holdout
creditors vs. the 100% upfront cash payment proposed by the
District Court (see:
Argentina: the Court’s “April Fools Order” commands caution—not
hope, Feb
29).
** In the second note mentioned in the
footnote above we addressed the likelihood of (what we believe
constitutes) the impossible: a scenario where Argentina surprises
markets and pays holdouts in full. We raised awareness of the fact
that the Argentine Treasury deposits at the Central Bank have
fallen $1.2 billion over the past two weeks without a justifiable
external debt payment obligation. This is relevant to the extent
that the District Court's order requires Argentina must pay
holdouts a similar figure ($1.4 billion) and that intensions to
abide by such a settlement might require stock-piling cash
elsewhere ahead of the surprise announcement. So without any
knowledge of the destiny of these “missing funds” we consider that
ahead of the ruling investors should be monitoring (to the extent
possible) any movements of Treasury cash.
|
