In this note we focus
on the possible implications of Argentina's proposal of a 'pro
rata' formula—the first issue on remand by the Court of Appeals. We
refrain from revisiting the second issue on remand (i.e. whether
financial intermediaries like BoNY will be constrained by Court
orders). Sufficient is to say that, while acknowledging that the
latter is not a settled matter yet, we expect that BoNY will not be
spared from the Court orders (see
Argentina: NY Court ready to slam the door of the US payment system
shut in Argentina's face, Feb 28).
We have been concerned
that if Argentina does not deliver enough flexibility (in NPV
terms) the Court will be inclined to rule against Argentina. The
analysis below suggest that despite variations around the 2010
proposal that can be used to "sweeten" the it, the NPV of most 'pro
rata' payment formulas proposed by Argentina will inevitably
represent a confrontational strategy rather than a compromise
strategy.
But we are watchful,
particularly given an article in the local press this morning
suggesting a possible package that might be considered a game
changer (although the devil is in the details) and, if so, may
offer the 'silver lining' in Argentina's 'pari passu' saga. See
below.
The package described
in today’s local press: a potential game-changer?
In contrast, to
packages that are limited to 'sweetening' the 2010 deal, any
proposal from Argentina that fully recognizes PDI—and hence,
deviates substantially from the 2010 offer—can shift expectations
in favor of a potential 'compromise' that materially diminishes
risks of future technical default. We lay out a simple
(theoretical) example of such a proposal consisting of a Par bond
payment for full claims and show that the NPV is attractive to
holdouts- and hence, to the Court.
In addition, we note an
article in today's
Ambito Financiero suggests a different package (a Par
bond for principal claims and a Discount bond for PDI claims) that
might be presented and - while not as attractive as the one above -
may be valuable enough to fall into the category of ‘compromise’.
We incorporate this package into the analysis below. Of course, we
cannot anticipate whether this article adequately characterizes the
proposal that Argentina will present on March 29– but if it does,
we point out that its NPV is potentially attractive for
holdouts.
This is because the
package described in the article would imply recognition of past
due interest (PDI) – and this implies a significant deviation from
the 2010 debt restructuring terms. While Courts have said that "we
are here to enforce contracts, not rewrite them" we believe that
holdouts have an interest in signaling their interest or lack
thereof in any proposal Argentina makes. And if, despite a
rewriting of contracts by Argentina, the NPV is attractive to
plaintiffs we find it hard to believe that the Court would ignore
the latter's opinion.
Is Argentina really
ready to ‘blink’ in the game of chicken and, hence, will President
Kirchner betray her promise to not pay holdouts more than
restructured bondholders? Ambito’s article implies that this may be
the case. We will have to wait until March 29 for certainty
regarding Argentina’s offer. But we want to highlight that this bit
of local press information provides an interesting option to watch
out for on March 29.
What to look for on
March 29
Upon disclosure of
Argentina’s ‘pro rata’ formula we believe it will be important to
classify that proposal in one of two possible buckets:
-
A
‘confrontational’ strategy: This would be the case if Argentina
stands by its promise to deliver a proposal along the lines of the
2010 restructuring (or one of several possible variations around
it). In this scenario the NPV of the proposal (even if enhanced
beyond the 2010 offer) falls significantly short of the value of
the plaintiffs' Court claims. This implies Argentina is seeking an
unprecedented sovereign ‘cram down’ from the Court. Market
uncertainty regarding the likelihood of that occurring will linger
until the Court effectively delivers a ruling. But bond prices are
likely to slip if the proposal falls into this category given the
heightened risk of technical default that such a strategy entails
if it fails.
-
A
‘compromising’ strategy: This would the case if instead,
Argentina surprises with a (significantly) better than expected
proposal—and one that offers an NPV that approximates the value of
the plaintiffs' Court claims. Here again, market uncertainty will
linger given the Court ruling remains pending. But bond prices may
rise given the risk that holdout creditors might respond by
signaling to the Court their willingness to embrace this offer.
That signal can go a long way to deterring the Court from imposing
one of two uncomfortable extremes: a ‘cram down’ (favorable to
Argentina) or a strict contractual interpretation (favorable to
holdouts).
Until today's Ambito
article we were expecting that Argentina's filing would represent a
‘confrontational’ strategy. President Kirchner has stated that
proposing anything better than the 2010 deal would be "illegal, not
economically feasible, and unfair." And the Minister of Economy has
stated that the strategy involves "convincing the judges, not the
holdouts"—suggesting the NPV enhancements that might be hung on the
2010 proposal are unlikely to go as far as tempting holdouts to
voluntarily embrace it.
Distinguishing a
‘confrontational’ from a 'compromising' strategy
In this brief we
provide investors guidelines to compare the value of potential
proposals that Argentina may offer the Court. While expecting
Argentina to adhere to the broad guidelines of the 2010 offer, we
allow room for variations in the offer that can enhance its
value.
One variation of this
sort would be to offer a Par bond instead of a Discount bond. Other
sweeteners include recognizing retroactive payments on GDP warrants
and/or retroactive interest on Republic 17s. We note that the net
present values (NPVs) of all these alternative proposals fall
visibly short of the value of court claims currently held by
holdouts.
This is true even when
the variations around the 2010 proposal are valued at a (lower) YTM
than that which prevails on Argentina's restructured bonds today.
Thus, we believe that all of these possible packages will be viewed
by the holdouts and the Court as representing a ‘confrontational’
strategy by Argentina in pursuit of a ‘cram down’
ruling.
In our view, the
potential "swing factor" that could signal a ‘compromising’
strategy acceptable to the Court would involve commitment to more
favorable treatment of past due interest (PDI) on old bonds than in
2010 (see
Argentina: The (improbable) "smoke screens" Kirchner needs to
deploy to obtain a surprise sovereign "cram down", March 3). This involves a
substantial (and hence, politically risky) deviation from the 2010
deal which we do not anticipate Argentina proposing. However, if
Argentina were to consider 'blinking' first (rather than waiting
for the Court to do so) we would look for that signal in its
proposed treatment of PDI claims.
Recall that the 2005
and 2010 deals recognized principal but not the PDI claims. The par
claims tendered by investors in 2010 were slightly above the 100%
principal claim (claim ratios varied widely from 10% to 135% but
the extremes reflected coupon strips—at the low end—and
capitalizing bonds—at the high end).
In contrast, currently,
the share of holdout creditor Court claims represented by PDI
claims far exceeds the principal claims. The Exchange Bondholder
Group (EBG) filings suggest that the plaintiffs’ $1.43 billion
claim against Argentina involves a principal claim of only $428
million. If so, this implies that plaintiffs’ par claim today
stands at 334% (composed of 100% principal + 234% ‘past due’
interest)—far above the ‘eligible claims’ (as unilaterally defined
by Argentina in both its 2005 and 2010 tender offers).
The difference between
the ‘eligible claim’ ratio (near 100%) of the 2010 offer and
plaintiff’s (334%) contractual claim is enormous. Thus, PDI
recognition is the single most important factor which can be
adjusted in order to approximate the NPV of the 2010 proposal to
the value of Court claims and determine a compromise.
The NPV of proposals
that follow the guidelines of the 2010 offer
Valuing Argentina’s
‘pro rata’ proposal of March 29 in order to determine whether it
reflects an ‘confrontational’ strategy or a ‘compromise’ involves
some arithmetic. The first two tables provide parameters to value a
proposal and the NPV associated to each of them.
First, we estimate the
value (at current YTM) of the "original" 2010 proposal (a Discount
bond exchange) if offered today. We also value an "alternative"
2010 proposal (a Par bond exchange) and the potential addition of
"sweeteners" to either (retroactive payments on GDP warrants and
Republic 17s). These valuations are all based on proposals that
preserve the critical feature of not recognizing PDI on old bonds
of the original 2010 offer. Therefore they represent a major
deviation from contractual law interpretation the Court might be
expected to embrace.
Second, we value these
same proposals at (lower) YTM: for instance, at the YTM prevailing
prior to the October 26 ruling, which is some 460 to 800 bps lower
than today. Why do we emphasize this metric? We use the lower YTM
prior to the adverse October 26 Court of Appeals ruling in order to
illustrate the potential (higher) value of such packages if markets
anticipate that holdouts will embrace the offer. There is no doubt
that holdout creditors are aware that this litigation risk premium
should disappear if they accept the deal and hence, they should be
expected to value Argentina proposal from a perspective of a lower
discount factor.
The rationale for
tweaking the 2010 deal and alternatively offering a Par bond (as
was the case in the 2005 restructuring) is that it provides more
favorable optics (relative to a Discount bond) for the Court since
it does not involve a principal haircut (while the Discount bond
offered in 2010 implies a 66.3% principal haircut). Judges might be
attracted to a proposal that leaves face value (FV) intact—and a
Par bond option offers a higher NPV recovery to holdouts than does
a Discount bond option. Of course, plaintiffs have an interest in
educating the Court regarding the vastly inferior NPV a Par bond
package (that only recognized principal claims and not PDI) brings
to the table relative to the value of a recognition of full legal
claims on record.
Indeed, the NPVs of
such proposals fall far short of the 334% value of the Court claims
held by holdout creditors. At current YTM the NPV ranges from
48-91% of principal ('eligible claim'). At the YTM prior to October
26 ruling their NPV rises to a range of 63-106% of principal
('eligible claims'). Therefore, while substantially above the value
conventionally associated with Argentina's 2005 or 2010 proposals
these valuations fall short of what holdouts might aspire to
collect on their claims after almost a decade of passing up
Argentina's offers and relying on litigating strategies. We
consider that all these variations of the 2010 proposal will be
viewed by the Court as 'confrontational' strategies—rather than a
sign of 'compromise'.
The potential ‘swing
factor’: The NPV of a proposal that recognizes PDI
Finally, we analyze the
value of a simple offer consisting of a Par bond and a Republic 17
(as PIK of retroactive interest on the Par bond) exchanged for full
principal and PDI claims as defined in court (estimated at 334%)
rather than claims as defined in the 2010 restructuring (in the
neighborhood of 100%).
Unlike the proposals
analyzed before, the theoretical Par bond proposal (recognizing
full Court claims) can unambiguously classify as a 'compromise'
because it yields an NPV of 225-287% of par compared to the 310%
par claim. Effectively, it represents an offer of 67-93% relative
to the court claims (vastly superior to the aforementioned offers
representing 20-34% relative to Court claims). The last two tables
summarize the proposals (valuing them alternatively at the current
YTM or at the YTM prior to October 26 ruling).
And what about the
'Ambito package'? The devil is in the (unknown
details)
In light of the
suggestions in the Ambito Financiero article we add the NPV
analysis implied by this package too – emphasizing that, if
proposed, it would imply a significant deviation from the 2010
offer and a political acknowledgement of defeat by President
Cristina Kirchner. The article only mentions payment of a Par bond
for principal and a Discount bond for PDI. It does not mention GDP
warrants nor does it clarify if the retroactive interest on the
Discount bond will be paid in kind (PIK) in the form of a Republic
17 (as was the case in 2010). Thus, we lay out two scenarios. One
with a Republic 17 bond (in line with 2010 proposal) and one
without (strict interpretation package in the Ambito article). The
results are in the table below:
The "Ambito proposal"
falls in a grey area. If it does not include a Republic 17 in the
package then the NPV is 133% in the best case (assuming pre-Oct 26
YTM) and looks like a "confrontational" proposal that would require
the Court to deviate significantly from contractual law (cram down)
to support it - unlikely in our view.
However, if a Republic
17 is included (which the article makes no mention of) then the
metrics start to change in a meaningful way. Now the NPV (while
nowhere near a simple Par bond package) is potentially worth 179%
of par claim in the best scenario (valued at pre Oct 26 YTM). True
falls short of 334%. But it exceeds by multiples the value at which
holdouts likely purchased the claims (implying a meaningful
economic windfall) and also the package that restructured
bondholders received in 2005 and 2010 (implying a compromising
offer by Kirchner).
Investors focused on
Argentine markets have been forced to second-guess the response of
Courts, Argentine politicians, third party intermediaries involved
in litigation. To anticipate markets, the time is now coming when
it becomes important to assess the potential value the NPV of the
March 29 proposal and second-guess the response from holdout
creditors.
Stay
tuned.
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