-
We recommend fading the Argentine
external bond market's rebound following the Court's 'RSVP
order'
-
The RSVP order itself
should not change prospects for negative ruling or an unlikely
voluntary negotiation
-
Focus of investors
bidding the market may instead respond to expectations over the
post-ruling outlook
-
Stays on orders are
possible and can delay the litigation end-game, important for CDS
term structure
-
Yet feasibility of
'payment re-routing' as a Plan B to exit a hypothetical 'technical
default' is highly tentative
-
In contrast to external
law debt rebound the bid for domestic USD law bonds may have more
legs to it
Surprisingly,
Argentina’s bond market rebounded last week off the back of the
Court’s ‘RSVP order’ directing holdout creditors to respond by
April 2 to Argentina's ‘cram down’ proposal of March 29 (See first
chart below)—even as 'technical default' risk remains high (see
second chart below)
Given the binary nature
of litigation outcome we are inclined to fade the rebound near-term
and to reassess the outlook once the Appeals Court delivers its
pending ruling.
Addmitedly, in some
respect, the price dynamics offers evidence of the supportive
‘technical position’ of the market (i.e. a lot of bad news is
already in bond prices). But if the current rebound is to
last—recall that the one following the Court's 'Proposal order' to
Argentina (March 1) was surprising but short-lived—then it should
be possible to identify a fundamental driver to give it its
legs.
Therefore, we ask
ourselves whether the market response to the issuance of the
Court's 'RSVP order'...
-
Suggests that the Court
might be inclined to avoid a negative ruling for
Argentina?
-
Suggests that the Court
might be effectively guiding Argentina and holdouts to a negotiated
solution?
-
Reflects a shift of
investor focus to a (potentially more hopeful) landscape
post-negative ruling?
We are unconvinced of
the first two possibilities. The third scenario is a plausible
explanation of price action. Indeed, it is consistent with the fact
that new investors entering the approaching Argentina's distress
opportunity are inclined to assume that Argentina is capable of
finding a way to efficiently delay, 'work around' (or 'work itself
out of') the potential 'technical default' threat that a negative
ruling represents. This is borne out by the recent spread
compression between USD and EUR discounts—where, given the
optionality of EUR paper being excluded from Court orders, new
entrants have concentrated bids (see chart below).
Delay is certainly
possible but at this stage we do not share the confidence in the
'work-around' scenarios. We do believe that domestic Argentine
politics would be supportive of a 'Plan B' to make debt payments on
restructured external debt. We discuss the alternative shapes of
such plans but we remain concerned that the current state of
discussion over the mechanics of such processes is green and too
many questions remain unanswered.
A negative ruling:
are 'second thoughts' justified? We do not think so.
The 'back and forth'
between the Court and parties involved can be interpreted as an
indirect sign of hesitation (or lack of consensus) from the panel
of Judges in the face of a decision to rule negatively (affirming
the District Court orders on remand). Does the Court’s issuance of
orders indicate that Judges are getting ‘cold feet’?
We are unconvinced of
this scenario and continue to expect a negative ruling. We continue
to anticipate that Argentina’s ‘cram down’ proposal will evaporate
any dose of sympathy the Judges might have harbored for Argentina.
Effectively, the lack of flexibility in the 'quantitative'
dimension of Argentina’s proposal unloads transfers all the burden
of compromise on the shoulders of the Court.
We note that this
week’s price action mimics the price rebound that followed the
Court’s ‘proposal order’ (March 1) directing Argentina to present
its payment formula. The latter ended up being a short-lived
affair.
That said, at this
point it is worthwhile to clarify what constitutes a negative
ruling. We believe that a negative ruling is one
that—notwithstanding possible 'silver linings or 'mitigating
factors' that may accompany it—effectively threatens to push
Argentina a step closer to 'technical default'.
The table lays out the
factors that may offer 'silver linings' but that would not change
the fundamental nature of a ruling if it is negative. We classify a
ruling as negative when it (a) constitutes a threat (at least) for
USD bondholder payments, (b) constitutes a constraint (at least) on
payment functions carried out by BoNY, and (c) when it defines a
ratable payment formula (either the District Court or, in
consideration of equities, an unknown alternative) that demands
greater compromise from Argentina than it is willing to deliver
(the 2010 'cram down').
A negotiated
solution: Is it being underestimated? We do not think
so.
We acknowledge—in
addition to reflecting 'due process'—the Court's recent orders
(both for a formula proposal from Argentina and for an RSVP from
holdouts) represent an active attempt to sponsor a dialogue between
the parties. We believe it is in the Court's interest to do so in
order to spare the Judges the uncomfort of a ruling that requires
choosing one of 'two evils' (either a 100% formula or a 'cram
down').
But we remain
unconvinced of the possibilities of such a convergence. We consider
that the NPV of Argentina's proposal (43-68% depending on spreads)
vs. holdouts court claims (334%) dashes any hope that the Court may
harbored in its own capacity to guide the parties toward a
voluntary reconciliation. Holdouts' negative response to the
'quantitative' aspect of Argentina's should be
predictable.
However, it will be
important to analyze the response from holdouts to the
'qualitative' aspects of Argentina's proposal. These may have a
bearing on Judges and any potential surprises from the subsequent
Court ruling could originate on this dimension.
By 'qualitative'
aspects we refer to the arguments Argentina included in its filing
to justify the 'quantitative' proposal (2010 'cram down'). In
reviewing the holdouts' response to that proposal Judges might feel
drawn to weighing the competing definitions of the equity of the
remedy, or of the economic feasibility of the payment, or of the
way interest claims ('past due' vs. 'retroactive') should be
defined on bonds that matured many years ago.
Holdouts are likely to
argue that these issues have been settled. However, we would point
out that—as an example to the contrary—during the February 27
hearing one of the judges hinted that the record may not
demonstrate the feasibility of the District Court's payment formula
(not surprisingly, in filing its proposal Argentina chose to claim
that Judge Griesa lacked ‘due process’ on this issue... hoping for
remand?).
Does the post-ruling
outlook offer hope? We take limited comfort from
stays/swaps.
We believe distress
situation investors buying Argentine in the last weeks may be
expressing a constructive view beyond a (likely negative) ruling.
The main post-ruling factors that will drive prices are stays and
swaps.
Stays/further
review: Delay tactics
Legal opinions
generally downplay the odds of a Supreme Court review (although in
2011 the so-called ‘alter ego’ litigation between Argentina and
holdouts was settled favorably for the latter by the Supreme
Justices). However, it is plausible that the Appeals Court's 'back
and forth' issuance of orders may inspire market confidence in the
possibilities that stays on Court orders are extended. If issued
free of conditionality (i.e. escrow deposit), stays would at least
protect coupon payments during the period that Argentina petitions
for review by the Supreme Court.
A delay tactic will not
dispel uncertainty and may only serve to avert 'technical default'
risk temporarily. But it requires acknowledging the optionality has
some value however low the probabilities (for instance, a delayed
final ruling beyond mid-term elections might be thought to
facilitate an Argentina negotiation; or a review by Supreme Court
could reverse the Appeals Court ruling in 2014).
Swaps
and re-routing of payments: Exit strategies
Recent comments by
Argentine government officials might also be inspiring expectations
for a resolution to a potential 'technical default' scenario. Those
statements have shifted the discussion in the market to the
assessment of a potential Argentine re-routing of payments on the
existing NY/UK law restructured bonds to an off-shore
location.
We are concerned that
the faith in a re-routing of payments may largely be based on
little more than the premise that ‘if there is a will, there is a
way’. If so, markets may risk underestimating the
mechanical/operational challenges that a re-routing strategy by
Argentina would face due to outstanding Court orders.
Note that the Court
orders not only bar intermediaries from making payments to
restructured bondholders in the absence of payments to holdouts
(order stayed). They also bar intermediaries from assisting
Argentina in re-routing payments on restructured bonds (order
effective).
Tactics to elude or to
exit a potential ‘technical default’ situation might be expected to
rely on one of the following alternatives:
-
A
'democratic' re-routing: A supra-majority vote by
restructured bondholders can change the terms—including payment
location—on the existing NY/UK law bonds (CACs allow a ‘cram down’
of dissenting investors);
-
A
'dictated' re-routing: A direct Argentine offer for
investors to tender existing NY/UK law bonds into new ARG law
bonds;
-
A
'stealth' re-routing: A secondary market purchases by an
Argentine agency of existing NY/UK law bonds (but settled with
simultaneous delivery of new ARG law bonds);
-
A
'force majeure' re-routing: A restructured bondholder vote to
adopt an off-shore trustee in response to a resignation of BoNY
(providing a 90-day notice).
We believe that the
comfort afforded from these alternatives may be overstated.
Practical difficulties to carrying them out are unlikely to be
fully appreciated at this stage.
The first two options
clearly expose financial intermediaries involved to the risk of
being held in contempt of Court if they assist the process. The
third option relies on arguing that legitimate secondary market
operations would protect intermediaries from contempt of Court.
(and if carried out, this strategy is liable to result in
piece-meal and protracted execution). The fourth alternative may
also expose intermediaries to liability although the transfer
functions to an off-shore trustee can be framed in the context of
'force majeure' if and when available alternative on-shore trustees
(required by contract to replace BoNY) decline the
job.
If legal/mechanical
risks to a Plan B are high then the ease with which Argentina might
be able to deliver an 'exit strategy' for a hypothetical 'technical
default' scenario after just one or two coupon misses is
questionable. However, even if a 'technical default' of external
debt is harder to repair than markets might expect, we remain
confident that the local law USD bonds (which the NY Court is not
interfering with) can continue being paid—thus, justifying the
negative local law - NY law risk premia.
Note that after the
'RSVP order' the widening negative local law risk premia (Boden
15-Rep 17) snapped back (see chart below). Yet we would expect that
negative spread to continue widening if a negative Court ruling
materializes. Indeed, we highlight that the local law USD sovereign
bonds constitute one of few vehicles to gain USD exposure that
locals can access and which has favorable tax treatment. They are
also shorter duration than external law bonds which is favorable in
a muddle-through scenario. Consequently, in the context of capital
controls and lack of new issuance from the government the resident
bid for local law USD paper can linger.
|