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Argentina: Fade the price rebound following the Court's 'RSVP order' to holdouts

  • 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.
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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).
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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'.
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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.
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