Argentina | Uruguay-style restructuring

admin | October 11, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The latest headlines make consistent reference to a Uruguay restructuring under the potential Fernandez administration. This implies a friendlier extension of maturities without an explicit haircut on capital and with a willingness to repay. But there is much debate on whether this is a solvency or liquidity problem. Execution risk is high if Argentina wants to avoid a hard default given difficult liquidity challenges and the complexity of coordinating a local and external debt restructuring.

It is not clear whether the next administration can separate external debt restructuring from IMF negotiations and then convince bondholders to accept terms without clearly explaining medium-term debt repayment capacity.  It’s not ideal if the debt re-profiling proposal pre-empts IMF negotiations; however liquidity relief would offer some necessary breathing room and imply some upside from current levels.  This probably explains the recent strength and outperformance of the shorter tenors.

The Uruguay restructuring was a friendly restructuring that offered a menu to investors of either a 5-year maturity extension option or the option of exchanging into a benchmark bond of either short, middle or longer tenors.  There was no explicit haircut on capital or coupons.  Uruguay took the difficult decision of seeking only liquidity as opposed to solvency relief on the expectations that it would successfully maximize participation—getting a threshold of 95% participation or cancellation and exit consents—without the cram-down of collective action clauses.  There was also the benefit of a track record of conservative policy management of its investment-grade status and the market’s willingness to interpret its 2002 liquidity crisis as the aftermath of extreme economic contagion from Argentina and not a self-inflicted crisis.  This provided some reassurance on the medium-term debt repayment capacity, especially against the backdrop of positive shock of higher commodity prices on double-digit China growth.

The context is different now for Argentina.  There is not the same confidence about policy management and debt repayment capacity; however collective action clauses may encourage majority participation—forced participation of pessimistic investors and voluntary participation of optimistic investors.   It’s going to be highly volatile on these opposing forces between high execution risks and suboptimal policy risks and positive event risk of liquidity relief post restructuring.  There has been consistent reference from candidate Fernandez and his economic advisers of “fiscal discipline” and friendly debt “re-profiling.” However, there is not yet a coherent plan about the challenges of reaching a primary surplus necessary to stabilize the debt dynamics.  There is also the concern that postponing amortizations is not sufficient liquidity relief after taking into account the large gross financing needs including a primary deficit of 1% to 2% of GDP and 3% of GDP in debt service and limited access to capital after already tapping the lender of last resort and having voluntary capital market access restricted after default. A pre-emptive debt negotiation with external investors apparently reflects a de facto reluctance to embrace fiscal reform.

Exhibit 1: The simulations of gains/losses after 5-year maturity extensions under different exit yields

Source: Bloomberg, Amherst Pierpont Securities

If we run a simulation of a Uruguay-style 5-year maturity extension on the Eurobonds, then the simple interpretation reaffirms the outperformance of the higher coupon and shorter tenor bonds (Exhibit 1). The initial guidance was for a 4-year extension up through 10-year maturities, but it’s unclear how to legally selectively default for cross default clauses. The negative interest rate environment offers a unique opportunity, with conservative exit yield scenarios (10%-15%) still offering potential for mark-to-market gains (Exhibit 2). The most conservative exit yields of 15% would still offer significant upside, ranging from 5%-22% capital returns from current dirty prices.

Exhibit 2: The pre and post bond prices for 5-year maturity extension under 12% exit yields

Source: Bloomberg, Amherst Pierpont Securities

Ecuador would represent an optimistic lower threshold for a post-restructuring comparative liquid, benchmark credit that trades at 10% for 10-year maturities. There are few if any currently performing emerging market credits that offer higher double-digit yields except perhaps Suriname and Zambia.  The liquidity relief on maturity extension would allow for lower yields on the shorter tenors for a bullish flattening trend, though not quite normalization for the persistent debt trap until there is conviction for a primary fiscal surplus. The lower coupon/longer maturity bonds underperform on the maturity extension scenario. We are hesitant to over-interpret these results at such an early phase and much uncertainty on rollover risks for still tight liquidity conditions. The “muddling through” scenario would be difficult post Uruguay-style restructuring without any relief on coupons at 1.5% of GDP for the large gross financing needs and limited access to capital. The relative value trends would shift if the debt restructuring includes a haircut on coupons with outperformance of the lower coupon/longer tenor bonds. There is high variability in these simulations dependent upon whether liquidity relief includes deferral of amortizations and/or coupons and an early phase of understanding the liquidity/solvency ratios following an assumed political transition next year.