Argentina | Restructuring simulations
admin | October 18, 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 debate about liquidity and solvency relief in Argentina should begin soon after elections. And the Uruguay debt restructuring of 2003 will likely offer a roadmap. It was offered under friendly terms with a menu of either a 5-year maturity extension or a benchmark bond. There was no explicit haircut on capital and liquidity relief came from some combination of terming out maturities and partial interest capitalization. Participation was high. But it is unclear whether the incoming administration in Argentina can follow the Uruguay map.
The high participation rate for Uruguay relied on a 90% minimum threshold requirement, exit consents and relatively friendly terms. It came against a track record of effective policy management and an investment grade credit. The context for Argentina is quite different with collective action clauses a substitute for other coercive tactics and much higher uncertainty on debt repayment capacity. That should imply higher exit yields post restructuring under the friendlier scenarios. It’s still an active debate about illiquidity versus insolvency and whether a Fernandez administration credibly can commit to medium-term debt repayment capacity. There is a clear tradeoff between fiscal discipline and debt relief as we await the post-election discussion on whether the Fernandez administration reaffirms the Uruguay restructuring terms.
Our simulations somewhat replicate the menu for Uruguay with a 5-year maturity extension as well as 4-year partial interest capitalization (PIK’33) against the opposing scenario of an additional 30% haircut on principal. The exit yields are a critical determinant for recovery value with a range of 10% to 12% the most realistic under the assumptions of policy moderation as opposed to the alternative reformist policy bias that would normalize yields. It’s also important to assume more aggressive liquidity relief with interest accrual for the large gross financing needs and limited access to capital. This argues for not just maturity extension but also partial coupon accrual (similar to the PIK’33 Uruguay benchmark bond alternative or the Argentina Discount bond). There are clear relative value considerations, though we caution that campaign promises may adjust under the reality of the economic crisis post elections which could then argue for notional haircut. This shifts our investment strategy towards risk/reward options under various alternatives with an emphasis that friendly/unfriendly scenarios are more relevant for determinant of total returns. Our preference is for the ARGENT’26 and ARGENT’36 for the combination of relatively low cash prices/higher coupons that offer potential for relative outperformance under binary scenarios.
Exhibit 1: Argentina debt simulation – 5-year maturity extension
Scenario: a 5-year maturity extension
The 5-year maturity extension scenario is the most friendly but least likely if we assume only a moderate as opposed to reformist Fernandez administration. This would also require a slightly higher exit yield of 12% on the uncertainty of medium term debt repayment capacity. There would be almost universal significant upside across the curve with the exception of the Par bond under the constraint of the low coupon/longer maturity. It’s still not clear how officials would treat the Par/Discount bonds as they were not initially targeted for restructuring; however it seems difficult to legally exclude these bonds on a selective default basis. The best risk/reward skews towards the shorter tenors with the highest coupons with perhaps the ARGENT’2026 more attractive versus the high cash price of the ARGENT’2021. There should still be core preference for lower cash price bonds on the uncertainty at an early phase with high mark to market risks. We do not expect a scenario similar to PdVSA (2015-2017) when Venezuelan authorities remained current on debt service much longer than expected with pull to par of the shortest tenors. There is a pre-emptive bias to quickly seek liquidity relief against the precarious liquidity ratios of low net FX reserves. The treasury cashflow stress suggests difficulty on remaining current until the April 2021 amortization. Our bias remains for the higher coupon bonds at similar cash price to similar maturities for the outperformance to the upside in Uruguay restructuring scenarios (ARGENT’36 versus ARGENT’46).
Exhibit 2: Argentina debt simulations – 5-year extension with partial interest capitalization
Scenario: 5-year maturity extension and partial interest accrual
The more realistic scenario assumes more aggressive liquidity relief through partial interest capitalization. If we simulate cashflow similar to the Uruguay’33 PIK then this allows for gradual increase in cash coupons over 4 years as well as a 5Y maturity extension. There are near infinite different combinations though the concept is to seek some reasonable interest relief via both coupons and maturities (and we exclude the Par and Discount bonds for their unique characteristic of interest accrual and low coupons that further complicates under this scenario). There are still potential significant upside gains across the curve under a similar 12% exit yield again biased towards the shorter tenors but the ARGENT’26 still offering the best risk/reward.
Exhibit 3: Argentina debt simulation – 5-year maturity extension with partial interest accrual, 30% haircut
Scenario: 5-year maturity extension, partial interest accrual, 30% haircut
It becomes increasingly complicated if the debate shifts from liquidity to solvency relief; however the potential for a lower exit yield of 10% would fully offset a theoretical 30% haircut on principal. This could argue for a bullish overall investment strategy for potential upside under some reasonable scenarios of a moderate haircut on principal as well as liquidity relief on interest accrual and maturity extension. There are less relative value considerations under this alternative with the shorter tenors more vulnerable and the intermediate sector of the curve still offering the best risk/reward with positive returns dependent upon a near normalization in exit yields to 10% (similar to Ecuador) for the solvency relief post restructuring and average recovery values above 50. This is the closest to a breakeven scenario that would still suggest upside from current prices with an optimistic 10% exit yield on the assumption of a somewhat stable muddling through scenario on policy management.