Argentina | The imminent launch of restructuring terms

admin | January 10, 2020

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. This material does not constitute research.

If there is any consistency in sovereign debt restructurings, it’s that every deal is unique and Argentina typically sets precedent in restructuring conventions. The debt restructuring is the critical near-term determinant for Argentina’s bond prices and turns on the success or failure of creditor negotiations and the recovery value and exit yield of the restructuring terms.

There has been only limited guidance on the actual process with Lisandro Pablo Cleri heading the Unit of External Public Debt Sustainability at the Finance Secretariat and subordinated to Economy Minister Guzman.  The unit has asked for debt proposals as well as bondholder identification proposals. The logistics are not quite clear on the communication process and whether or not there are active negotiations with bondholder groups. There has also been limited guidance on the potential terms that appear biased towards liquidity over solvency relief and a fast track deadline for 1Q20.  This suggests upside bias for bond prices. However, high deal risk also implies downside risk of a hard default if officials cannot quickly restructure ahead of the 2Q20 burden of debt service. It’ll be important to monitor foreign exchange reserve accumulation to remain current beyond the 1Q20 deadline.  The highest execution risk depends on whether large bondholders including the IMF accept the restructuring offer but lack conviction about future debt repayment capacity.

The logistics?

The time constraints suggest an imminent kickoff for debt restructuring talks with an often referenced deadline of 1Q20 and the intent to avoid a hard default ahead of the burdensome 2Q20 debt service. The recent payment on bulky December Discount bond coupons reaffirms the intentions to remain current on debt service while restructuring with bondholders.  It seems possible the debt unit team could unilaterally announce the restructuring terms after reviewing all of the submitted proposals as an alternative to active negotiations.  It seems logistically difficult to coordinate with a large and disparate group of investors with the recent offer to receive proposals a passive and quicker approach to incorporate bondholder views. The alternative approach would be to convoke discussions within a formal creditor committee with potential for active debate about the legal considerations and specific terms.  This coordinated approach may prove lengthier but would allow for lower deal risk to negotiate for higher participation rates.  The recent announcement from the Debt Unit seeks bondholder verification through a January 13 deadline with the Economy Ministry spearheading the process without the apparent assistance from investment banks. The turnover of the debt commission and the apparent exclusion of Daniel Marx doesn’t inspire as much confidence about the experience and technocrat credentials of the team. However, the accumulation of FX reserves provides some flexibility if the debt restructuring process delays.

What are the terms?

The official communication continues to emphasize liquidity over solvency relief which probably also coincides with bondholder proposals to avoid a large haircut on capital.  There are near infinite combinations on the exact terms with an emphasis on maturity extension and higher recovery value to maximize bondholder participation.  There is frequent reference to the original proposals from the economic team when they were consultants like current Economy Minister Guzman or former Head of the debt committee Daniel Marx.  The maturity extension was the main feature of the proposals.  The consultancy report from Daniel Marx offers the most details that include a 5Y maturity extension, partial interest accrual for four years (50% 1Y, 50% 2Y, 75% 3Y and 100% 4Y cash payout on coupon) with a 20% haircut on principal for maturities through 2028. The recovery value would then depend upon the exit yield, which we assume would be closer to 12% (55-60) as opposed to the Marx simulation of 8% on still the uncertain medium term debt repayment capacity.   This selective haircut across the shorter maturity bonds seemingly intends to tackle the concept of pari passu with a similar recovery value across the different bonds.

Pari passu?

This then shifts the debate to the deal risk of the transaction including the legal risks and the reception from large investors. There have been many questions as to why the ARGENT’21 should trade at a much higher cash price versus the ARGENT’48 when typically all bonds converge as a % of par claim on a single recovery value claim.  This becomes more complicated when the restructuring proposal looks to alter the terms of the individual bonds with a maturity extension alternative as opposed to offering different bonds with a benchmark bond alternative. There is also the additional complication on how to treat the “Kirchner” bonds like the Pars and Discounts.  These bonds were originally excluded in the initial guidance for restructuring announced by the Macri administration last year.  Although previously restructured debt from 2005 and 2010, it seems difficult to exclude these bonds from another restructuring for potential violations of pari passu.  The concept of pari passu will require serious legal debate and may challenge the recent outperformance of the ARGENT’21 and the Discounts until we have clarity of the exact proposals and the legal robustness of the exchange offer.

What’s the DSA?

The more important constraint is the role of large creditors and the uncertainty about medium term debt repayment.  There has been so much emphasis on recent measures to manage cashflow constraints and achieve near term stability without any emphasis on medium term economic model that determines future debt repayment capacity. Could Argentina launch a debt offer without a carefully explained medium term economic plan and without formalizing IMF relations?  Whether or not large creditors, including the IMF, accept the offer will determine the success/failure of the debt restructuring.  It’s a difficult tradeoff with many large bondholders probably preferring the uncertainty of future debt repayment as a better alternative than a large haircut on debt. Perhaps their emphasis will focus on maximizing near term coupon payments.   The rhetoric from the IMF remains supportive though it becomes difficult to restructure the loan repayments without realistic external and fiscal debt sustainability analysis. The IMF role will determine the success/failure of creditor negotiations and proposes the highest of the execution risks. If there is politically influenced flexibility and passive extension of loans, this would reduce a lot of the deal risk and allow for a rally from current levels to unwind execution risks for the debt restructuring.

The investment implications are difficult to assess with potential for heightened volatility on the tradeoff between deal risk and the recovery value terms. Despite the potential upside of a successful debt restructuring under the context of a passive IMF, we assume latent bias to sell into strength on only temporary relief on still unresolved debt solvency that constrains the exit yield post restructuring.