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Argentina | High risk of default

| April 24, 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.

Perhaps Argentina’s Minister of Economy Martin Guzman blinks at the last moment, but the latest intransigent take-it-or-leave-it offer may soon shift to the “disorderly macroeconomic effects” of a hard default. Instead of a counter-offer to investors, Minister Guzman has doubled down on a coercive and unilateral approach to missing $503 million in coupon payments and setting a 2-week, May 8 deadline for responses to Argentina’s restructuring offer. It’s difficult to understand the strategy, which seems more based on ideology than pragmatism. There is still a narrow window ahead of the final May 22 deadline for Minister Guzman to improve the terms, but the logistics aren’t favorable while the two sides are probably still far apart.

The countdown now begins for the 30-day grace period on the $503 million coupons of the ARGENT’21, ARGENT’26 and ARGENT’46.  There are only two ways to avoid default: either launch a consent solicitation for a temporary standstill and negotiate in good faith or unilaterally improve the terms sufficiently for bondholders to accept.

It’s not clear whether there are any last-minute tactics that will allow for a successful restructuring. Exit consents would require majority participation and sweeteners would also only be marginally helpful.  The documentation clearly states there is no recognition of “interest accrued and unpaid since the last applicable interest payment date.” This reaffirms not even minimal flexibility to improve the terms.  It’s difficult to understand the game plan for debt restructuring other than seeking political validation for nonpayment and trying to avoid the stigma of a “unique recalcitrant debtor.” Ecuador stands in stark contrast. It has the optimal alternative of a temporary standstill to then reassess payment capacity and negotiate with bondholders when the worst of the crisis subsidies.

The limited market communication from Argentina and ideological constraints show no goodwill for compromise.  The bondholder committees have all rejected the offer with now a tradeoff between the activist legal alternatives or the passivist standstill that waits for a better offer.  The main difference to the 2005 restructuring offer was that discouraged investors were more motivated to participate after four long years of nonpayment.  If there are no payments through 2023, then bondholders are motivated to reject the first offer and wait for the next offer. The larger holders may be motivated to wait longer since the investment strategy focuses on longer term returns as opposed to mark to market returns.

There could be some participation from the 2021, 2022 and 2023 bonds for the marginal upside to the estimated $35 recovery value of the New 2030 Eurobond and the incentive to take advantage of the priority status before reaching the $11.4 billion allocation cap. The additional value would then depend upon lower exit yields under a global recovery scenario and effective crisis management.   The exchange bonds are more vulnerable with no motivation to forfeit the stronger legal rights under covenants of the 2005 indenture, especially against the unattractive proposed NPV valuations. The implied recovery value of $33.8 for the New 2039 (based on par claim) contrasts against a dirty price of $40.4 for the discount bonds and $32.3 recovery value for the New 2043 against the dirty price of $33.5 for the par bond. Why would Argentina purposefully offer worse terms to bonds held by more activist investors? This almost looks like a political strategy for a scapegoat when the deal fails.  If Argentina is unable to reach the high CAC thresholds of  85% aggregate plus 67% each series for the 2005 indenture bonds and 67% aggregate plus 50% each series for the 2016 indenture bonds to eliminate the cross defaults, then the alternative is either termination and hard default on May 22 or an unilateral better offer.

Why would Argentina pursue a strategy of premeditated failure, fully admitting that bondholders will reject the terms but refusing to seek a compromise? The economic side effects are inconvenient, further restricting access to credit for a country that is suffering from worse external and fiscal shocks.  The hard default could also complicate IMF negotiations, with lending into arrears requiring good faith efforts to negotiate with bondholders. The IMF loan repayment schedule remains onerous at only $4.9 billion in 2021 but then later spikes to above $18 billion in 2022 and 2023. The economic management seems biased towards inward isolation dependent upon capital controls and deficit monetization and no attempt to seek external credit through the recent crisis. This suggests still a downward bias for Eurobond prices with no implicit floor of $32 if there is no majority participation in the exchange transaction and no efforts to meaningfully improve the terms ahead of the deadline. It would then shift to a waiting game for a turnover of the economic team that improves the willingness to pay.

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