Argentina | Game theory

admin | July 17, 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.

It is difficult to say whether Argentina is engaged in game theory or just political theater. By proposing a minimum of half of bondholders participate in its latest debt restructuring offer, it could show real interest in reaching a majority or discourage participation by raising the risk of litigation by an unhappy minority. With current average prices for Argentina around 43, the balance of risk and reward in Argentina’s debt looks interesting.

This 50% minimum participation threshold could determine the success or failure of the debt restructuring. The 50% threshold does not resolve the legal risks of coming in below the 66.7% to 75% thresholds set out in the collective action clauses of its various bond indentures.  The public rejection of the latest terms by the Adhoc Bondholder Group and its allies may encourage others to remain sidelined as litigation risk drives higher exit yields and lower mark-to-market gains. It will take some effort to reach a minimum threshold of 50% or 77% of outstanding bonds after excluding the 35% blocking share of the AdHoc investors.

There have been no revisions to the latest offer, and it looks somewhat like a stalemate.  Perhaps Argentina is waiting to gauge participation rates and then, if the numbers disappoint, try to revise the terms. Or if the numbers are close to 50%, then it is a strategy to isolate the holdouts and coerce their participation. A negotiated resolution still looks most likely since neither side appears committed to lengthy and costly litigation. This then suggests upside from current levels on Argentina’s bonds, with target gains dependent upon exit yields perhaps closer to 11% than breakeven levels of 12.5%.

The local headlines suggest still a stalemate with Argentina hoping perhaps for diplomatic intervention. This does not sound like a great plan or an understanding of bondholder motivations.  It seems like the parties are all just waiting for something to happen and, if nothing happens, wait for Argentina to negotiate again.  The last offer was reasonable on the financial terms, but tensions still run high, and this take-it-or-leave-it approach in the final stages just doesn’t work when a blocking group of bondholders are unwilling to accept the terms.

This does not imply a lengthy stalemate. The 50% minimum threshold should serve as a trigger to force a resolution.  If the holdouts don’t cooperate and their 35% blocking share discourages other holdouts, then the two sides would have to come back to the negotiation table with or without Minister of the Economy Martin Guzman.  The potential setback then implies potential upside for bond prices as markets interpret failure as an improved offer.  The official rhetoric continues to insist that there is no ability to improve on the latest terms. Some marginal flexibility, however, seems like a better option than years of litigation. Perhaps Argentina could reconsider a value recovery instrument as a politically viable compromise?

The alternative scenario could also force a resolution if Argentina is able to reach the 50% aggregate threshold and the higher CAC threshold on a few series of the bonds.  This cramdown would reduce the holdout blocking share on those specific series. This may encourage the holdouts to participate on the threat of unfavorable cramdown terms such as forced allocation into the lowest recovery value of 49 of the New’2046 and loss of 1.6 points of PDI.  The holdouts would then face worse alternatives as an increasing marginalized and smaller stock of bonds that eventually accepts the terms through an extension of the transaction.   The invitation expires on August 4 with options to amend, extend or terminate the transaction. The alternatives suggest that this could be resolved in the next few weeks on either a below-50% aggregate threshold forcing a negotiated solution or an above-50% threshold coercing a solution by marginalizing the holdouts—with the critical assumption that both sides want to avoid litigation.

If we can assume a resolution of deal risk, then the upside returns remain a function of the subsequent exit yields.  There has been the beginning of a debate between Argentina and Ecuador exit yields where the official reference has been 10% for Argentina at 53 recovery value and 12% for Ecuador at 50 recovery value.  However, Argentina continues to trade at a significant price discount of 10 points to 11 points as opposed to a 3-point price premium. Is this a potential credit dislocation? Or perhaps a penalty for liquidity with a 3:1 ratio of Argentina compared to Ecuador bonds? Or perhaps it’s relative positioning with trapped longs in Argentina and flatter positions in Ecuador?

The relative credit comparison seems to focus on the narrative of friendly versus unfriendly policy management focusing on bondholder relations through the debt restructuring. However, this argument is not valid until there is clarity on the political transition in Ecuador and threat of far left or radical candidates.  Ecuador’s President Lenin Moreno’s term ends in 10 months with critical fiscal reform necessary for debt sustainability.  Whoever follows will determine whether exit yields trade at normalized or distressed levels.  The ability to pay should be much stronger in Argentina due to their conservative medium term projections (1.3% primary surplus/1.5% GDP growth) that biased lower restructured debt payments against the more optimistic medium term projections in Ecuador (3.1% primary surplus/2.5% GDP growth) that biased higher restructured debt payments.  Those deferred Ecuador debt payments in 2026-2035 will require commitment to fiscal adjustment of 3% of GDP with a reminder of the failed IMF program and inability to deliver in 2019.  This relative execution risk should logically argue for lower exit yields in Argentina and higher exit yields in Ecuador. There is better balance of risk and reward for current Argentina average prices of 43 that implies a breakeven exit yield of 12.5% if deal risk is resolved in the next few weeks.