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Province of Buenos Ares | Next in line

| August 7, 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.

The deadline for the Buenos Ares debt restructuring that kicked off last April has now moved to August 14 with the three main creditor groups all rejecting the deadline, no signs of any breakthrough and no apparent active negotiations.  The local headlines logically suggest the Province of Buenos Aires would start negotiating in earnest only after Argentina’s sovereign debt restructuring.  The recent solution for the sovereign suggests that talks could soon get back on track.

What’s the Buenos Ares debt restructuring strategy? The markets have already anticipated an improved offer with prices rising on each successive improvement of the sovereign official offer and BUENOS trading as a leveraged trade on the sovereign.  BUENOS could outperform based upon the specific revisions of a new offer.  On lessons learned from the sovereign restructuring, the 2006 indenture bonds—maturing in 2021 and 2028—seem undervalued relative to the 2016 bonds while current prices also don’t seem to differentiate PDI. There is some potential for follow-through gains as deal risk declines while relative value trends favor the 10.875% BUENOS’2021, 9.625% BUENOS’2028 and 10.875% BUENOS’2021 based on lessons learned from the sovereign restructuring, which provided favorable treatment of PDI and preferential legal indenture.

There should soon be some headway on the next largest debt restructuring in Argentina–the $7 billion in Province of Buenos Aires Eurobonds. The provinces are in various stages of creditor negotiations, with the April launch of the debt restructuring in Buenos Aires long delayed by the conclusion of the sovereign debt restructuring.  It doesn’t seem logical for Buenos Aires to follow the same strategy for debt negotiations as the sovereign and waste many more months of active negotiations after many months of inaction.  The process seems to echo the last debt restructurings in 2005 and 2006 where the sovereign sets the floor for recovery value (32) and then Buenos Aires offers a premium (40) in their debt restructuring months later.  The higher debt repayment terms are then later discounted at higher exit yields—for the illiquidity premium and off index status of Buenos Aires—for prices that trade at comparable levels in the secondary market.  The sequencing requires the sovereign to first set the stage with a macro framework of debt sustainability based on ability to repay, biased under the Kirchnerismo political framework of unwillingness to repay. The provinces are all economically subordinated to the sovereign for the broad policy framework while Buenos Aires is the most integrated as the largest province with the closest political ties and limited fiscal independence and autonomy.

There has been no discussion of specific debt sustainability for Buenos Aires.  There has been an obvious liquidity shock to all of the provinces; however it’s difficult to argue a solvency problem for a credit that was not overly indebted and reached primary fiscal surplus in 2019.  There is a clear distinction between the sovereign and the provinces on liquidity and solvency trends. The provinces do not have the same access to credit and therefore cannot accumulate debt and cannot overspend to the same degree as the sovereign.  This is why the initial offer was promptly and quickly rejected across all creditor groups.  “Regrettably, rather than engaging in substantive discussions, the Province chose to launch a unilateral exchange offer that is not based on credible policy efforts or forecasts that bondholders can support.”

The next stage is an improvement from the initial offer last April that implied 36.5 average recovery value (12.5% discount rate) with small principal haircut, large coupon haircut and maturity extension into a 2032 or 2040 bonda with an interest-only security for the 2006 indenture holders.  These initial terms would have to change probably similar to the sovereign to reach a majority compromise with bondholders. Without a DSA framework or budget constraint formula, Buenos Aires would have to at least offer financial terms superior to the sovereign with the same ratios of the initial offer – 40 (sovereign) and 48 (Buenos) compared at the same 10% exit yield.

If we simply assume the aggregate 37.5% improvement (40 to 55) of the final sovereign offer then this would imply an average recovery value of 52.6 (12.5% discount rate) against current prices of 50.2 for Buenos Aires.  This suggests some marginal upside; however it’s difficult to fine-tune a specific strategy without the revised terms and against the uncertainty of the appropriate discount rate. The debate for the sovereign has been an exit yield ranging from 10% to current implied levels of 11.75%. Assuming a conservative exit yield near 11% for the sovereign and a 150 bp spread differential for Buenos Aires (referencing yield differential on ARGENT’27 /BUENOS’27 from June/July 2019), then this would translate into a 12.5% exit yield and some residual desk risk on current prices.  We assume more favorable technicals for BUENOS that could argue for a tighter spread premium based on less crowded longs, higher current yield and stronger relative fiscal/debt dynamics. The current prices also do not offer much differentiation between the 2006 and 2015 indenture bonds despite the bias of more favorable treatment of the 2006 bonds (financial compensation for forfeiting the stronger legal indenture).  This suggests more potential upside for the ARGENT’21 and ARGENT’28 bonds, especially the ARGENT’28 if there is recognition of PDI. The recognition of stronger legal indentures and PDI are probably important concessions that would benefit the higher coupon bonds and the 2006 indenture bonds.

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