Argentina | Investment options
admin | April 16, 2021
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.
Argentina stands out as an underperformer this year. Prices have retraced to historic lows after last year’s debt restructuring led to no follow-up economic plan. It will take some creative thinking to generate positive total returns with near zero-coupon bonds. The passive approach assumes historic low prices are more sensitive to positive than negative news and have potential upside from a moderate policy shift after elections. But Argentina could still underperform over the next six months with almost no coupon and further risk of disappointment if International Monetary Fund negotiations get delayed into next year.
The alternatives are off-index opportunities in quasi-sovereigns such as BUENOS or waiting to position closer to potential positive events toward year end. The most upside clearly depends on a return to 4Q2020 levels if Argentina reverts to policy moderation and normalization of creditor relations after 4Q2021 elections. The alternative strategy is adopting a longer view that focuses on cumulative coupon payments. There has been increasing focus on the step-up coupons in Ecuador with Argentina on a similar schedule after July with an increase in current yields. This same analysis now shifts to Argentina. Argentina’s low average coupons require a strategy of conservative entry levels—prices closer to 30 than 35—and preference for the higher coupon bonds on the important assumption that the Fernandez administration avoids default through his term and through January 2024 coupon payments.
The low Eurobond prices in Argentina are a function of not only weak fundamentals but also weak technicalS. There are legacy long positions, no incremental buyers and near-zero coupons. If we assume that cash flow stress from hefty IMF loan repayments in 2022 will ultimately force a resolution late this year or even early next year, the lower discount rates should allow for outperformance across the curve. Although ideological differences will prove difficult in IMF negotiations, there is no other alternative to an IMF program ahead of $18 billion in payments through 2022. Higher commodity prices would not prove sufficient to accumulate enough foreign exchange reserves to repay the current schedule of IMF loan payments. The potential for a positive shock on normalization of IMF relations could conservatively imply a reversal back to the credit risk levels in 4Q2020 and maximize the potential near-term gains for bondholders. This would provide a potential windfall and opportunity for outperformance with asymmetry to the upside and with current prices trading at or below historic recovery value. The shorter tenors would outperform under this scenario on curve normalization. The moderate policy shift post-elections and yield compression closer to 4Q2020 levels would provide the best risk and return profile close to 25% to 39% total returns from current levels.
The alternative strategy takes a longer-term view to buy at price lows and maximize carry returns through the duration of the Fernandez term. The higher current yield after July step-up coupons reminds investors about the optionality of coupon payments. The step-up annual coupons of 2.0% and 2.5% for the ARGENT’38 and ARGENT’41 would increase the current yields to 5.4% and 7.15%, respectively at today’s low prices. The still low average coupons 2% to 2.5% for the Kirchner bonds (2038, 2041) and 0.5% to 1.125% for the Macri bonds (2035, 2046) do not offer much passive returns on a 12-month basis. This is where potential returns are more interesting on a longer-term horizon. Not necessarily for the optionality of higher recovery value after another debt restructuring but rather the coupon payments prior to another default.
The current low prices may discount a high probability of default; however the timeframe is critical. The latest statements from Vice President Fernandez de Kirchner are highly relevant. “We are not saying that we won’t pay the debt. Our political front has been the only one to pay the debt of other governments….”
There has been a unique track record of Kirchnerismo to avoid debt issuance but yet pay the debt issued (BODEN’15) with favorable relative treatment of the “Kirchner” relative to the “Macri” bonds in the last 2020 debt restructuring. It would be illogical from both a political and economic perspective for the Fernandez administration to default so soon after a restructuring, especially since there was significant cashflow relief through 2024.
If we assume that the Fernandez administration avoids default through January 2024 coupon payments, this provides cumulative coupon payments of 8.11 points for the 2038 and 7.86 points for the 2041 bonds. The breakeven return analysis then depends on the entry and exit price to capitalize on the coupon payments. If we assume a conservative recovery value of 30 to 32, then it’s critical that investors enter close to these levels to maximize potential returns. It is also worth remembering the favorable relative treatment of the “Kirchner” versus the “Macri” bonds through the restructuring on higher recovery value while maintaining the same favorable indentures. This implies a slightly higher recovery value for the ARGENT’38 and ARGENT’41. The ARGENT’41, ARGENT’35 and ARGENT’46 seem to offer the best combination of a relatively lower cash prices and higher cumulative coupons for total returns of 8% to 13% through January 2024 based on low 30 recovery value. However, these returns are clearly suboptimal for the lengthy 2.5-year investment horizon with breakeven returns not too far above current levels at 36 to 37. This would then require more optimistic scenarios of higher recovery value (closer to 40 than 30) or delayed timeframe for default (beyond January 2024) or preferably a shift in policy management that allows for lower default risk and near-term tactical gains on IMF negotiations late this year /early next year.
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