The Big Idea
Province of Buenos Aires | Low political risk
Siobhan Morden | August 18, 2023
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 Province of Buenos Aires debt still trades with a stubbornly high risk premium compared to the Argentina sovereign benchmark, with valuations that ignore some important fundamentals. The country’s recent primary elections highlighted the contrast in political risk between the quasi-sovereign and the sovereign. But behind that stand differences in liquidity, solvency and convertibility risk that also favor the quasi-sovereign. It is not clear why the Province of Buenos Aires trades below recovery value and with likely limited downside. This distorted premium should start to narrow as the political process moves ahead.
The much better liquidity, solvency, and convertibility risks
There is clear contrast between the province’s debt and the sovereign. None of the quasi-sovereigns suffer from the same execution risks as the country since none of them face the same liquidity and solvency risks. The binding constraint is that quasi-sovereigns cannot deficit finance and accumulate debt. The federal government not only has to tackle a structural fiscal deficit equal to 5% of GDP but also a public debt burden approaching 100% of GDP. This raises the stakes for the sovereign’s effort to make macro adjustments after elections and explains the high risk premium on sovereign bonds. Argentina faces high gross financing needs with a wall of Eurobond payments in 2025 approaching $10 billion.
The 2021 debt restructuring of the Province of Buenos Aires not only provided liquidity relief but also opportunistic solvency relief through a 25% haircut on coupon payments. The relief was so impactful that the 2023 budget clearly shows only marginal debt service compared to other provincial spending categories. The province’s gross Eurobond financing needs are also much smaller at $400 million in 2023 that increases to $700 million in 2024.
US dollar scarcity weighs on all credits through the current economic stress. However, convertibility risks should greatly improve on the positive terms-of-trade shock next year. The conservative estimates suggest not only a reversal of the $20 billion in exports lost to drought this year but also the gradual increase in gas and lithium exports and an increase in tourism. The reversal on US dollar cash flow should be sufficient for the entirety of the $2 billion annual Eurobond debt service from the provinces ($700 million from Buenos Aires). It’s unrealistic to reference the weak stock of assets when the smaller gross financing needs of the provinces would enormously benefit from the estimated $12 billion positive cash flow from a terms-of\-trade shock next year.
The political risks
It’s also difficult to even try to calculate recovery value when there are no metrics that demand liquidity or solvency relief. The “unwillingness to pay” may again resurface, but this would confront organized and hostile bondholders (@ArgProvBonds) that would demand a rational approach, especially after only recently been forced to provide significant relief back in 2021.
There has also been a broader shift in political rhetoric in Argentina around reducing domestic as opposed to external Eurobond liabilities, with an orthodox approach to regain investor confidence necessary for a broader economic recovery. The specific leadership of the Province of Buenos Aires is also in contention with a high probability that the Milei (LAA) specific candidate backs out of the race on last minute negotiations to either strengthen governability under either a LAA or JXC administration. Why would candidate Milei allow for his third place candidate to split the provincial elections when there would be better political leverage to exploit at the national level? This really questions why the provincial bonds trade with such heavy political risk.
The payout structure also provides beneficial risk-and-reward under a scenario of paying for longer or, our base case view of avoiding default. The breakeven return analysis of the BUENOS’37A suggests a recovery value at new historic lows of 30 after 10 points of payout through September 2024 that declines to a recovery value of 20 after September 2025. This contrasts to the lowest recovery value of 40 back in 2003. The high gross financing needs for the sovereign suggest high implied default risk for 2025. But that does not necessarily transfer to the provinces for their much smaller financing needs, low leverage and prospects of a strong willingness to pay The below default level bond prices provide a considerable buffer to downside risks and much higher optionality to the upside, especially on a positive political shock of the provincial election results.