Thursday, 17 January 2019

Carrion carry-on

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  • Vultures battle for a cow carcass as they feed

This could be the year when the Argentine holdout debt story is finally resolved. A settlement is essential for the country, which has been shut out of the capital markets since its 2001 default.

Argentina’s long-standing battle with restructuring holdouts is like the finance industry equivalent of Boyhood, the Oscar-nominated film by director Richard Linklater that was shot over a 12-year period, retaining the same cast throughout and reuniting them to shoot scenes for a few days every year or so before everyone went back to their day jobs.

Like Linklater’s film, Argentina’s dispute with the hedge funds it calls vultures began in 2001, and over the past 14 years it has featured many of the same protagonists, pitching Paul Singer’s NML Capital, a unit of Elliott Management, against President Cristina Kirchner’s government. And like Boyhood, 2015 could be the year when the Argentine holdout debt story is finally resolved.

The dispute with the bondholders stems from Argentina’s default in 2001 and there have been repeated signs that the impasse might be broken between Argentina and the group of funds, which rejected the original terms of Argentina’s 2005 and 2010 debt restructurings and are holding out for better terms. But hope for a settlement has been repeatedly dashed on the rocks of legal delay and political inertia.

A settlement is essential for Argentina, which has been shut out of the capital markets since its 2001 default. On February 26, the sovereign halted a planned US$2bn sale of Bonar 2024 bonds to non-US investors hours after US District Judge Thomas Griesa ordered banks managing the sale to produce documents and witnesses for a deposition.

The court order came in response to a subpoena served on February 9 by lead holdout creditor NML Capital. Deutsche Bank and JP Morgan, the banks managing the sale, were trying to avoid legal hurdles in the US by marketing the bond issue exclusively to non-US investors.

Optimists had hoped for a settlement in January. When Argentina swapped 93% of its global bonds for new paper offering about 30 cents on the dollar in 2005 and 2010, it included a Rights Upon Future Offers clause saying no one would be offered a better restructuring deal. The expiration of that clause in January 2015 should have paved the way for talks, but there was no end to the impasse.

Instead, Argentina’s economy minister Axel Kicillof made an offer that fell well short of what the holdout investors were expecting. Argentina’s latest offer asked the holdouts to accept a haircut of 65% on the bond principal – based on the notion, in the words of Kicillof that “the exchange were taking place in 2005”.

He did offer a sweetener, which included all of the past due interest accrued on the discounted bonds since 2005, but the holdouts want their original par value, and they regarded the latest offer as a half-hearted attempt at negotiation.

So the deadlock continues between Argentina and the hedge funds, which are being represented by Judge Griesa, who won a ruling halting payments to all bondholders until a deal with the holdouts is reached.

“We are of the view that the stand-off with holdouts is unlikely to be resolved while the current administration is in office”

There is a fresh glimmer of hope for a return to negotiations after March 3, when Judge Griesa has a set a hearing on whether interest payments can be processed under local Argentine laws.

If a solution were to emerge this month, it would be a source of great surprise to strategists and investors, who don’t expect that impasse, which has dragged Latin America’s third-largest economy into recession, to be broken until after Argentina’s elections in October, when Kirchner will step down.

“We are of the view that the stand-off with holdouts is unlikely to be resolved while the current administration is in office,” said Rafael de la Fuente, an economist for Latin America at UBS.

That’s a widely held view. There’s no doubt that the continuing stalemate is bad for Argentina. In the run-up to the election, international reserves will fall further, inflation is likely to accelerate, the economy will be mired in recession, and the need for an even larger FX correction will grow.

Waiting for October

But, in the absence of an unforeseen economic shock, Argentina is expected to tough it out until October and its bonds are being supported on the expectation that a new government will bring about a solution and an improvement in the country’s economic fortunes.

“They are pro-actively managing dollar reserves at around US$31bn and that is supporting the bonds,” said Daniel Chodos, debt strategist for Latin America at Credit Suisse in New York.

Reopening Argentina’s path to international capital markets will be an obvious boon, but the current regime, which is in its last lap of power, has no real incentive to negotiate.

Despite Argentina being one of the best performing emerging markets of 2014, investors believe the credit rally still has some way to run, and that will continue to support prices. But investors of all stripes are jostling for position for when the negotiated settlement arrives.

“It’s not that we see a huge demand for bonds, it’s that no one wants to sell. Investors are looking to allocate capital to anything related to Argentina,” said Chodos.

No payout in 2015

There’s been a strong rally in GDP warrants, an instrument that pays out on the basis of an official GDP target being met. With Argentina in recession, there is little hope of a payout this year and perhaps nothing until 2018, and yet the warrants have rallied strongly in 2015.

Chodos believes Argentina still offers value in the medium term.

“Its sovereign bonds are trading at 600bp to 650bp and we think they can converge to spreads of other sovereign credits in the region,” he said. “Our target would be closer to 500bp, which is still a massive discount to the rest of Latin America.

“Mexico and Chile are trading at 200bp. And if you look at Brazil, which has fiscal problems, is in recession and has the Petrobras scandal, it’s trading at around 300bp.”

If the sovereign bonds tighten by 200bp, it will trigger considerable upside on the discount bonds.

“The prospect of that upside is keeping bonds in Argentina supported,” said Chodos. If that tightening occurred hand-in-hand with a settlement, the upside would be even more attractive. On a rough calculation, there could be around US$20 in capital gains plus another US$16 past due interest. No wonder investors are piling in.

The rally is down to optimism that the incoming administration will place striking a deal with the holdouts at the top of its agenda and there will be an accompanying uplift in the economy.

“Unlike Venezuela, Argentina should emerge from its current problems with its private sector largely intact,” said UBS’s de la Fuente.

“The country’s level of indebtedness is low and suggests that it can be increased to negotiate a settlement with holdouts. The fiscal deficit is large, but not insurmountable if the government can start reducing subsidies, which we think is achievable. All told, we think Argentina is in with a chance to turn its situation around.”

A change in government after October’s elections will benefit bondholders more than a settlement with holdout creditors because the candidates to replace Kirchner have promised to reduce inflation and lure foreign investment. Analysts believe that Argentina will be the country to invest in over the next five years, although as de la Fuente said, “we recognise that implementation risk will remain high even in a post-Kirchner era”.

Investors will hope it’s worth the wait. “I think we’ll probably see a rally, then some sell-off after there is an agreement with the holdout creditors driven by profit-taking and rotation from distressed funds to dedicated EM investors,” said Chodos.


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