Monday, 24 September 2018

Rehabilitation of an outcast

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Argentina’s placation of holdout investors could propel it back to the forefront of the bond markets.

Long the market pariah, Argentina is quickly turning a new leaf and becoming the rising star in Latin America as the new government reverses leftist policies and reaches an historic accord with major holdouts that have kept it locked out of the capital markets for over a decade.

Success in Argentina could just provide the upside investors and banks alike need in an otherwise gloomy backdrop for the region.

President Mauricio Macri has moved faster than many had expected since he narrowly defeated late last year the candidate supported by then incumbent Cristina Fernandez de Kirchner, whose stand-off with hedge funds Elliott Management and Aurelius Capital has become legend.

Markets have cheered rapid policy changes after the new administration let the peso float, unwound capital controls, overhauled the discredited statistics agency and lifted caps on tariffs in effort to fix economic imbalances.

Despite a broader bout of risk aversion, Argentina bonds have outperformed EM indices this year as markets anticipated a high likelihood that the South American country’s holdout saga was nearing an end and that credit quality was on the mend.

JP Morgan’s EMBI Global Diversified index returned 1.66% in February compared to 5.48% for Argentina, which still carries default ratings from S&P and Fitch.

“The market has compressed as a result of [a potential holdout] settlement and is pricing Argentina at a level much higher than its rating,” said Michael Roche, an EM fixed income analyst at the Seaport Group. ”I reckon the credit will settle around BB– or B+.”

Gabriel Torres, a senior credit officer at Moody’s, which rates the sovereign Caa2, said in late February that Argentina “could commence its transition out of the Caa range”, now that it has cut a deal with creditors.

Tackling holdouts

In many ways, reopening access to the international capital markets has been the cornerstone of Macri’s strategy, as he seeks to partly finance a widening fiscal deficit while also tackling inflation without increasing the money supply as his predecessor did.

The president asked Congress in March to support his agreement with holdout investors, which was negotiated in a matter of months and culminated in a deal with Paul Singer’s Elliott and Aurelius Capital – the two most aggressive holdouts in the over 10-year legal saga with the sovereign.

“These are clearly the toughest guys out there and they have reached an agreement with Argentina after litigating over a decade,” said Alejo Czerwonko, emerging markets economist in the chief investment office at UBS Wealth Management.

The deal has paved the way for Argentina to end a near 15-year isolation from the international capital markets after its 2001 default and, as of early March, it had reached agreement with about 85% of creditors suing the country in US courts.

If all goes according to plan, Congress will repeal certain debt laws and the country will soon come with its first cross-border bond since 2001.

The government said in March that it planned to return to market in mid-April with bond sales totalling US$11.68bn comprising tenors of five, 10 and 30 years in an effort to cover holdout payments.

A deal of this size would make it the largest bond offering ever from an emerging markets borrower, putting it just ahead Brazilian oil firm Petrobras’ US$11bn issue in 2013, according to Thomson Reuters data.

More Argentina supply is likely to follow as the government tries to raise tens of billions of dollars to plug the country’s growing fiscal gap.

A string of provinces are also preparing international bond sales, led by Buenos Aires, which kicked off European and US roadshows in March through Citigroup, HSBC and JP Morgan.

And corporates such as real estate firm IRSA and oil company YPF, as well as utility Pampa Energia, are expected to tap the markets this year.

Music to the ears

All this is music to the ears of bankers toiling to generate mandates in a region where dollar funding has lost its allure amid FX volatility, slower growth and a deepening political and economic crisis in Brazil.

“This is the worst I have seen it since 1998 – much worse than 2008,” said a veteran DCM banker. “We have a pipeline but it isn’t nearly what it was last year. The only thing that is vastly different from before is Argentina.”

Argentina has once again become a popular stomping ground for DCM bankers scouring the region for business as the country wins favour with the international investment community.

DCM activity in Argentina – which was once a major fee-generator – may help bolster shrinking bond fee wallets, which, according to Thomson Reuters/Freeman Consulting, fell to US$252.21m last year from US$676.39m in 2014, and stand at just US$25.10m so far this year.

It remains to be seen whether Argentina can fill even a portion of the gap left over from Brazil, where cross-border bond sales have ground to a halt. But this has not stopped bankers from trying.

BBVA, Citigroup, Deutsche Bank, HSBC, JP Morgan and UBS reportedly extended a US$5bn bridge loan to help Macri’s new administration bolster dwindling reserves earlier this year, putting them in pole position for future sovereign mandates.

The move underscores the importance of Argentina for certain financial institutions, even as many of these banks beat a broader retreat from the region.

Clinching mandates on sovereign and other deals in Argentina could make a large dent in the P&L statements of LatAm DCM departments this year.

The US$11.68bn transaction from the sovereign would almost double the US$15.4bn in new supply seen from Latin American borrowers in the first two months of 2016, and propel lead banks to the top of the league tables.

“[The sovereign deal] is pretty important,” said a syndicate banker. “It gives big league table credit and there are obviously fees.”

The large sum alone should mean a big payout for banks involved, though questions remain over the size of fees to be charged to a junk-rated sovereign long absent from the markets.

“I don’t think it will be in the single digits,” said a DCM banker. “They have to pay if they want to get the job done. It is not a matter of showing up and putting a 1bp–2bp fee on it.”

The region’s more sophisticated public credit departments, such as in Colombia and Mexico, have been content to pay anywhere between 14bp and 25bp on recent dollar and euro transactions, and Argentina is expected to be no different.

Even at the low end of that range, the payout on the US$11.68bn bond offering should be more than satisfactory, even when shared among competitors.

Execution risks?

But can the markets absorb a US$11bn-plus offering in one fell swoop – or even price within the 7.5% target announced by Secretary of Finance Luis Caputo in March?

While some have their doubts, many think Argentina’s exceptional circumstances make such a foray possible – even though the buyside has lost its enthusiasm for emerging market credits.

“We have a high degree of confidence that it is doable, assuming you have a stable market,” one debt syndicate banker told IFR. “This is one of the few positive stories in EM.”

Still, the deal would almost certainly have to come in both US dollars and euros with a variety of tenors and would require a broad sweep of the global investor base as well.

“If they need all the US$15bn at once, they could do US$10bn in dollars and US$5bn in euros,” said Sean Newman, a senior portfolio manager at Invesco. “The market is there, but it would lead to some indigestion.”

Supply concerns have been at the forefront of investors’ minds as the market anticipates more issuance from the sovereign, provinces and corporates – not to mention selling from hedge funds seeking to profit from earlier bets on a resolution to the country’s holdout saga.

“There will be a lot of supply coming out of Argentina, and that is where it gets challenging – for investors to digest the supply,” said Baur at Eaton Vance.

“The flip side is that they are starting from very low levels of debt and there is a lot of room for the government to expand the amount of debt. That is one of the reason I would look at [the bond issue].”

In fact, the size of the deal may help, as it will give the country significant weighting in debt indices and will force accounts to sit up and listen.

“If the larger asset managers are underweight Argentina, there could be billions of dollars on the sidelines,” said a hedge fund lawyer.

And, in the end, the trade may simply be too tempting to resist, especially given that Argentina will have to pay up if it wants to keep investors satisfied and sell more deals later on down the road.

Despite its rising credit profile, Argentina will likely have to pay a premium over Brazil, which has now fallen fully into junk territory. Some investors think an Argentina 10-year should come as high as 8% or more, while Brazil’s benchmark 2025s are being quoted at 6.50%.

“If it comes at 8%, I would definitively look at the transaction carefully,” said Newman. “Argentina is still not out of the woods. People will turn their lenses on inflation and fiscal reform. You can’t ignore these things, and that is why you need to price at the high end.”


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