A Victory for Argentina

By Roy C. Smith

Argentina’s massively oversubscribed $16.5 billion bond issue last week reflected a surprising degree of confidence in the new government of Mauricio Macri, given the country’s considerable economic problems and those of its fallen-angel neighbor, Brazil.

It also demonstrated an unquenchable thirst for yield on the part of investors willing to grab at a 683 basis points spread over 10-year German bunds for a B3 rated bond by an issuer with a long history of defaults. 

Perhaps more important, however, is that it signaled the end of a difficult 15-year effort to restructure Argentine bonds that defaulted in 2001, and regain access to capital markets.

Argentina’s $82 billion default, the world’s largest, was a “can’t pay, won’t pay” event imposed by a floundering Argentine government, that was later led Nestor Kirchner, the country’s socialist Peronista party president elected in 2003 who was succeeded in 2007 by his wife, Christina Fernandez de Kirchner, and who died in 2010. The Peronistas have governed Argentina for the past 25 years.

The default was probably unavoidable, the economy was in free-fall and money was rushing out of the country. But the government chose a politically popular but highly confrontational approach to dealing with its creditors, eschewing any involvement by the IMF and ignoring demands of creditor committees.

Four years after the default, it offered a take-it-or-leave-it exchange of new bonds for old valued at $0.34 on the dollar. This was a value far less than other emerging market debt restructurings, and less than what most of the banks believed Argentina could manage to pay

To help persuade banks to accept the offer, the Argentine parliament passed a law making it illegal for the government to change the terms of the offer.

A 75% majority of the banks folded and took what they could get, writing off the rest.

But there were some holdouts that refused to exchange their debt, mainly hedge funds that had bought their positions from banks. So there was a second exchange offer made in 2010 that 66% of the holdouts representing $18 billion of claims accepted.

The die-hard hedge funds continued to resist, however, filing lawsuits seeking to block Argentine assets outside the country, including a naval training ship seized by creditors in 2012. When Argentina nonetheless sought to raise additional funds in the markets, the holdouts sued in New York and a judge ruled in 2015 that Argentina could not take on new debt until it paid off what was left of the old. 

In the end, despite mighty and heavy-handed efforts by Christina Fernandez to get around the courts, the game was lost. Her second term as president expired in 2015, and Macri replaced her.

Macri was heartily welcomed by politicians such as Barack Obama, and by investors. He made settling with holdout bondholders a priority, and decided to take advantage of the market’s good will to raise the new debt, with some of the proceeds going to repay the hedge funds.

The new bonds are issued under New York law and will be subject to future court rulings if the Argentine government seeks to interfere with bondholders’ rights in the future. 

But those rights are diluted by a “collective-action clause” (CAC) that will enable the government to change the maturity, interest rate and/or other terms of the bonds “with the consent of less than all of the holders.” If the designated percent of bondholders agree to the change in terms, then all bondholders are committed.

If the CAC covers exchange offers, issuers are able to avoid the headache of holdouts, which in Argentina’s case added ten years to the time it was able to re-enter capital markets after the first exchange offer.

Investors in emerging market debt know that governments are shielded by sovereign immunity that enables them to avoid direct legal remedies for default such as bankruptcy. They also may know that according to a Moody’s study of sovereign defaults from 1983-2010, that in any single year the default rate of Ba or B rated debt was about 4.0%, but over a 10-year period, the cumulative default rate for speculative-grade sovereign debt was 34%.

In other words, an investment in Argentina’s new 10-year bonds at 6.8% above the “risk-free rate” (i.e., the German bunds) would clear the Moody’s single year default rate expectation by 2.8%; but over 10-years the gain would not be enough to compensate for the cumulative 34% default rate.

Mr. Macri has got off to a good start, from a bondholder’s point of view. He devalued the country’s currency, moved to lower subsidies, laid off 20,000 unionized public service workers and imposed other austerities to help shore up the country’s finances.

But Argentina still has many challenges. Thousands of workers have already marched in protest of Macri’s proposals, and analysts expect the economy to shrink this year. The Inflation rate is currently over 30%.

Lots of unforeseen things can get in the way between a good start and a good finish to a bond issue.  If they do, the CAC will do away with both the opportunity and the pressure on the government represented by holdouts.  And Argentina’s go-it-alone, cram-down restructuring involving a 66% write-off in 2005 will be a tough precedent for it to resist in the future.