Argentina's restructuring offer could push it to default

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Argentina’s offer to restructure $66.2 billion in foreign-law bonds with a three-year grace period and a 62% reduction in interest payments sparked speculation about whether it will be accepted by bondholders or not, with some analysts saying it is too early to tell and others saying a default is imminent.

"It is not going to be accepted by bondholders," said Mauro Mazza, head of research at Bull Market Brokers in Buenos Aires.

He estimates that the acceptance rate will be 25% to 30% for the 21 bonds in the offer, putting Argentina at "enormous risk of default."

Mazza's expectations echoed around the market as analysts held calls and poured over the preliminary announcement of the offer made late Thursday by Economy Minister Martín Guzmán.

The proposal calls for a three-year grace period on capital and interest payments, a 62% discount in interest payments and a 5.4% reduction in capital payments. All told, it would reduce debt payments by $41.5 billion and give Argentine time to pull out of a recession that is only expected to get worse as a result of coronavirus pandemic.

According to a statement on Friday evening, Argentina will swap outstanding bonds for new notes that mature in 2030, 2036 and 2047. The new bonds, denominated in dollars and euros, will pay between 0.5% and 4.875% per year.

Guzmán said on Thursday that the average interest rate for all of the new bonds would be 2.33%. The bonds will start accruing interest on November 15, 2022 and will pay principal in five to 20 installments, depending on the maturity.

There is not much time to evaluate the offer. Guzmán has given bondholders 20 days to make a decision, saying it was the final offer, and shot down a demand from bondholders for Argentina to cut spending, especially now that the government is trying to limit the economic and social impact of the pandemic, which led to a lockdown from March 20 to April 26.

"We believe that there is not enough space for Argentina to improve its fiscal accounts as fast as the creditors demand," said Luis Prato, an economist at Torino Capital in New York. "On the contrary, Argentina is going to need resources to face the impact that COVID-19 will have on the population."

Argentina's economy is expected contract 5.84% this year, but the government will "continue to use policies to stimulate the economy to avoid the collapse of the productive system, which could generate an inflationary impact," Prato said. "For this reason, the fiscal deficit will increase, which in 2020 could reach, according to our estimates, 5.5%."

Tough negotiations ahead
Bondholders will likely use as a timeframe for the negotiations – and a gauge of the government's willingness to amend the offer – the next bond payment of $500 million due April 22. If not paid, the government will have a 30-day grace period to make the payment or fall into default on around May 22.

José Ignacio Bano, head of research at InvertirOnline.com, a brokerage firm in Buenos Aires, said the payment can be made easily with foreign reserves, but he added that Argentina may not comply because President Alberto Fernández said in the presentation on Thursday that the country is already in "virtual default."

If the payment is not made on April 22, "the negotiations are going to be tough, very tough," Bano said.

Argentina needs to have a majority of the bondholders accept the offer. Most of the 21 bonds include clauses that say if a majority, usually around 75%, accept the offer, the rest have to follow suit. But if even one of the bonds does not meet the minimum acceptance rate, then the entire restructuring could fail, Bano said.

Priscila Robledo, a Latin America economist at London-based Continuum Economics, said the proposal is "harsher than what most expected, albeit not by much."

She said that the relatively small haircut on the principal "seems to have been well received in general," but warned that the government's suggestion that it will not accept a counter-proposal "most likely will age poorly."

While most investors will probably be willing to accept the proposal in order to avoid complicated legal trials, "the key question is, however, whether the offer will have a sufficient rate of approval so that it does not get blocked by a sufficiently large minority of bondholders (which varies between 15-33%)," Robledo said. "As they are now, we believe the terms of the offer are in line with our baseline scenario of a hard default."

Even so, Robledo said there is the possibility of averting such a default if the government makes "enough concessions to the current proposal."

Argentina, too, could benefit from a push for flexibility in debt payments around the world because of the financial impact of the COVID-19 crisis, she added.

Prato said much the same. "Argentina could appeal to this situation to take advantage of the impossibility of meeting its obligations, given a cause of force majeure that will imply a reduction in its economic growth rate and, with it, in its debt repayment capacity," said.

Willing to negotiate?
Ezequiel Zambaglione, head of strategy at Balanz Capital Valores, a brokerage firm in Buenos Aires, said he thinks that Argentina will improve the offer.

The current proposal puts more emphasis on cutting interest payments over capital, a response to a request from bondholders as they do not sacrifice too much of the principal if a dispute ends up in court, he said.

Still, the biggest point of contention is going to be the grace period, Zambaglione said.

At three years, it is so long that it could be more beneficial to wait for the bonds to go into default, he said. In Argentina's 2005 default on nearly $100 billion, it took three years for the government to negotiate a restructuring deal. By New York law, defaulted bonds capitalize at 9% per year, which is a better return than getting nothing during the proposed grace period, he said.

"If there is something to adjust, it is the grace period," Zambaglione said. "That is where the negotiation is going to be."

Torino's Prato said that while such a long grace period may be hard to accept, "it opens up a margin of negotiation that could imply, for example, an advance payment on principle, which could be supported by a loan from the IMF [International Monetary Fund]."

In February, the IMF, Argentina's largest creditor with a $44 billion loan out of a $57 billion credit line, called on private bondholders to make a "meaningful contribution" so Argentina can emerge from its debt crisis.

If the IMF approves the final restructuring offer, that could be "vital" for its success, Prato said.

Too much of a haircut
It may not be easy to convince bondholders to accept the offer. Norberto Sosa, a director of IEB Invertir en Bolsa, a brokerage in Buenos Aires, said the COVID-19 crisis has cut the prices of the bonds in the offer, taking the implicit haircut based on current market prices to levels close to the 76% of Argentina’s 2005 debt restructuring.

The offer is "a little beyond what the bondholders are willing to put up with," he said.

The risk for the government is that if the negotiations fail, bond prices could fall below $20, a level that could attract hedge funds to buy them and hold out of the restructuring offer to collect 100% of the face value, plus penalties and past-due interest, through litigation.

On Friday, the 4.625% January 2023 bond was up 3.5 points in price to bid 33.25 while the January 5.875% 2028 issue was trading up 1.03 points in price to bid 27.36, according to data provider Refinitiv.

A number of hedge funds, often dubbed vulture funds, held out of the 2005 restructure and wound up collecting large profits in 2016, keeping Argentina out of the international capital markets for 15 years from when it declared default in 2001.

"If it has to go to litigation, I think it would be less difficult to have to advance in that area with firms like PIMCO, Templeton and BlackRock, instead of vulture funds," Sosa said.

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