Credit Suisse Research Alert: Argentina: Increasing risk of technical default

Credit Suisse Research Alert – Mariano Arrieta

We believe that the likelihood of Argentina entering into a technical default has advanced beyond our previous expectations and we therefore recommend that investors reduce risk exposure.

Depending on their risk profiles, investors could also consider switching existing holdings into to low-priced Par bonds or Bonar 2013 (local law) bonds.

Regardless of the final decision by the Appeals Court, Argentina’s credit metrics continue to deteriorate. We are reaffirming our Negative fundamental credit view.

Investment strategy

We recommend that investors reduce credit risk exposure to Argentina. In our view, the likelihood of Argentina entering into a technical default scenario (as per ISDA terms) has increased following the country’s response to the latest ruling from the New York District Court. However, bond prices have sold off dramatically and some instruments are trading at close to default levels. In this respect, we would suggest two defensive strategies: 1) Switch existing holdings into low-priced Par bonds and limit the loss from a technical default scenario, and/or; 2) Switch existing holdings into Bonar 2013 (local law) bonds maturing in September 2013 with no cross-default clause with foreign law bonds.

The legal saga

On 23 February 2012, Judge Thomas Griesa ruled against Argentina in the case filed by a group of investors (NML Capital and other plaintiffs), still holding defaulted bonds as a consequence of the 2001 crisis. According to Judge Griesa, Argentina breached the Pari Passu (or equal treatment) provision when they made payments on bonds issued after the 2001 default (performing bonds), while refusing to pay holdouts. Argentina appealed the ruling, but the Court of Appeals reaffirmed the decision and asked Judge Griesa for clarity about the “payment formula” to compensate the plaintiffs. On 21 November, Judge Griesa upheld the ruling and ordered Argentina to pay USD 1.3 bn in escrow until the Court of Appeals reaches a final decision. Judge Griesa rejected several arguments presented by third parties and mentioned that bondholders knew “full well” that the holdouts would seek payment through litigation when they accepted Argentina’s restructuring proposal. He also said that he would normally leave the stay order in place until the end of the appeal process, but repeated declarations from high-ranking officials (including President Cristina Kirchner) with respect to not paying holdouts created “extraordinary circumstances.”

Argentina’s response

Argentina’s Minister of Economy, Hernan Lorenzino, held a press conference yesterday indicating that the decision was unfair and illegal in terms of the local legislation. He reiterated Argentina’s stance and mentioned that the country will ask for a revision next Monday and will go to the US Supreme Court if necessary. It is unclear, however, whether the Supreme Court would accept the case. The Supreme Court certainly has the power to grant a new stay.

Potential claims

While the final ruling does not change Argentina’s repayment capacity materially, it could trigger similar actions from other holdout creditors with a stronger impact. According to the local newspaper El Cronista, the stock of untendered bonds governed under the New York law amounts toUSD 6.2 bn. The stock of untendered bonds denominated in EUR or JPY (USD 5 bn) could also be a potential source for future claims.

Moreover, bondholders who accepted a haircut in 2005 and2010 could also claim for equal treatment if Argentina pays holdout creditors the full amount. In any of these cases, Argentina’s debt burden would be affected substantially.

Rising risk of technical default

Argentina could enter into a technical default, despite its willingness to keep serving performing bonds. If Judge Griesa’s decision is upheld and Argentina does not comply in any way, the US Court could eventually block debt payments under New York law to creditors that accepted the 2005 and 2010 debt exchange (Discount, Par, Global 2017 bonds and GDP warrants). The new ruling limits Argentina’s legal scope, while increasing the odds of a negative outcome if Argentina does not pay on 15 December, exactly when GDP warrants have to be paid.

Fundamental view

We reaffirm our Negative Fundamental credit view on Argentina, based on our belief that policy continuation will increase macro imbalances and exacerbate the economic slowdown. A deteriorating growth/inflation mix and persistently high interventionist policies (i.e. import restrictions and FX controls) are likely to continue weighing on the business climate. On the fiscal side, it is unlikely that the government will cut spending significantly in a year with mid-term elections. Policy continuation will probably exacerbate the discontent with the administration, while increasing political noise. All in all, Argentina’s credit fundamentals are likely to keep deteriorating, regardless of the outcome of the most recent events. In this scenario, investors should not be surprised by periods of adverse news flow that would probably lead to a correction in bond prices.

(23/11/2012)