Sovereign Analysis /

Argentina's debt exchange: Counter proposals are in, what happens next?

  • Bondholder groups submitted their various counter proposals to the government's exchange offer, which closes Friday

  • Failure to reach agreement also risks default given expiry of the grace period on missed coupons on the same day

  • No agreement and default look likely; the best we can hope for is goodfaith negotiations towards an agreement soon

Argentina's debt exchange: Counter proposals are in, what happens next?
Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
19 May 2020
Published byTellimer Research

Bondholder groups submitted their various counter proposals to the Argentine government late on Friday (15 May), in a coordinated response, ahead of the 22 May twin deadline for the government's exchange offer and the expiry of the grace period for US$500mn in missed coupons. While the counter proposals and some softening in the rhetoric from the government's side mark progress, how much depends on the extent of the gap between the two sides and whether it is bridgeable, and time is running out. We think the gap between the government's offer and the bondholders' is large, which we estimate at about 20pts, but it is not unsurmountable, depending on the willingness on both sides to compromise, and from the government's side, finally to engage in goodfaith discussions, although it seems unlikely that this gap can be closed in just the few days that remain.

Still, with little prospect of the government's deal being accepted, and no time to reach a revised agreement by Friday (let alone operationalise or implement it), Argentina could be heading towards yet another default, much of its own making (again), despite what the government and its supporters say. This eventuality would not be much of a surprise to anyone.

So what happens next? 

We highlight a few possible scenarios.

1. The government's exchange offer is accepted by bondholders as it is (without modification) so that it doesn't have to make the coupon payments and thereby it can avoid default. However, we think this is unlikely. For this to be effective and eliminate legal risks, we think participation would have to be high enough to reach thresholds under the collective action clauses, which would then bind non-participating creditors and thereby remove legal risks from holdouts (for two or more series, that is two-thirds individually and 85% in aggregate for the 2005 Indenture bonds, and 50% individually and two-thirds in aggregate for the 2016 Indenture bonds). Given participation was as low as 15% after the exchange's original 8 May deadline, and the rejection by the main international creditors, it would seem unlikely that such sufficient acceptance will be achieved. 

2. The government's exchange offer is rejected (by the majority of bondholders), there is no (or not enough) modification (and we think there isn't enough time to reach agreement on modifying it), so the government makes the coupon payments to avoid default, and it buys more time to negotiate a deal with bondholders (similar to what we saw in the Province of Buenos Aires earlier this year when it ended up paying after creditors rejected its consent solicitation to defer bond payments). Presumably the government would only do this though if it thinks an acceptable deal is close to being had, and would be seen as a sign of goodwill (it would probably also have to cancel its existing offer). Buying time could be formalised in standstill agreement, which could be a reciprocal demonstration of goodfaith by the bondholders. But we think paying is unlikely. Sure, US$500mn is not much set against the cost of default, and with US$43bn in reserves, arguably Argentina has the money. But paying is not the government's narrative, and without grounds for a goodfaith negotiation or a formal standstill, the deadline would simply shift to the next coupon date and there is no guarantee that we'd be any closer than we are today. The next coupon dates are end-June (28 June for US98mn on the century bonds and 31 June for US$479mn on the Discounts), which would imply near end-July using the grace periods again. Still, this provides two months, which could be more than enough time to reach a deal. However, there may also be questions over intercreditor equity for bondholders that get paid now compared to those that don't.

3. The government's exchange offer is rejected, there is no modified deal (not enough time), no payment, but negotiations continue in default amid an informal agreement to refrain from litigation, perhaps with the government extending the deadline again. Argentina is already in a virtual state of default, a point recognised by its government, so non-payment may be a non-event (it would have a ratings impact, trigger CDS and impact banks' provisioning). If the government doesn't dismiss the counter proposals out of hand, and sees them as providing a reasonable basis for taking forward goodfaith discussions, we think the market will be able to overlook payment default and bondholders should be able to continue negotiations. Bondholders may then not seek to trigger cross default or to accelerate (which requires 25% of the bonds, and 50% to rescind) –although that always remains a valuable option. This is not unprecedented; similar patience has been exercised elsewhere (Cote d'Ivoire 2010 and Mozambique 2016 to name but two). Moreover, the committees represent the lion's share of the bonds anyway so it might be easier to get a tacit or voluntary agreement among holders not to do this, as a further show of goodfaith. Bondholders would, however, want some assurance that such discussions wouldn't be open-ended, although they can be compensated in terms of recognition, and payment, of PDI. What the government does with those that do accept could also be important in setting the tone for such discussions. 

4. No deal, no payment, but negotiations continue under a standstill agreement (although this is in the wrong order of doing things and seems like closing the stable door after the horse has bolted). This would formalise the above process, with bondholders voting for a standstill through a consent solicitation exercise to defer payments and refrain from litigation. It would provide space for negotiations to continue (or start). This idea is reportedly doing the rounds in Buenos Aires, perhaps after seeing Ecuador do this successfully earlier, although this is something the government had previously ruled out. However, it seems impossible for this to be effected by Friday and creditors have little incentive to agree to a standstill after then (crucially, Ecuador reached a standstill agreement before the end of its grace periods, which is the usual order of doing things). Moreover, we don't see the need for it if both sides are committed to goodfaith negotiations, although the government could feel it provides protection if talks subsequently break down. But we think it's too late for this now, Argentina has lost this opportunity because of its piecemeal and unilateral approach. 

5. No deal, no payment, no negotiations. Either immediately, or later, negotiations break down, if the government is unwilling to concede to bondholders' demands and/or bondholders are unable to make further compromises, and we enter a period of blame, confrontation and a protracted default with little hope of a deal (sound familiar?). Whether the government chooses to accept bonds from those that did tender, and go ahead with closing the exchange without the consent of the majority who have opted out, rather than cancel it, could complicate future discussions by creating another class of bondholders, while selective default risks litigation, isolation and financial autarky. But Argentina has a strong incentive to avoid this path in this environment; unlike in 2005, when global conditions were more favourable to it. 

But it seems much will depend on the government's willingness to concede ground on one of the creditors' key issues, that is the grace period, which means no payments for three years under the government's proposal.

There may also be the possibility of additional sweeteners, including state contingent coupon payments or value recovery rights (or GDP warrants). However, while they may offer some upside potential, their merits might be questionable given Argentina's tarnished reputation with its existing GDP warrants and uncertainty over what its growth model is, and investors will want to ensure if there are any such payments, they are more tightly designed and offer stronger legal protection. 

Moreover, the government is also trying to reach a deal against a difficult (and evolving) economic backdrop, which could complicate ongoing discussions and the post-deal economic outlook. It is resisting heavy pressure on the exchange rate, evident in the difference between the official rate and the parallel rate (ARS/U$67 and over ARS/US$120, respectively). Addressing this economic imbalance could constrain policies and subdue the growth outlook for some time to come. The government might see this as a reason for bondholders to accept a bigger share of the burden, although conversely, it might be an argument for reaching a quick compromise deal in order to stimulate new capital inflows to help the adjustment process. 

As an aside, if Argentina does fall into a lengthy and protracted default, we wonder what lessons global policymakers will take away from it. Argentina's previous defaults have, in part, prompted legal changes in bond documentation, such as the widespread adoption of collective action clauses, aggregation clauses, and tighter interpretation of pari passu, all with the intention of reducing the threat of litigation from holdouts. Argentina may prove that CACs are no guarantee if a government chooses to ignore them (thankfully, in every other sovereign restructuring we can think of where CACs have been present, this hasn't been the case). Best practice on sovereign debt restructuring and engagement between sovereigns and bondholders have also evolved and been codified over the last 15 years. Our lesson is that it is difficult to legislate for recalcitrant debtors that refuse to play by the rules, and global policymakers should refrain from changing the international financial architecture to accommodate Argentina's behaviour in what has become the exception rather than rule. And it is no coincidence to us that Argentina's two lost decades since its 2001 default mirrors unpredictable policies and its mistreatment of creditors. 

The counter proposals 

The three main bondholders groups (the Bondholder Group, the Ad Hoc Bondholder Group and the Exchange Bondholder Group) submitted their counter proposals. Our summary below and assessment of terms is based on what has been reported in media – see here for example. But we stress that the proposals haven't been published officially so we should treat media reports with some caution. And while full details haven't been made available, we expect there is broad equivalence between the different proposals in financial terms. 

Generally, the counter proposals envisage removing the three-year grace period on payments and having a higher and faster coupon step-up. There is no (or virtually none) principal haircut in any of the proposals. Accrued is paid in cash. The Bondholder Group proposes a strip (we think similar to Greece and Ukraine), with holders receiving an equally weighted portfolio of bonds with amortisations from 2027-2040, one in US$ and one in EUR. Payments resume in November 2020, with the coupon starting at 1.25%, rising to 5.875% in November 2025, for the US$ bonds. The Ad Hoc Bondholder Group is closer in structure to the government's proposal with a menu of bonds, six each in US$ and EUR (with the addition of a new shorter 2027 bond). Amortisations begin from 2025. Payments resume in November 2020, with the coupon starting at 2.25% over 2020-2022 for the US$ bonds, but this is fully capitalised in year 1, partially capitalised in year 2, and paid in cash from year 3 onwards, with the coupon rising thereafter depending on the specific bond (rising to 3.75% on the shortest 2027 bond and as high as 6.95% on the 2039 bond). For the 2005 indenture bonds, the Exchange Bondholder Group proposes two new bonds, one maturing in 2033 (amortising from 2027) and one in 2040 (amortising from 2034). Payments resume in November 2020, with the coupon on the shorter bond rising from 1.25% to 5.875% from 2023 and from 1.25% to 5.875% from 2025 for the longer bond. Additional cash payments or sweeteners linked to GDP are also proposed (perhaps to compensate for giving up their stronger legal protections compared to the 2016 indenture bonds, although it is not clear if they apply to both classes of bonds). However, it is not clear to us if these are state contingent coupon uplifts or detachable instruments. 

It remains to be seen whether the government sees any of these payment profiles as consistent with its own debt sustainability analysis and assessment of its very limited capacity to pay. The Ad Hoc Group state that their proposal provides aggregate cash flow relief of over US$32bn over a ten-year period and implies an average coupon reduction of 30% from a contractual rate of 7% to a rate of 4.5% (compared to 2.3% in the government's proposal).

Valuing the counter proposals

Our estimated recovery values based on our understanding of one of the proposals (for simplicity) according to media reports, the Bondholder Group's, are shown in Table 1 (excluding cash payments and additional sweeteners or recovery rights). We note, however, that modelling of the proposals is difficult given limited information, so we should exercise some caution in interpreting the results. The NPV of the offers have been reported in the media as being in the range US$58-60 (at a 10% exit yield).

We estimate a PV of US$63 for the strip (ie average across all the instruments) at a 10% exit yield for US$ bonds. This compares to our estimated recovery values under the government's proposal of c40 for US$ bonds under the 2016 Indenture at the same exit yield. That suggests a gap of about 20pts between the two sides. However, we also think a 10% exit yield is generous for Argentina not only in the current environment but also for a government in which we really have very little visibility – and confidence – in their macro policy framework, track record and reform commitment, especially in the absence of an IMF programme. At a still generous 12% exit yield, our estimated recovery value falls to US$54 compared to c31-36 in the government's proposal (albeit still a wide gap). The current environment may even justify a higher exit yield (say 14%), although conversely, one could argue that post-deal, with Argentina set to pay very little in the first few years, that should mean a lower probability of default and justify a much lower exit yield.

Our estimated recovery values compare to current prices of c40 at the front-end (2021-2023), c33 in the belly and c31 at the long-end for Macri bonds, and 42 for the US$ discounts (Table 2). As such, the proposal offers some 20-30pts upside for those with an aggressive view on exit yields and still some 15-20pts under a less aggressive view, with the longer lower cash price bonds offering the most upside. This may sound like a Buy signal, although we suspect there is still some way to go, and plenty of deal risk, and scope for compromise to reduce the gap between the two sides and which could reduce estimated recovery values. 

The bonds have already rallied in the last few weeks (with the 5.875% 2028s up 35% for instance, see Figure 1) perhaps as confidence grew that a robust and well coordinated group of creditors may be able to extract better terms and amid perceptions that the government's own stance may have softened after saying it was open to offers following the failure of its own debt swap on its original 8 May deadline. 

Table 1: Estimated illustrative recovery values for US$ strip*  
Exit yield (%)Present value**
Source: Tellimer Research. *Based on our understanding of the Bondholder Group proposal according to media reports. **Average PV across the strip. PV expressed per unit of existing principal. Excluding cash payments and additional sweeteners. 

Table 2: Argentina US$ bond prices  
US$ bondsMid price
6.875% 2021
5.625% 2022
4.625% 2023
7.5% 2026
6.875% 2027
5.875% 2028
6.625% 2028
7.125% 2036
7.625% 2046
6.875% 2048
7.125% 2117
Source: Bloomberg, Tellimer Research. As of cob 18 May 2020.  

Figure 1: Price of ARGENT 5.875% 2028 (US$)

Source: Bloomberg, Tellimer Research