Last updated: 11:49 / Tuesday, 1 July 2014
Viewpoin by Investec AM

Argentina is Dealt Another Blow

Argentina is Dealt Another Blow

Argentina’s long-running legal battle with a group of holdout bondholders is now in its penultimate stages. The US Supreme Court’s decision to deny its appeal, closes one of the key doors that could have led to a neat, market-friendly solution to the holdout problem.The outcome remains uncertain and much will depend on the pragmatism of the government. Price action is likely to remain poor while uncertainty prevails.

Accroding to Vivienne Taberer, portfolio manager at Investec Asset Management, it is a harsh ruling which neither the government nor the market expected, given the negative price action of the past few days. In an address to the nation, President Cristina Fernandez de Kirchner called the ruling, which could result in claims against Argentina of up to US$15 billion, “extortive”. There is support for this view in the country, with the opposition backing the government position to some extent but making it clear that a negotiated settlement would be the best outcome.

What are Argentina’s options from here? There are essentially four possibilities. The first and least likely option would be to default and restructure all outstanding debt. We believe that this has effectively been ruled out as the president has pledged to meet Argentina’s debt obligations, which arose during the Kirchners’ respective terms in office. This option would have the biggest impact on prices, resulting in sizeable further falls in bond prices from here. Despite the government’s recent statement that it would not pay the 30 June coupon to the holdouts, the asset manager do not expect a default on all outstanding debt. However, the likelihood of a technical default has risen, given the limited time between now and the end of the grace period for the coupon payment to be made.

The second option would be to pay the holdouts their US$1.5 billion claim in full. In our opinion this is also unlikely. The government, not unreasonably, believes that this could pave the way for more claims, from other holdouts and from holders of the restructured debt that could amount to as much as US$15 billion.

The third and fourth alternatives open to Argentina remain the most likelyand the ones which we believe the government will pursue concurrently. This is likely to result in volatile price action that will ultimately lead to further underperformance of Argentine bonds, and particularly those issued under New York law.

The third option would entail negotiating with the holdouts through the court of Judge Griesa. Argentina has based its opinion on Griesa’s statement that his ratable payment order does not force the country to default. The judge, however, is not in a position to force a settlement on the parties. Serious questions remain as to the holdouts’ willingness to accept a lesser settlement and Argentina’s willingness and ability to offer better terms than those received by the restructured bondholders.A deal that settles somewhere between meeting the holdouts’ demand for full payment and a price that reflected the same terms as received by the restructured bondholders would no doubt be significant and ultimately lead to a material rally in bond prices.

The last option would entail the government attempting to facilitate a local law swap and seek a way to continue paying the restructured bondholders. It is not at all clear how this would work in practice, and there are not insignificant risks that such a move could challenge Judge Griesa’s order. Given that Argentina is sending lawyers to negotiate with the holdouts, a swap of this nature will likely only happen once a default, even if it is only technical, has already occurred. If this happened, we would expect to see continued pressure on bond prices.

In summary, the direction of bond prices from here remains very uncertain, with risks skewed to the downside. Investec believe the Argentine administration is a lot more pragmatic than it has been in the past and that ultimately the long-term outlook for Argentina is improving. However, they also believe that yields can widen further from here, and that until the situation becomes clearer the asset manager will maintain their underweight.

Read the viewpoint in full here.