Default Risk Still High Despite Swap Proposal

The latest developments in Argentina's long-running legal battle against holdout investors - those who have refused restructuring offers on defaulted bonds - reaffirm our view that there is a growing possibility of a technical default on the country's restructured sovereign bonds in the next few weeks. Argentine Economy Minister Axel Kicillof announced on June 17 that the government would attempt to swap the country's New York law debt for local bonds, a scenario we had previously identified as a possible reaction to the US Supreme Court's June 16 action in favour of the holdouts ( see 'Default Risk Rises On Supreme Court Ruling', June 16). However, as we have previously highlighted, this course of action is quite risky, and we see a high potential for a unilateral swap of this nature to trigger a technical default and credit default swap (CDS) payout. Unsurprisingly, the price of default protection has soared since the court's decision, with the spread on Argentina's one-year sovereign CDS contract spiking to 5,991 basis points (bps) at one point on June 18 from 2,623bps on June 16.

Additionally, the yield is rising on Argentina's restructured bonds, reflecting growing concern about the fallout from the US court case. By refusing to hear an Argentine appeal, the US Supreme Court left in place a lower court decision that Argentina must pay holdouts in full or lose access to the US financial system for making coupon payments on the restructured debt. Bonds due in 2033 have seen the nominal yield increase from 10.7% on June 16 to 12.3% at one point on June 18.

The Argentine government has underscored in recent days its desire to keep making payments on the restructured debt, one reason we believe the reaction in the bond market has been relatively minor compared to the blowout in CDS spreads. However, we see risk of a much larger sell-off in these bonds, especially if market participants come to question the feasibility of the plan outline by Kicillof. We believe, in such a scenario, the yield on the 2033 bond could quickly rise to the 13.0-16.0% range, where it traded for much of 2013.

Default Risks Soaring
Argentina - One-Year Sovereign CDS Spread, bps

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Related sectors of this article: Economy, Finance, Fixed Income, External Debt
Geography: Argentina

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