Settlement With Holdouts Unlikely Before 2015

BMI View: Argentina will likely find a way to resume coupon payments on its defaulted debt. However, the standoff between Argentina and holdout investors is likely to drag on until at least early 2015, when the government will face a reduced risk of cross-default claims from exchange bondholders. A prolonged period of uncertainty will reverse the positive strides the government made in H114 to bolster investor sentiment.

The Argentine government will resume payment on its restructured debt, following the July 30 expiration of a 30-day grace period after missing a coupon payment ( see 'Settlement With Holdouts Still Likely After Default', July 31). However, we see a growing likelihood that the standoff between Argentina and investors who have refused restructuring offers on defaulted debt - the so-called 'holdouts' - will stretch on until at least the beginning of 2015, when legal prohibitions on offering a better restructuring deal than that offered in 2010 will expire.

In that light, we view Argentine President Cristina Fernández de Kirchner's plan to submit a bill to congress offering bondholders the right to exchange their existing securities, which are governed under US law, for dollar-denominated local bonds governed under Argentina law, as unlikely to gain traction. Foremost, the potentially insurmountable legal complications involved in such an exchange make it unlikely to occur. Indeed, exchanging the restructured global bonds for local bonds would entail surpassing US court rulings prohibiting the relevant financial intermediaries in the US from participating in such a swap. Meanwhile, the majority of bondholders are likely to view the prospect of moving their bonds under Argentine law as unattractive, even in the context of the government's default. As such, we view the offer as a signal of the government's intention to continue delaying the resumption of substantive negotiations on a settlement for at least a few more months.

Room For A Further Spike In Yields
Argentina - Restructured US Dollar 2033 Bond Yield, %

BMI View: Argentina will likely find a way to resume coupon payments on its defaulted debt. However, the standoff between Argentina and holdout investors is likely to drag on until at least early 2015, when the government will face a reduced risk of cross-default claims from exchange bondholders. A prolonged period of uncertainty will reverse the positive strides the government made in H114 to bolster investor sentiment.

The Argentine government will resume payment on its restructured debt, following the July 30 expiration of a 30-day grace period after missing a coupon payment ( see 'Settlement With Holdouts Still Likely After Default', July 31). However, we see a growing likelihood that the standoff between Argentina and investors who have refused restructuring offers on defaulted debt - the so-called 'holdouts' - will stretch on until at least the beginning of 2015, when legal prohibitions on offering a better restructuring deal than that offered in 2010 will expire.

In that light, we view Argentine President Cristina Fernández de Kirchner's plan to submit a bill to congress offering bondholders the right to exchange their existing securities, which are governed under US law, for dollar-denominated local bonds governed under Argentina law, as unlikely to gain traction. Foremost, the potentially insurmountable legal complications involved in such an exchange make it unlikely to occur. Indeed, exchanging the restructured global bonds for local bonds would entail surpassing US court rulings prohibiting the relevant financial intermediaries in the US from participating in such a swap. Meanwhile, the majority of bondholders are likely to view the prospect of moving their bonds under Argentine law as unattractive, even in the context of the government's default. As such, we view the offer as a signal of the government's intention to continue delaying the resumption of substantive negotiations on a settlement for at least a few more months.

Crucially, the longer Argentina remains in default, the more difficult it will be for the government to reintegrate into the international financial community, and address the underlying economic imbalances that could precipitate an exchange rate or balance of payments crisis over the medium term ( see 'New Inflation Index A Crucial First Step To Improving Confidence', February 14). Moreover, it is an open question whether exchange bondholders will remain willing to wait until 2015 for a resolution without coupon payments. Media reports indicate that a decision by exchange bondholders to accelerate cross-default claims would result in USD29.0bn of principal and interest claims due immediately, exhausting the country's currency reserves. Such a scenario would leave the Argentine government with limited ammunition to defend the peso against another devaluation ( see 'Risk Scenarios Could Prompt Another Devaluation', August 6).

The yield on Argentina's 2033 restructured US dollar bond will head higher in the coming weeks, as the market prices in an increased likelihood that a settlement will be further delayed. With the 2033 bond currently yielding 11.2%, well below the 11.5-17.0% yield recorded through most of 2013, there is substantial room for the yield to spike. In addition, new legal claims by exchange bondholders could further sour market sentiment towards Argentine assets, putting additional upward pressure on yields.

Room For A Further Spike In Yields
Argentina - Restructured US Dollar 2033 Bond Yield, %

Fernández To Remain Focused On Domestic Audience

Fernández's swap offer indicates that placating her domestic political audience will remain a chief goal over the coming months. The Argentine president has long taken a politically popular hard-line stance against international investors, and manufacturing a scenario in which bondholders reject the opportunity to swap their current holdings for local debt will allow Fernandez to paint the bondholders as the intransigent party in the dispute. Nevertheless, we believe the anticipated surge in Fernández's approval rating will be transient, as recent polling indicate the country is moving in favour of negotiating an agreement to resume coupon payments ( see 'Default To Exacerbate Fernández' Political Woes', August 14). A drop in approval would be likely to increase pressure on the president to come to an agreement with holdouts in the coming months. Moreover, such a development would bolster our core view that candidates associated with the policies of the ruling Frente Para la Victoria will fare poorly in the October 2015 presidential election.

Default Protection Price Reflects Likelihood Of Payout
Argentina - 5-Year Sovereign Credit Default Swap, bps

CDS Payout Still Likely Following Default

We view a payout of the roughly USD1.0bn of insurance claims written on Argentine debt through sovereign credit default swaps (CDS) as being imminent, despite a delay to the International Swaps and Derivatives Association proceedings in  setting up an auction to disperse payment. While not at record highs, Argentina's sovereign CDS spread has remained elevated in recent days, reflecting the growing likelihood of a CDS payout following the expiration of the 30-day grace period. As we have previously noted, while a payout could have large ramifications for the parties involved, we do not see it in and of itself as posing a major systemic risk at this point. CDS prices have long implied that a default was a clear possibility, and as a result the outcome will catch few investors off guard.

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Sector: Country Risk
Geography: Argentina
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