Wednesday, July 30, 2014

Argentina's Last Debt Tango?

Richard Lough of Reuters reports, Argentine debt talks go down to the wire to avert default:
Argentina faced a race against on time on Wednesday to avert its second default in 12 years, needing either to cut a deal by the end of the day with "holdout" investors suing it or to win more time from a U.S. court to reach a settlement.

Argentine Economy Minister Axel Kicillof hurried to New York on Tuesday to join last-ditch negotiations, holding the first face-to-face talks with the principals of New York hedge funds who demand full repayment on bonds they bought at a discounted rate after the country defaulted in 2002.

Kicillof emerged from talks late on Tuesday, saying only that they would resume on Wednesday, but mediator Daniel Pollack said issues dividing the parties "remain unresolved" and that the two sides had not decided whether to meet on Wednesday.

Argentina has until the end of Wednesday to break the deadlock. If it fails, U.S. District Judge Thomas Griesa will prevent Argentina from making a July 30 deadline for a coupon payment on exchanged bonds.

Argentina's key dollar bond due 2033 rose sharply on Wednesday, and its debt insurance costs fell as investors took some cheer from the meeting.

Argentina's five-year credit default swaps dropped 30 basis points from Tuesday's close to 1,869 basis points, according to Markit. The CDS had hit six-week highs on Tuesday. The nation's one-year credit default swaps dropped 51 basis points from Tuesday's close to 4,708 basis points.

The CDS continue to price in a very high probability of default in the near term.

"Bonds have fallen in recent days but are far from pricing a default," said Emiliano Surballe, fixed income analyst at Bank Julius Baer.

"While nothing has been done yet to avoid a default, the chances of a last-minute transfer of funds to pay creditors leaves the door open for a boom (if Argentina pays) or bust (should there be a default)," Surballe said.

The hedge funds are owed $1.33 billion plus accrued interest, but an equal treatment clause in an agreement Argentina made with bondholders in 2005 would cost the nation many billions more.

FOCUS ON RUFO CLAUSE

Latin America's No. 3 economy has for years fought the hedge funds that rejected large writedowns, but after exhausting legal avenues, it faces default if it cannot reach a last-minute deal. According to bank sources and media, a group of private banks in Argentina is set to offer to put up $250 million as a guarantee to convince lead holdouts of the nation's good faith and convince Griesa to re-establish the stay.

Kicillof's unexpected appearance in New York raised hopes that there was still time to avoid a default that would bring more pain to an economy already in recession, though not the economic collapse seen in 2002 when it defaulted on $100 billion in debt.

The Buenos Aires government has pushed hard for a stay of the U.S. court ruling that triggered Wednesday's deadline.

Its chances of success were boosted on Tuesday when holders of Argentina's euro-denominated exchanged bonds said a suspension would encourage a settlement.

They also said they would facilitate a deal by waiving the so-called RUFO clause that prevents Argentina from offering other investors better terms than it offered them.

Argentina has consistently argued the RUFO clause prohibits it from settling with the holdouts.

"Obtaining a waiver of the RUFO clause, however, will take time," the group of bondholders said in an emergency motion for a stay filed on Tuesday.

While unnerving, the debt crisis is a far cry from the turmoil of Argentina's record default in 2002 when dozens were killed in street protests and the authorities froze savers' accounts to halt a run on the banks.

Christine Lagarde, the head of the International Monetary Fund, said on Tuesday that an Argentine default was unlikely to prompt broader market repercussions, given the country's relative isolation from the international financial system.
In his analysis, Robert Plummer of the BBC reports, Argentina in denial over debt dispute:
Right from the start, the Argentine government's attitude to its debt dispute with US hedge funds has made it all but inevitable that the country will fail to reach a compromise.

"We're not going to default, they'll have to invent a new term to define what's happening," said President Cristina Fernandez de Kirchner last week, deep in denial, as the deadline loomed for the country to meet its obligation to the so-called "vulture funds".

Thanks to a US court decision, Argentina is required to pay $1.3bn (£766m) to investors who bought its bonds at a big discount after its economic meltdown and previous default in 2001-02.

It failed to do so by 30 June and a 30-day grace period is now set to expire.

But the government has been resisting this course of action, because it fears that this could lead to the unravelling of other debt deals that it struck with most of its creditors.

As a result, a second default is now in prospect, and the outcome could be painful for an economy that is already in recession.
Distressed debt

Last time around, Argentina was left unable to repay or service more than $100bn of debt. The resulting default meant that it has not been able to borrow further money on the international markets since then.

Two successive restructuring deals, in 2005 and 2010, covered the overwhelming majority of bondholders, who agreed to accept about one-third of what they were originally owed.

However, hedge funds NML and Aurelius Capital Management snapped up a large chunk of the remaining distressed debt at low prices and are now pressing to be paid the full face value of their holding.

Their case against the Argentine government has been trundling through the US judicial system for some time. But Buenos Aires didn't expect the crunch to come so soon.

President Fernandez's government fully expected the dispute to go all the way to the US Supreme Court, which would have bought the country more time.

But in June, the Supreme Court declined to hear Argentina's appeal against the decision of a lower court that made it liable for the money.

Under that court's ruling, Argentina cannot use the US financial system to keep paying the restructured bondholders unless it also pays the "vulture funds".

And there are other hold-outs from the previous restructuring deals who could now follow the hedge funds' example and press for the full face value of their bonds.
Wider economy

From Argentina's point of view, there is a legal obstacle to its acceptance of the hedge funds' terms: a clause in the deals with the restructured bondholders, known as Rufo (rights on future offers).

This clause, which expires at the end of the year, states that Buenos Aires cannot favour the hold-outs over those who accepted the restructuring deals.

Given the choice, Argentina would like to spin out the negotiations with the "vulture funds" until 2015, when the clause will no longer apply.

But the US courts have refused to comply, seeing the restriction as one of Argentina's own making that could be circumnavigated if the government wanted to.

And after all, why should the Argentine government put itself out? As Capital Economics emerging markets economist David Rees points out, any default will have a "negligible" direct impact on it.

"The authorities are already locked out of international markets and will remain so," he says.

"But default is likely to have negative consequences for the wider economy in two ways," he adds.

"First, it is likely to cause interest rates on corporate debt to increase, which may deter investment and hamper activity in the private sector.

"Second, default may spur some capital outflows, exacerbating a shortage of hard currency and putting renewed pressure on foreign exchange reserves and the peso."
Combative style

That hard currency shortage is reaching a critical point. The amount of foreign exchange held by the central bank fell by 30% last year and is now less than $30bn (£18bn) - the lowest level since 2006.

As well as allowing Argentina to service its debts, that money is also needed to finance imports. Capital outflows would also do further harm to an economy that is expected to contract by 1% this year.

Undeterred by all this, President Fernandez is ploughing on in her usual combative style, while seeking help from other quarters.

Earlier this month, she wangled an invitation to the Brics summit in the Brazilian city of Fortaleza as a special guest, alongside the leaders of member countries Brazil, Russia, India, China and South Africa.

While there, she obtained support from the group in her battle against the "vulture funds".

She also came away with assurances that the organisation's new Development Bank could well offer her an economic lifeline.

But Argentina's woes are testing her leadership style to the limit, while economic and political analysts are already hoping that the end of her mandate in October 2015 will usher in an era of renewal after the next presidential election.
The latest from the Wall Street Journal is that Argentina's banks are preparing a bid to help the country avoid default:
Members of Argentina's banking association, known as Adeba, are working on a last-minute plan to help the country avoid default, according to people familiar with the matter.

News of the plan came as Argentina's economy minister said late Tuesday that the country would continue negotiations on Wednesday with holdout investors after failing to reach a deal during a full day of talks. Argentina needs to reach an agreement with the investors by Wednesday to prevent a default, which would be its second in 13 years.

Meanwhile, Argentina's representatives and the holdout creditors met face to face for the first time Tuesday, the court-appointed mediator, Daniel Pollack, said in a statement after the talks had concluded.

"The issues that divide the parties remain unresolved," Mr. Pollack said.

Mr. Pollack said Argentina and the holdouts hadn't yet determined whether and when to meet on Wednesday.

Elliott Management Corp., one of the leaders of the holdouts, couldn't immediately be reached for comment.

The bankers association's plan, which hasn't been completely hashed out among the banks, would entail buying the legal claim and paying off the holdout creditors who are suing Argentina in U.S. courts for full payment on bonds the country defaulted on in 2001.

In exchange, the banks would ask the holdouts to ask U.S. District Judge Thomas Griesa, whose ruling has barred Argentina from paying its restructured bondholders unless it pays off the holdouts, to suspend his ruling.

"There is a little bit of a mess within Adeba," said one of the people, noting that the president of one of the banks took the lead in trying to organize the plan without getting full authorization from the other banks.

Another person said the idea is for the banks to buy the government's claim in three cash installments. In exchange, the banks would ask the government to pay them back in bonds beginning in January, when a key clause in the case expires.

This clause, the "Rights Upon Future Offers," or RUFO clause, says that any voluntary deal offered to the holdouts before the end of this year must also be offered to the restructured bondholders. Argentina has argued that if it pays the holdouts, the country would also have to pay as much as $120 billion to other bondholders to comply with the RUFO clause.

"I don't think we can say today that this proposal from Adeba is firm," a person familiar with the situation said.

The person said the banks first need to agree among themselves on the details of the proposal, then they would need to get assurances from the government that they would be adequately compensated.

This plan, if it works, would be a huge breakthrough in a case that has weighed on the country's citizens and politicians, as well as lawyers and bondholders, for years.

Argentine officials were in talks with the mediator at his New York office for 12 hours on Tuesday.

Argentine Economy Minister Axel Kicillof arrived approximately seven hours into the negotiations.

Argentina missed an interest payment on its restructured bonds due June 30, and the grace period for that payment ends on Wednesday. A U.S. judge has said Argentina isn't allowed to make that payment until it pays the holdouts. Argentina had refused to pay the holdouts or even meet with them face-to-face for negotiations.

Argentina's dispute with these creditors is a long-standing battle that stems from the country's default in 2001. The holdouts were the approximate 7% of Argentina's bondholders who refused to accept the country's debt-restructuring offers in 2005 and 2010 and have instead sued for full payment.

A default could send Argentina's struggling economy deeper into recession and keep the country shut out of debt markets. Argentina already suffers from annual inflation that some economists estimate is close to 40%, and a default could fuel inflation further by putting pressure on the peso's value and making imports more expensive.
Finally, in her analysis, Linette Lopez of Business Insider reports, Argentina's Leaders Might Be Totally Genius:
There have been moments in the decade-long legal battle between Argentina and a small group of hedge fund creditors known as NML Capital when one could only step back and think, The people running Argentina have got to be out of their minds.

One analyst note, however, suggests that Argentina may have been playing this thing the right way the whole time.

The Republic's leaders have until Wednesday to either pay NML more than $1.3 billion worth of debt; get a stay of payment to all bondholders holding this same debt (allowing the country more time to negotiate with NML); or face default.

For years the country has argued it should not have to pay NML 100 cents on the dollar for debt dating to its 2001 default, when over 90% of the same bondholders took a haircut.

The U.S. Supreme Court finally shut the door on that argument in June.

Despite several meetings with a special master of the court over the past few weeks, Argentina has been refusing to negotiate with NML until a stay of payment has been granted.

Now it's really down to the wire.

So Abadi & Co. Global Markets published a note outlining all the scenarios. It includes the table below (click on image to enlarge).



Now let's walk through the scenarios. Keep in mind that Argentina has said that it wants to pay this debt in 2015 because of something called the RUFO (Rights Upon Future Offers) clause. Basically the clause says if Argentina voluntarily negotiates better terms with some creditors before 2015, all creditors are entitled to those same improved terms.

Argentina has been saying that negotiating with NML triggers RUFO and opens it up to $15 billion worth of claims from other creditors holding the same bonds.

So with that ...

Both parties lose if Argentina goes into default. Argentina's domestic economy will suffer as will its relationship with the rest of the world. For NML, its claim will be undermined and the country will be even more justified in arguing that it can't pay.

NML wins if it gets paid in cash or bonds for obvious reasons, though it may not get absolutely full satisfaction of its claim if it gets paid in bonds.

Both parties win if Argentina is granted a stay and the Republic then stands by its word and negotiates with NML. NML gets paid in 2015, Argentina avoids default and doesn't have to deal with a bunch of RUFO claims.

But there's some stickiness there. First off, you have to trust that Argentina really means what it says and that it wants to negotiate to avoid triggering RUFO. Could be that Jan. 1, 2015, will come and go and Argentina will sill refuse to obey the court and pay NML.

Based on its previous behavior, such a move wouldn't be surprising. That's why the judge, Thomas Griesa, has already refused to place a stay on payment once this month.

The other thing you have to keep in mind is that Argentina has defaulted before and survived. Plus, in this case, the government isn't completely broke like it was in 2001. It could potentially keep the country running until 2015 when it could pay the holdouts without triggering RUFO.

So to Argentina this is the choice it's handing hedge fund managers — we, as a nation, will be paying you in 2015. We can do it in pain and under duress, or we can do it in compliance with the Court.

But it's 2015 or bust.

Now, this whole scenario is thrown for a loop if you don't buy that Argentina is waiting for RUFO to expire. Some people don't believe that argument. They think that since RUFO is only triggered if Argentina is voluntarily negotiating, being forced to negotiate by the court (i.e., what's happening now) does not trigger the clause anyway, so this is all a charade.

Graham Fisher analyst and debt specialist Josh Rosner is one of the people who have argued this. Not only does he think the country could avoid RUFO now if it wanted to, but he also thinks that if the country paid NML — thereby entering the international financial community having resolved its major debt disputes — it could easily raise the necessary money to pay RUFO claims even if the clause was triggered.

From Rosner's note:
"Argentina has ignored the reality that even if that $15 billion number was correct and the creditors unwilling to negotiate a payment formula that was acceptable to both parties, the government would still be able to manage the increased debt burden as a percent of GDP. Moreover, late last year, at least one Wall Street firm offered to raise the full $15 billion that the government claims it owes. If the government chose to raise capital as a means of resolving this impasse, it would normalize its relations with the international capital markets, reduce its cost of funds going forward and immediately begin to attract the foreign investment necessary to develop key industries, including its energy sector and the broader economy."
So maybe NML doesn't want the stay because it isn't buying this whole RUFO argument, the same way Rosner isn't, and isn't willing to give Argentina time to slip out of this one.

Or maybe NML just hasn't realized that Argentina is willing to sit in extreme discomfort until 2015.

The latter may sound crazy at first glance, but, when you think about it, it's kind of crazy like a fox.
Whether or not the deal from Argentina's banks is accepted and helps the country avoid another default remains to be seen. Pay attention to what is going on in Argentina because it could have global ramifications (never mind what the IMF says).

And if you really want to understand what is going on in Argentina, read Michael Hudson's latest, Vulture Funds trump Argentinian sovereignty. Michael and James Henry, a leading economist, attorney, investigative journalist and former chief economist at McKinsey & Company, were interviewed by Paul Jay of The Real News Network.

You can watch the clip below and listen carefully to their insights. These hedge fund holdouts stand to make enormous profits for themselves and their clients but as they argue, Judge Griesa's ruling could spell trouble for Wall Street banks who are on the other side of these debt default swaps and who sell and buy emerging market bonds.

I particularly like Henry's closing statement:
"I could say, just to end a positive note, last week not only did Argentina almost win the World Cup, but the Chinese premier came to Argentina with 200 business executives, and he is setting up a $7.5 billion project lending facility plus a $11 billion currency swap facility. Chinese companies are looking seriously at investing in farms, farmland, grain production, and in the shale oil deposits that Argentina has, which are larger than the United States’, potentially.

So this country has great future, and I think it’s disappointing for the United States not to be able to behave in a more professional way toward Argentina, one that values this long-term relationship."
Argentina may have lost the World Cup 2014 Final but it certainly has a great future. If they can only get these insanely greedy vulture funds off their back! Stay tuned, this could get ugly but I doubt the powers that be will let it degenerate into a full blown catastrophe.

Update: Reuters reports Argentina will default on its debt within hours after talks with holdout creditors broke down on Wednesday. Citing the WSJ, Zero Hedge reports that J.P. Morgan is about to bailout Argentina by paying the credit holdouts. I can't confirm any of this. Argentina blamed the United States Thursday for the legal battle that forced it into its second default in 13 years, accusing the judge and mediator in the case of "incompetence."

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