The markets have continued to trade Argentine bonds with caution, ahead of the Supreme Court audience on the Argentina-Holdout case, which will take place on June 12th. We view the possible outcomes as follows: (1) The Supreme Court accepts the petition to hear the case, perhaps reacting to the plethora of amicus curiae that have been presented in favor of the Republic’s case (great scenario for markets), (2) The Supreme Court asks to hear the input of the solicitor general on the possible implications of this case on the sovereign immunities act before making a final decision, an outcome that could stretch the decision timeframe out to 2015 (good for markets), or (3) The Supreme Court just denies the request to hear the case, in that manner exhausting all the possible appeals of Argentina in the US Court system (very bad scenario). If Scenario 3 occurs, the payment of the interest on the 2033 Discounts, scheduled to take place on June 30, would feasibly be attachable by the holdouts. In other words, under the third scenario, Argentina would most likely default on performing debt.
We will not attempt to forecast how the Supreme Court will act, but rather assume an equal weighting to the just-mentioned possible scenarios. Nine months ago we would have assigned 0% probability to the scenario of the Argentine government agreeing to pay full claim to the holdouts in the event of an adverse Supreme Court decision. Now we see an increased probability of the government potentially deciding to pay the holdouts, most likely in kind (paid with additional bonds rather than cash), as was the case with Repsol. As we argued in our “Winds of Change” piece at the beginning of this year, the authorities have clearly internalized that a recovery in the capital account is a necessity for the current economic model to survive, hence their decision to become increasingly pragmatic on the economic management front.
There seems to be an understanding by the authorities that running a current account surplus is not sufficient to keep money demand strong, and that without external financing, the reserve drain will continue (the reason the government elected to pay Repsol and reach an agreement with the Paris Club is tied to the need to reopen external credit lines). Alternatively, if the US justice system forces Argentina to default, the government may decide to call a debt swap for holders of performing debt, so that investors can receive “mirror” bonds carrying Buenos Aires legislation –and in that manner be able to get paid. The problem with this scenario is that the execution of this strategy seems quite complicated from a logistical point of view, and also, the capacity of provinces and corporates to issue in the future under New York law could be compromised.
The bottom-line: While it is impossible to forecast how the US Supreme Court will ultimately act, our conviction view asserts that the interest of a very small minority places at high risk the right of “the many” (in this case 93% of the holders of debt) to get paid under New York jurisdiction. In any case, we continue to recommend investors stay involved in this credit through sovereign USD-denominated Buenos Aires law paper (2015s and the new 2024s, currently yielding an attractive 10.7%) and NY Law provincial debt (BA 2015s and 2021s, for example). We are not lawyers, but our view is that provincial debt should remain immune to the events affecting the sovereign.
Clearly, if the Supreme Court rejects the case, and Argentina’s ability to make the interest payments on the NY Law 2033s is withheld, there will be ample volatility, but we sense that the willingness of the Fernandez de Kirchner administration to continue paying the debt will remain intact. The amortization schedule of Argentina is relatively light (USD $8.3 billion of public debt matures in 2014, according to the official September 2013 Public Debt Update), and Argentina will probably benefit from increased sources of capital account financing following the agreements reached with the World Bank, the Paris Club, and Repsol.
Now, if Argentina loses the case, but subsequently acts pragmatically, i.e. pays the holdouts to keep interest payments from being attached by the plaintiffs, then we think that the holders of performing debt will refrain from suing the Republic (for violating the most favored offer clause included in the 2005 and 2010 covenants). We maintain this view not least because a decision by the Republic of Argentina to finally end the holdout debacle would likely generate a material, unprecedented rally in Argentine debt given the implied capacity of Argentina to be able to issue without problems in New York. Under this “good case” scenario, we would not be surprised to see the NY-law USD-denominated 2033s rally north of $115 (clean price, now trading at $78) if indeed the government is able to clear the problem with the holdouts.
Alberto J. Bernal-León is Head of Research and partner at Bulltick