Argentina
Following Deadline Extension, Argentina, Creditors Remain Far Apart on $65B Deal; Contingent Instruments, Interest Only Securities Could Bring Parties Together, Subject to Appropriate Structure
Tue 05/12/2020 13:03 PM
Relevant Items:
Prospectus Supplement
Offer Press Release
Exchange Offer Model (Excel Download)
Despite the extension of the deadline for Argentina’s exchange deal to May 22 from May 8, the sovereign and its various creditor groups appear to be far apart regarding the terms that might be acceptable to consummate a potential transaction.
At least three separate groups of creditors have formed - and individually as well as collectively rejected Argentina’s offer. Each group has distinct positions in the debt structure and correspondingly somewhat distinct objectives. This is in part because Argentina’s bonds were issued under two different indentures - one from 2005, with broadly stronger contractual provisions for negotiating leverage, and the other from 2016, with somewhat less leverage relative to the 2005. Reorg previously analyzed and valued Argentina’s exchange offer to creditors.
This report assesses the negotiating dynamics between Argentina and its primary creditor groups and analyzes potential integrative modifications to the offer that could help bring the parties closer together. First, the report reviews Argentina’s offer and discusses market dynamics and the creditor groups’ positioning.
Then, based on our analysis and discussions with parties on various sides of the transaction, the report provides an overview of practical and integrative transaction modification options, including:
Initial Offer
As previously discussed, Argentina’s proposal entails exchanging $64.6 billion of foreign currency-foreign law bonds issued under the 2005 and the 2016 indentures for new securities of five different maturities - 2030, 2036, 2039, 2043 and 2047 - denominated in dollars and euros. Each of the exchange bonds includes an interest holiday through the end of 2022, along with, on average, much lower interest rates than the existing bond obligations. At the same time, the exchange bonds’ valuations are highly sensitive to the exit yield, with indicative estimated valuations for the USD-denominated bonds ranging from 29.4% to 67.4% and for the euro exchange bonds from 25.8% to 60.4%.
The exchange proposal groups 29 series of outstanding bonds into 11 groupings (four under the 2005 indenture and seven under the 2016). Each grouping is offered the choice of two or three different options, each of which includes different par values - ranging from 78 to 140 per 100 of outstanding principal - of different types of exchange bonds, which in turn have distinct maturities, interest rates and amortization profiles.
All things being equal, estimated recoveries are more favorable to 2005 indenture bondholders, relative to holders under the 2016 indenture. This is likely a reflection of the 2005 indenture having generally stronger contractual rights, as discussed in more detail below.
Market Dynamics
The prices for Argentina’s foreign currency-foreign law bonds have fallen sharply over the course of this year, suggesting that the restructuring proposal put forth by Argentina may result in substantial losses to creditors, depending on their entry point into the bonds.
The chart below shows prices for a representative sample of Argentina’s sovereign bonds between 2019 and May 2020 based on Refinitiv data. The Republic’s January 2022 and December 2033 maturities traded in the mid-to-high 80s for much of 2019 but fell sharply after early voting results showed overwhelming support for center-left opposition candidate Alberto Fernández over the incumbent centrist, Mauricio Macri (shown in the first red oval). At the same time, Argentina’s longer-dated debt, maturing January 2027, December 2038 and 2117, traded lower, between the high 50s and mid-70s, perhaps reflecting the market’s broader concern about the Republic’s financial health. The spread between Argentina’s debt securities compressed substantially in late 2019 when the newly elected government first hinted at restructuring its external debt.
In March, with the onset of the coronavirus pandemic, Argentina’s publication of a restructuring decree and the government’s decision to formally hire advisors to negotiate with investors, Argentina’s bonds fell further, to a range from the mid-20s to the mid-30s, where they generally remain at present.
Creditor Groups and Negotiation Dynamics
Argentina’s foreign currency-foreign law bonds have different collective action clause, or CAC, provisions, complicating the negotiating dynamics. The Republic’s exchange offer contemplates that the new exchange bonds would be issued under the 2016 indenture, which provides for more debtor-friendly provisions relative to the 2005 indenture.
Specifically, the 2016 indenture includes CACs that would allow the issuer to amend certain terms and provisions of the bonds with lower consent thresholds, outlined in the following table, which compares Argentina’s provisions with those of Lebanon and Zambia.
Most importantly, for our purposes, under the 2005 indenture a creditor group can secure a blocking position of a restructuring with 15% of the aggregate outstanding principal of bonds. In order to block a deal, the 2016 indenture requires a higher threshold of 25% of aggregate principal across all the bonds under that indenture in the event that the “uniformly applicable” condition is met. If the uniformly applicable condition is not met, the sovereign would need the consent of holders of two-thirds of aggregate principal across all the bonds under that indenture, as well as 50% of each series of bonds.
In addition, the 2016 indenture also includes generally more sovereign issuer-friendly priority ranking provisions, with the language detailed below:
The table below summarizes Argentina’s three organized creditor groups. The ad hoc group, represented by White & Case, appears to have blocking positions in the 2005 indenture, with over 15% of the exchange bonds, and potentially also under the 2016 indentures, if Argentina were to pursue the single limb multiple series vote. At the same time, the exchange group of bondholders, represented by Quinn Emmanuel, has a blocking position in the 2005 indenture, holding about 16% of the exchange bonds. The Argentina creditor committee’s holdings have not been publicly disclosed.
As discussed above, the parties’ entry points into the bonds are likely to have been very different, suggesting that certain holders may be willing to accept lower recovery values than others.
Assuming that institutional members of the ad hoc group purchased post-2016 bonds at or around par, those holders are poised to face the steepest losses, while hedge funds in the exchange group could recover at or near their entry point, depending, of course, upon the point in time at which they bought their holdings and if they are successful in their negotiations with the Republic.
Recoveries under Argentina’s exchange proposal vary considerably based on the specific bond grouping as well as the offer “option” that the holder selects. Further, the uncertainty regarding the appropriate exit yield compounds the computational complexity.
Recoveries range as follows for the 2005 indenture:
Recoveries range as follows for the 2016 indenture:
In nearly all cases, however, Argentina’s bonds trade below their indicative recoveries under most scenarios, suggesting that market participants are using exit yields above 14% (the highest exit yield in Reorg’s five scenarios) or anticipating potentially adverse subsequent changes to the offers as presented.
At the same time, Argentina’s restructuring will ultimately entail not only bridging the divide between the Republic and its creditors but also developing a structure aligned with the disparate interests of the bondholder groups.
Potential Exchange Offer Modifications
While the parties appear far apart in terms of a transaction, the respective groups’ public statements and precedents from recent sovereign transactions and supranational developments suggest plausible avenues toward adjusting the transaction in a manner that may help bridge the gaps.
There are at least five nonmutually exclusive options that could address creditor concerns while remaining within the debt sustainability guidelines put forth by Argentina and the IMF. (The short-term standstill is arguably not a transaction modification option in and of itself, and may best be viewed as a means toward extending the parties’ negotiating runway.) As discussed in depth, these four options include:
Short-Term Standstill
The Covid-19 pandemic has arguably compounded the challenges inherent to analyzing Argentina’s debt sustainability in light of its long-standing macroeconomic and fiscal issues. That, in turn, likely results in higher dispersion among scenarios, making it harder to get to a mutually agreeable economic baseline from which to negotiate debt modifications.
Because of this, some market participants have suggested that the parties pursue a short-term standstill, allowing the Argentine government breathing room to focus on addressing the Covid-19 pandemic at present - an endeavor that will likely require further IMF support - while also giving the parties the opportunity to reassess the sovereign’s debt sustainability based on a more stabilized baseline.
Two recent developments provide precedent for such an approach - Ecuador’s consent solicitations for a debt standstill and the G-20’s “time-bound” debt suspension for certain emerging market sovereigns.
Ecuador’s transactions in particular may offer a potentially transferable structure. Facing similar constraints amplified by the Covid-19 crisis, Ecuador recently announced and executed consent solicitations for about $19 billion of outstanding eurobonds. In exchange for a relatively manageable consent payment of 50 cents per $1,000 principal, or 5 basis points, the sovereign received an approximately four-month interest deferral and standstill. The consent payment would also be netted against the first interest payment after the standstill, mitigating the associated expense.
Ecuador’s deal was structured as two separate consent solicitations due to different consent solicitations included in the bonds. The consents were supported by creditors, with the first consent solicitation, affecting about $17 billion of obligations, supported by 91.62% of creditors and the second, affecting about $2 billion of obligations, supported by 82.24%. The high level of support from Ecuador’s creditors indicates general market appetite for a standstill transaction, and our conversations with market participants involved in Argentina’s restructuring suggest potential appetitive for such an approach - contingent on an appropriate structure, requisite shows of good faith on both sides, and potential milestones in a debt sustainability analysis.
While the G-20 debt deferral decision does not directly apply to Argentina, the rationale for it - namely, to allow financially constrained governments an opportunity to focus on the coronavirus crisis - is arguably applicable to Argentina’s circumstances. At the same time, the G-20 decision, which clearly delineated the unique circumstances regarding Covid-19 issues, may provide negotiating cover to creditors otherwise apprehensive about setting a precedent.
If Argentina were to pursue such a “pause” in respect of its foreign currency-foreign law debt, like Ecuador it would likely have to structure it as a two-part consent solicitation for bonds issued under both indentures. Reflecting the dynamics of its exchange offer discussed above, such a transaction would have different applicable thresholds as well.
Assuming such consent solicitations were effective, Argentina and its creditors could restart negotiations after the standstill expires.
Contingent Instruments
Argentina’s debt restructuring guidelines and statements from its political leadership indicated amenability to including in the exchange a contingent instrument tied to Argentina’s economic performance. In the sovereign debt context, a contingent instrument, often in the form of a GDP-linked security, allows creditors to benefit from a sovereign’s economic expansion following a restructuring of its obligations. In that regard, the instrument conveys an almost equity-like exposure, intended to help align interests between the parties to bridge an otherwise oftentimes zero-sum divide.
In their webinar presentation, the exchange group suggested that “a contingent instrument” would be the “natural way” to bridge the “gap” of the parties’ macroeconomic forecasts. At the same time, according to the creditor group, the contingency does not have to be in the form of a GDP warrant. Instead, it could be a simple designed coupon boost or an acceleration of amortization schedules.
However, contingent instruments present unique administrative and instrument-level complexities. First, collection and analysis of the underlying input data regarding GDP and other economic and financial variables can be intensive and require a significant amount of trust in the respective reporting agencies. Second, the computations - which, in essence, generally make payments to holders contingent upon the sovereign achieving certain levels of growth over a prescribed period of time - are, in practice, complex and instrument-specific, creating an inherent friction cost due to the efforts required to analyze the securities.
This complexity has presented itself in ongoing litigation over GDP-linked warrants that Argentina issued in connection with its prior restructurings in 2005 and 2010. In that litigation, Aurelius, the beneficial owner of about $739.6 million notional amount of GDP warrants, is seeking damages totaling about $90.1 million to partially recover an alleged contractual breach by Argentina related to computation of payments under GDP warrants issued as part of its 2010 restructuring.
While a coupon step-up or amortization acceleration, as suggested by the exchange group, could somewhat lessen the issues associated with the computation of macroeconomic metrics, the pain points of both compiling the data and analyzing the contingency appear to remain as potential challenges.
That being said, some of the most acute measurement and analysis issues - particularly those concerning potential mistrust between the parties - could be mitigated by incorporating an impartial third-party calculation agent. For instance, the World Bank’s pandemic bond facility relies on a third-party agent to determine when the requisite trigger conditions have been met, after which investor capital is released to fund pandemic relief efforts. Such a calculation agent - whether public or private sector - could be added to a potential contingent instrument structure for Argentina. This would potentially help mitigate investor concerns regarding the accuracy and impartiality of the underlying calculations, increasing faith in the instrument and in turn potentially reducing the required exit yield for it.
Interest Only Securities
The exchange offer presented by the Argentine province of Buenos Aires, or PBA, also highlights an additional potential avenue toward bridging the gap between the parties through interest only, or IO, securities. Similarly to the sovereign, Buenos Aires has debt issued under two main indentures - one from 2006, with more creditor-friendly terms, like the sovereign’s 2005 indenture, and the other from 2015, with terms most comparable to the sovereign’s 2016 indenture. Under the terms of PBA’s offer, the IOs were only offered to consenting holders under its 2006 indenture and not to holders under the 2015. Reorg previously analyzed and valued the transaction.
The interest only securities provide a sweetener, which when analyzed at exit yields between 6% and 14% have an estimated indicative value between 4.1 and 8.8 points for the USD-denominated IOs and between 3.5 and 7.6 points for the euro-denominated IOs.
A similar structure - with IOs offered to consenting creditors under the 2005 indenture with a stronger contractual position - could be beneficial for the sovereign, providing similar economics as a coupon step-up but with more flexibility through a stand-alone instrument. That being said, USD- or euro-denominated IOs still represent external exposure from Argentina’s perspective, likely limiting issuance capacity for debt sustainability. This is because the IMF’s prior analysis reiterated in the latest technical report:
However, Argentina may have meaningfully more room to issue IOs that are denominated in pesos. While understandably less than palatable to some creditors, the approach may have some merits as an integrative solution.
First, on an exchange rate adjusted basis, Argentina could offer a disproportionately higher interest rate on a peso-denominated IO security than it could afford (and the IMF would realistically permit) for external USD or euro exposure. As long as the peso does not meaningfully weaken against the dollar over the life of the security, that could be economically favorable to bondholders.
Second, though a complex and nonlinear macroeconomic relationship, peso-denominated interest payments would arguably, or at least directionally, provide creditors with exposure to “upside” from an Argentine economic revival. Unlike a contingent instrument, a peso-denominated IO would not have the same measurement issues or analytical complexity, further streamlining the structure.
Finally, due to the IO’s structure as a stand-alone instrument, creditors who do not want or are unable to hold peso-denominated exposure could simply sell those securities to other pre-exchange noteholders or in the open market. Alternatively, such holders could enter into currency swaps with broker-dealers to convert the payment streams from pesos to their preferred currency.
Amendments to Existing Offer
Creditors have, not surprisingly, generally pushed Argentina to “sweeten” the terms of its exchange offer, arguing that the sovereign could afford to pay more based on its debt restructuring guidelines and the IMF’s earlier analysis.
Such amendments may have a zero-sum element, making them difficult for the sovereign to execute, both as a practical and potentially political matter. However, certain modifications may be plausible toward bridging the gaps, particularly to the extent that they can provide (or be perceived to provide) a net benefit to the parties involved while making a strong showing of good faith. Such steps could potentially include: (i) payment of accrued interest; (ii) a shorter interest grace period; or (iii) a steeper coupon step-up.
Argentina’s prospectus supplement for the exchange states that tendering bondholders “will not be entitled to receive payment of any accrued and unpaid interest on [their] modified and substituted or tendered Eligible Bonds for the period since the last interest payment date under your Eligible Bond” (emphasis added).
The payment of accrued interest has been a particular point of contention raised by creditors in the exchange group, who have argued that inclusion of accrued but unpaid interest has been common in prior sovereign restructurings. One can also see from Argentina’s perspective, however, the practical challenges in committing to paying accrued interest. The outstanding bond obligations have meaningfully higher interest rates relative to the exchange bonds, which are subject to an interest grace period through late into 2022.
Thus, if Argentina committed to paying accrued interest on existing bonds, that interest would accrue at a higher rate than for the exchange bonds, potentially creating incentives for parties to hold out from the exchange transaction while still having a potential claim for a significant interest spread over the holdout period. Such parties may pursue claims through litigation, which could be a concern for Argentina given issues during its prior restructuring, including certain long-running litigation with creditors.
However, such hold-out risk could be mitigated by allowing payments of accrued interest only to consenting and supporting noteholders who tender through an exchange, but not to holdout creditors. In that regard, the accrued interest could essentially operate as a consent payment to supporting bondholders.
Creditors have also objected to Argentina’s proposed interest grace period until the end of 2022. One creditor group submitted a proposal under which interest during the period would be partially payable in kind, accruing toward the principal outstanding. Such an approach, if structured appropriately, could help parties “split the difference,” providing some compensation to bondholders while still limiting Argentina’s cash outlays and interest expense. Such PIK interest could also potentially be a sweetener that the sovereign offers solely to consenting parties.
Finally, the coupon payment step-up and/or amortization schedule could be adjusted to increase the net present value of the exchange bonds. Given the uncertainty regarding Argentina’s finances and debt sustainability, structuring such a payment step-up or acceleration as a contingent instrument may be more palatable to the IMF and other multilateral creditors, as discussed below.
At the same time, Argentina could potentially make the transaction modifications on a non-pro-rata basis for the two indentures, thus improving deal economics for one group of creditors but not the other. That being said, at least one creditor group - the White & Case-represented ad hoc group - is reported to have blocking positions across both indentures, which may complicate such an approach at least with respect to such cross-over groups.
Revenue-Backed Tranche
An innate complication in sovereign finance is that generally, due to a host of issues including state sovereignty, sovereign bonds are typically issued on an unsecured basis. While less problematic for investment-grade sovereign issuers, for non-investment-grade sovereigns, issuing only unsecured obligations can mean a higher cost of capital, despite the issuer potentially having valuable collateral that could de-risk the obligation from a creditor’s perspective.
To get around this issue, municipal debt issuers in the United States, for instance, commonly use a revenue bond structure through which certain circumscribed cash flows from an asset flow directly to creditors. The Argentine province of Chubut has notably utilized a similar structure, issuing bonds backed by hydrocarbon royalties and paid to creditors through a trust.
The sovereign could potentially take a similar approach, leveraging as collateral, for instance, its shale assets or ownership of certain operating businesses, such as YPF. Issuing bonds backed by revenue from such obligations has a number of potential benefits for Argentina as well as its creditors:
However, given the distinct and potentially creditor-favorable aspects of the debt, it may be possible that a relatively small revenue-backed issuance could be meaningfully accretive as a sweetener in helping to move forward the larger restructuring transaction.
--Lev E. Breydo and Katherine E. Wegert
Prospectus Supplement
Offer Press Release
Exchange Offer Model (Excel Download)
Despite the extension of the deadline for Argentina’s exchange deal to May 22 from May 8, the sovereign and its various creditor groups appear to be far apart regarding the terms that might be acceptable to consummate a potential transaction.
At least three separate groups of creditors have formed - and individually as well as collectively rejected Argentina’s offer. Each group has distinct positions in the debt structure and correspondingly somewhat distinct objectives. This is in part because Argentina’s bonds were issued under two different indentures - one from 2005, with broadly stronger contractual provisions for negotiating leverage, and the other from 2016, with somewhat less leverage relative to the 2005. Reorg previously analyzed and valued Argentina’s exchange offer to creditors.
This report assesses the negotiating dynamics between Argentina and its primary creditor groups and analyzes potential integrative modifications to the offer that could help bring the parties closer together. First, the report reviews Argentina’s offer and discusses market dynamics and the creditor groups’ positioning.
Then, based on our analysis and discussions with parties on various sides of the transaction, the report provides an overview of practical and integrative transaction modification options, including:
- Short-term standstill. This approach, modeled on Ecuador’s successful consent solicitations to achieve a four-month “pause,” could provide the parties valuable time to analyze Argentina’s post-Covid-19 debt capacity, allow the sovereign to reach an agreement with the International Monetary Fund and then restart negotiations on a surer footing;
- Contingent instruments. Such an instrument, potentially in the form of a gross domestic product warrant or bond with a contingent “step-up” structure, could help bridge gaps between the parties by providing bondholders with exposure to the “upside” from Argentina’s recovery.
- Interest only securities. Based on the structure used in Buenos Aires’ exchange offer, interest only, or IO, securities could provide flexibility relative to securities with a higher bond. Such a structure could work by offering bondholders a choice between interest denominated in foreign currency or in pesos. The benefit of foreign currency-denominated payments would be allowing bondholders to receive interest in their home currency. While peso-denominated interest may be unpalatable to some holders, such payments could be higher relative to foreign currency, as local currency obligations could provide Argentina with more flexibility relative to taking on incremental external exposure while offering creditors exposure with some properties of a contingent instrument, at least directionally tied to Argentina’s broader recovery and performance.
- Amendments to existing offer. Such amendments could take a number of different forms, including payment of accrued interest to consenting creditors, a shorter grace period for interest or an accelerated amortization schedule.
- Revenue-backed notes. Based on the structure used by the Argentine province of Chubut as well as U.S. municipal bond issuers to issue oil royalty-backed bonds, the Argentine sovereign could issue a relatively small tranche of revenue-backed obligations, which may help bridge a gap between the parties toward reaching a deal.
Initial Offer
As previously discussed, Argentina’s proposal entails exchanging $64.6 billion of foreign currency-foreign law bonds issued under the 2005 and the 2016 indentures for new securities of five different maturities - 2030, 2036, 2039, 2043 and 2047 - denominated in dollars and euros. Each of the exchange bonds includes an interest holiday through the end of 2022, along with, on average, much lower interest rates than the existing bond obligations. At the same time, the exchange bonds’ valuations are highly sensitive to the exit yield, with indicative estimated valuations for the USD-denominated bonds ranging from 29.4% to 67.4% and for the euro exchange bonds from 25.8% to 60.4%.
The exchange proposal groups 29 series of outstanding bonds into 11 groupings (four under the 2005 indenture and seven under the 2016). Each grouping is offered the choice of two or three different options, each of which includes different par values - ranging from 78 to 140 per 100 of outstanding principal - of different types of exchange bonds, which in turn have distinct maturities, interest rates and amortization profiles.
All things being equal, estimated recoveries are more favorable to 2005 indenture bondholders, relative to holders under the 2016 indenture. This is likely a reflection of the 2005 indenture having generally stronger contractual rights, as discussed in more detail below.
Market Dynamics
The prices for Argentina’s foreign currency-foreign law bonds have fallen sharply over the course of this year, suggesting that the restructuring proposal put forth by Argentina may result in substantial losses to creditors, depending on their entry point into the bonds.
The chart below shows prices for a representative sample of Argentina’s sovereign bonds between 2019 and May 2020 based on Refinitiv data. The Republic’s January 2022 and December 2033 maturities traded in the mid-to-high 80s for much of 2019 but fell sharply after early voting results showed overwhelming support for center-left opposition candidate Alberto Fernández over the incumbent centrist, Mauricio Macri (shown in the first red oval). At the same time, Argentina’s longer-dated debt, maturing January 2027, December 2038 and 2117, traded lower, between the high 50s and mid-70s, perhaps reflecting the market’s broader concern about the Republic’s financial health. The spread between Argentina’s debt securities compressed substantially in late 2019 when the newly elected government first hinted at restructuring its external debt.
In March, with the onset of the coronavirus pandemic, Argentina’s publication of a restructuring decree and the government’s decision to formally hire advisors to negotiate with investors, Argentina’s bonds fell further, to a range from the mid-20s to the mid-30s, where they generally remain at present.
Creditor Groups and Negotiation Dynamics
Argentina’s foreign currency-foreign law bonds have different collective action clause, or CAC, provisions, complicating the negotiating dynamics. The Republic’s exchange offer contemplates that the new exchange bonds would be issued under the 2016 indenture, which provides for more debtor-friendly provisions relative to the 2005 indenture.
Specifically, the 2016 indenture includes CACs that would allow the issuer to amend certain terms and provisions of the bonds with lower consent thresholds, outlined in the following table, which compares Argentina’s provisions with those of Lebanon and Zambia.
Most importantly, for our purposes, under the 2005 indenture a creditor group can secure a blocking position of a restructuring with 15% of the aggregate outstanding principal of bonds. In order to block a deal, the 2016 indenture requires a higher threshold of 25% of aggregate principal across all the bonds under that indenture in the event that the “uniformly applicable” condition is met. If the uniformly applicable condition is not met, the sovereign would need the consent of holders of two-thirds of aggregate principal across all the bonds under that indenture, as well as 50% of each series of bonds.
In addition, the 2016 indenture also includes generally more sovereign issuer-friendly priority ranking provisions, with the language detailed below:
The table below summarizes Argentina’s three organized creditor groups. The ad hoc group, represented by White & Case, appears to have blocking positions in the 2005 indenture, with over 15% of the exchange bonds, and potentially also under the 2016 indentures, if Argentina were to pursue the single limb multiple series vote. At the same time, the exchange group of bondholders, represented by Quinn Emmanuel, has a blocking position in the 2005 indenture, holding about 16% of the exchange bonds. The Argentina creditor committee’s holdings have not been publicly disclosed.
As discussed above, the parties’ entry points into the bonds are likely to have been very different, suggesting that certain holders may be willing to accept lower recovery values than others.
Assuming that institutional members of the ad hoc group purchased post-2016 bonds at or around par, those holders are poised to face the steepest losses, while hedge funds in the exchange group could recover at or near their entry point, depending, of course, upon the point in time at which they bought their holdings and if they are successful in their negotiations with the Republic.
Recoveries under Argentina’s exchange proposal vary considerably based on the specific bond grouping as well as the offer “option” that the holder selects. Further, the uncertainty regarding the appropriate exit yield compounds the computational complexity.
Recoveries range as follows for the 2005 indenture:
(Click HERE to enlarge.)
Recoveries range as follows for the 2016 indenture:
(Click HERE to enlarge.)
In nearly all cases, however, Argentina’s bonds trade below their indicative recoveries under most scenarios, suggesting that market participants are using exit yields above 14% (the highest exit yield in Reorg’s five scenarios) or anticipating potentially adverse subsequent changes to the offers as presented.
At the same time, Argentina’s restructuring will ultimately entail not only bridging the divide between the Republic and its creditors but also developing a structure aligned with the disparate interests of the bondholder groups.
Potential Exchange Offer Modifications
While the parties appear far apart in terms of a transaction, the respective groups’ public statements and precedents from recent sovereign transactions and supranational developments suggest plausible avenues toward adjusting the transaction in a manner that may help bridge the gaps.
There are at least five nonmutually exclusive options that could address creditor concerns while remaining within the debt sustainability guidelines put forth by Argentina and the IMF. (The short-term standstill is arguably not a transaction modification option in and of itself, and may best be viewed as a means toward extending the parties’ negotiating runway.) As discussed in depth, these four options include:
- Short-term standstill;
- Contingent instruments;
- Interest only securities;
- Amendments to existing offer; and
- Revenue-backed notes.
Short-Term Standstill
The Covid-19 pandemic has arguably compounded the challenges inherent to analyzing Argentina’s debt sustainability in light of its long-standing macroeconomic and fiscal issues. That, in turn, likely results in higher dispersion among scenarios, making it harder to get to a mutually agreeable economic baseline from which to negotiate debt modifications.
Because of this, some market participants have suggested that the parties pursue a short-term standstill, allowing the Argentine government breathing room to focus on addressing the Covid-19 pandemic at present - an endeavor that will likely require further IMF support - while also giving the parties the opportunity to reassess the sovereign’s debt sustainability based on a more stabilized baseline.
Two recent developments provide precedent for such an approach - Ecuador’s consent solicitations for a debt standstill and the G-20’s “time-bound” debt suspension for certain emerging market sovereigns.
Ecuador’s transactions in particular may offer a potentially transferable structure. Facing similar constraints amplified by the Covid-19 crisis, Ecuador recently announced and executed consent solicitations for about $19 billion of outstanding eurobonds. In exchange for a relatively manageable consent payment of 50 cents per $1,000 principal, or 5 basis points, the sovereign received an approximately four-month interest deferral and standstill. The consent payment would also be netted against the first interest payment after the standstill, mitigating the associated expense.
Ecuador’s deal was structured as two separate consent solicitations due to different consent solicitations included in the bonds. The consents were supported by creditors, with the first consent solicitation, affecting about $17 billion of obligations, supported by 91.62% of creditors and the second, affecting about $2 billion of obligations, supported by 82.24%. The high level of support from Ecuador’s creditors indicates general market appetite for a standstill transaction, and our conversations with market participants involved in Argentina’s restructuring suggest potential appetitive for such an approach - contingent on an appropriate structure, requisite shows of good faith on both sides, and potential milestones in a debt sustainability analysis.
While the G-20 debt deferral decision does not directly apply to Argentina, the rationale for it - namely, to allow financially constrained governments an opportunity to focus on the coronavirus crisis - is arguably applicable to Argentina’s circumstances. At the same time, the G-20 decision, which clearly delineated the unique circumstances regarding Covid-19 issues, may provide negotiating cover to creditors otherwise apprehensive about setting a precedent.
If Argentina were to pursue such a “pause” in respect of its foreign currency-foreign law debt, like Ecuador it would likely have to structure it as a two-part consent solicitation for bonds issued under both indentures. Reflecting the dynamics of its exchange offer discussed above, such a transaction would have different applicable thresholds as well.
Assuming such consent solicitations were effective, Argentina and its creditors could restart negotiations after the standstill expires.
Contingent Instruments
Argentina’s debt restructuring guidelines and statements from its political leadership indicated amenability to including in the exchange a contingent instrument tied to Argentina’s economic performance. In the sovereign debt context, a contingent instrument, often in the form of a GDP-linked security, allows creditors to benefit from a sovereign’s economic expansion following a restructuring of its obligations. In that regard, the instrument conveys an almost equity-like exposure, intended to help align interests between the parties to bridge an otherwise oftentimes zero-sum divide.
In their webinar presentation, the exchange group suggested that “a contingent instrument” would be the “natural way” to bridge the “gap” of the parties’ macroeconomic forecasts. At the same time, according to the creditor group, the contingency does not have to be in the form of a GDP warrant. Instead, it could be a simple designed coupon boost or an acceleration of amortization schedules.
However, contingent instruments present unique administrative and instrument-level complexities. First, collection and analysis of the underlying input data regarding GDP and other economic and financial variables can be intensive and require a significant amount of trust in the respective reporting agencies. Second, the computations - which, in essence, generally make payments to holders contingent upon the sovereign achieving certain levels of growth over a prescribed period of time - are, in practice, complex and instrument-specific, creating an inherent friction cost due to the efforts required to analyze the securities.
This complexity has presented itself in ongoing litigation over GDP-linked warrants that Argentina issued in connection with its prior restructurings in 2005 and 2010. In that litigation, Aurelius, the beneficial owner of about $739.6 million notional amount of GDP warrants, is seeking damages totaling about $90.1 million to partially recover an alleged contractual breach by Argentina related to computation of payments under GDP warrants issued as part of its 2010 restructuring.
While a coupon step-up or amortization acceleration, as suggested by the exchange group, could somewhat lessen the issues associated with the computation of macroeconomic metrics, the pain points of both compiling the data and analyzing the contingency appear to remain as potential challenges.
That being said, some of the most acute measurement and analysis issues - particularly those concerning potential mistrust between the parties - could be mitigated by incorporating an impartial third-party calculation agent. For instance, the World Bank’s pandemic bond facility relies on a third-party agent to determine when the requisite trigger conditions have been met, after which investor capital is released to fund pandemic relief efforts. Such a calculation agent - whether public or private sector - could be added to a potential contingent instrument structure for Argentina. This would potentially help mitigate investor concerns regarding the accuracy and impartiality of the underlying calculations, increasing faith in the instrument and in turn potentially reducing the required exit yield for it.
Interest Only Securities
The exchange offer presented by the Argentine province of Buenos Aires, or PBA, also highlights an additional potential avenue toward bridging the gap between the parties through interest only, or IO, securities. Similarly to the sovereign, Buenos Aires has debt issued under two main indentures - one from 2006, with more creditor-friendly terms, like the sovereign’s 2005 indenture, and the other from 2015, with terms most comparable to the sovereign’s 2016 indenture. Under the terms of PBA’s offer, the IOs were only offered to consenting holders under its 2006 indenture and not to holders under the 2015. Reorg previously analyzed and valued the transaction.
The interest only securities provide a sweetener, which when analyzed at exit yields between 6% and 14% have an estimated indicative value between 4.1 and 8.8 points for the USD-denominated IOs and between 3.5 and 7.6 points for the euro-denominated IOs.
A similar structure - with IOs offered to consenting creditors under the 2005 indenture with a stronger contractual position - could be beneficial for the sovereign, providing similar economics as a coupon step-up but with more flexibility through a stand-alone instrument. That being said, USD- or euro-denominated IOs still represent external exposure from Argentina’s perspective, likely limiting issuance capacity for debt sustainability. This is because the IMF’s prior analysis reiterated in the latest technical report:
“At that time [of the prior article IV report], the IMF assessed Argentina’s public debt to be sustainable, but not with high probability, given downside risks resulting from: (i) the vulnerability of the public debt trajectory to a further weakening of the exchange rate, as a large share of debt was denominated in foreign currency; (ii) heightened rollover risks due to the increasingly short maturities of new issuances; and (iii) large external financing needs, often a predictor of external crises. Subsequently, those risks materialized.”
Given that backdrop, it would appear likely that the IMF would be particularly concerned about external debt vulnerability, particularly in light of recent weakness and volatility in the peso-USD exchange rate.However, Argentina may have meaningfully more room to issue IOs that are denominated in pesos. While understandably less than palatable to some creditors, the approach may have some merits as an integrative solution.
First, on an exchange rate adjusted basis, Argentina could offer a disproportionately higher interest rate on a peso-denominated IO security than it could afford (and the IMF would realistically permit) for external USD or euro exposure. As long as the peso does not meaningfully weaken against the dollar over the life of the security, that could be economically favorable to bondholders.
Second, though a complex and nonlinear macroeconomic relationship, peso-denominated interest payments would arguably, or at least directionally, provide creditors with exposure to “upside” from an Argentine economic revival. Unlike a contingent instrument, a peso-denominated IO would not have the same measurement issues or analytical complexity, further streamlining the structure.
Finally, due to the IO’s structure as a stand-alone instrument, creditors who do not want or are unable to hold peso-denominated exposure could simply sell those securities to other pre-exchange noteholders or in the open market. Alternatively, such holders could enter into currency swaps with broker-dealers to convert the payment streams from pesos to their preferred currency.
Amendments to Existing Offer
Creditors have, not surprisingly, generally pushed Argentina to “sweeten” the terms of its exchange offer, arguing that the sovereign could afford to pay more based on its debt restructuring guidelines and the IMF’s earlier analysis.
Such amendments may have a zero-sum element, making them difficult for the sovereign to execute, both as a practical and potentially political matter. However, certain modifications may be plausible toward bridging the gaps, particularly to the extent that they can provide (or be perceived to provide) a net benefit to the parties involved while making a strong showing of good faith. Such steps could potentially include: (i) payment of accrued interest; (ii) a shorter interest grace period; or (iii) a steeper coupon step-up.
Argentina’s prospectus supplement for the exchange states that tendering bondholders “will not be entitled to receive payment of any accrued and unpaid interest on [their] modified and substituted or tendered Eligible Bonds for the period since the last interest payment date under your Eligible Bond” (emphasis added).
The payment of accrued interest has been a particular point of contention raised by creditors in the exchange group, who have argued that inclusion of accrued but unpaid interest has been common in prior sovereign restructurings. One can also see from Argentina’s perspective, however, the practical challenges in committing to paying accrued interest. The outstanding bond obligations have meaningfully higher interest rates relative to the exchange bonds, which are subject to an interest grace period through late into 2022.
Thus, if Argentina committed to paying accrued interest on existing bonds, that interest would accrue at a higher rate than for the exchange bonds, potentially creating incentives for parties to hold out from the exchange transaction while still having a potential claim for a significant interest spread over the holdout period. Such parties may pursue claims through litigation, which could be a concern for Argentina given issues during its prior restructuring, including certain long-running litigation with creditors.
However, such hold-out risk could be mitigated by allowing payments of accrued interest only to consenting and supporting noteholders who tender through an exchange, but not to holdout creditors. In that regard, the accrued interest could essentially operate as a consent payment to supporting bondholders.
Creditors have also objected to Argentina’s proposed interest grace period until the end of 2022. One creditor group submitted a proposal under which interest during the period would be partially payable in kind, accruing toward the principal outstanding. Such an approach, if structured appropriately, could help parties “split the difference,” providing some compensation to bondholders while still limiting Argentina’s cash outlays and interest expense. Such PIK interest could also potentially be a sweetener that the sovereign offers solely to consenting parties.
Finally, the coupon payment step-up and/or amortization schedule could be adjusted to increase the net present value of the exchange bonds. Given the uncertainty regarding Argentina’s finances and debt sustainability, structuring such a payment step-up or acceleration as a contingent instrument may be more palatable to the IMF and other multilateral creditors, as discussed below.
At the same time, Argentina could potentially make the transaction modifications on a non-pro-rata basis for the two indentures, thus improving deal economics for one group of creditors but not the other. That being said, at least one creditor group - the White & Case-represented ad hoc group - is reported to have blocking positions across both indentures, which may complicate such an approach at least with respect to such cross-over groups.
Revenue-Backed Tranche
An innate complication in sovereign finance is that generally, due to a host of issues including state sovereignty, sovereign bonds are typically issued on an unsecured basis. While less problematic for investment-grade sovereign issuers, for non-investment-grade sovereigns, issuing only unsecured obligations can mean a higher cost of capital, despite the issuer potentially having valuable collateral that could de-risk the obligation from a creditor’s perspective.
To get around this issue, municipal debt issuers in the United States, for instance, commonly use a revenue bond structure through which certain circumscribed cash flows from an asset flow directly to creditors. The Argentine province of Chubut has notably utilized a similar structure, issuing bonds backed by hydrocarbon royalties and paid to creditors through a trust.
The sovereign could potentially take a similar approach, leveraging as collateral, for instance, its shale assets or ownership of certain operating businesses, such as YPF. Issuing bonds backed by revenue from such obligations has a number of potential benefits for Argentina as well as its creditors:
- Expanded payment capacity. Utilizing secured debt may expand Argentina’s overall payment capacity without further extending tax revenue, although it could result in losing access to other government revenue streams. Further, given the current low oil price environment, the transaction could be structured to allow creditors to contribute project-level equity in certain circumstances, incentivizing asset development and introducing technology that could reduce production costs, potentially bringing more assets back into the money based on then-prevailing oil prices.
- Collateralized borrowing. Creditors may be comfortable receiving a potentially lower par amount of secured debt or be willing to accept lower rates, relative to unsecured government borrowing. This approach could allow Argentina to potentially issue less debt in the aggregate or enjoy lower interest expense, creating integrative value for both parties.
- Lower correlation debt. Revenue-backed obligations could add additional incremental value for Argentina by diversifying the exposure in its debt stack. Currently, all Argentina debt is essentially backed by the sovereign’s faith and credit and its taxing power. Thus, if the nation experiences financial distress, the bonds are all similarly adversely affected. Revenue-backed and commodity-linked obligations, however, could be less correlated to the sovereign’s fiscal fate. For instance, Argentina may experience financial distress in an environment of stable or increasing oil prices or experience a recovery in an environment of falling commodity prices. That being said, revenue-backed obligations are likely to remain at least somewhat innately tied to the sovereign, resulting in some degree of residual correlation.
However, given the distinct and potentially creditor-favorable aspects of the debt, it may be possible that a relatively small revenue-backed issuance could be meaningfully accretive as a sweetener in helping to move forward the larger restructuring transaction.
--Lev E. Breydo and Katherine E. Wegert
This article is an example of the content you may receive if you subscribe to a product of Reorg Research, Inc. or one of its affiliates (collectively, “Reorg”). The information contained herein should not be construed as legal, investment, accounting or other professional services advice on any subject. Reorg, its affiliates, officers, directors, partners and employees expressly disclaim all liability in respect to actions taken or not taken based on any or all the contents of this publication. Copyright © 2024 Reorg Research, Inc. All rights reserved.