Argentina and holdouts play chicken

Fri Jul 25, 2014 12:19pm EDT

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NEW YORK, July 25 (IFR) - The prospect of a technical default by Argentina is looming as the government and holdout investors stare each other down in a very public battle of nerves ahead of the expiration of a grace period for debt payments on July 30.

Efforts this week by US District Court Judge Thomas Griesa to force the two parties together until they reached an agreement brought some comfort, but growing frustration about the lack of progress in negotiations has whip-sawed Argentine assets.

"It is not too late to work out some sort of accord and avoid default, but they are leaving it to the eleventh hour, which Argentina has done before," said Stuart Culverhouse, chief economist at broker Exotix.

The buyside has largely been betting on a last-minute resolution to the country's holdout crisis, putting a floor under bond prices, but with just days left before payments are due, investors have been fretting about their exposure to Argentine risk.

"I would have been selling the bonds on Argentina's deteriorating fundamentals and the only thing that kept me holding them was the possibility of a settlement [with holdouts]," said a US-based investor. "If we are not going to see a settlement, it makes me think twice."

HEATED RHETORIC

Heated rhetoric from both sides has only inflamed concerns about a negative outcome to closed-door negotiations. Bond prices took another hit on Friday morning after holdout investor NML Capital circulated an email saying it was clear that the South American country would choose to default this week.

"This outcome is unfortunate and completely unnecessary," an NML spokesman said in a statement. "We will continue to seek ways to engage Argentina in negotiations, but there is currently a total lack of willingness on Argentina's part to solve the problem."

In turn, Argentina has expressed a need to reach a solution that would avoid triggering a so-called RUFO clause that might lead to further lawsuits if it offered better terms to holdouts than those given to investors during the 2005 and 2010 restructurings.

Without such guarantees, the government is seeking a stay to reach what it calls a "fair, equitable, legal and sustainable" solution for 100% of its bondholders.

By Friday, neither Griesa nor the holdouts had succumbed to Argentina's request for a stay. It is assumed that the government would first have to show a good faith gesture before a stay was granted.

An agreement that would permit payment next year after the RUFO clause expires may suffice to convince holdouts to push for a stay until then, allowing Argentina to make payments to existing exchange bond holders next week and avoid a technical default.

This idea was floated this week in local Argentine newspaper La Nacion, which quoted sources saying that NML would ask Griesa to reinstate a stay until the end of the year, and in return have Argentina deposit money in an escrow account.

Fellow holdout fund Aurelius Capital, however, called the La Nacion report "utter fiction", according to Reuters.

Still, if both parties can overcome their differences on a stay, the rest of the process is seen as relatively straightforward, notwithstanding the complications of further "me-too" claims in the wake of a legal victory for the holdouts.

A template for how to pay holdouts has already been established through the case of Spanish oil company Repsol, which received a series of bonds in compensation for the expropriation of its stake in YPF.

"To get a deal through is less arduous than people think," said Michael Roche, emerging markets fixed-income strategist at the Seaport Group.

DEFAULT SCENARIOS

Most investors assume that the government would prefer to avoid a default that would worsen economic conditions for Argentines and damage President Cristina de Fernandez Kirchner and her party's political reputation.

If a default happens, however, many think that fallout - at least in the financial markets - would be comparatively mild. Sovereign CDS has been pricing in high default expectations, with traders quoting five-year protection this week at 1,480bp. But bond prices provide a different story.

On Friday, discount 2033 notes were still trading in the mid to high 80s, while pars were at around 53.50-54.25.

"CDS may get triggered, but bond markets are not pricing this in because even if Argentina defaults, it will be short-lived," said one trader.

A knee-jerk reaction to the news is likely to ensue, as investors that are forbidden to hold defaulted bonds will be forced to liquidate.

Yet many feel prices would find a floor at around 50-60 cents rather than the 30 or below levels seen in a typical restructuring scenario. That's because the government has expressed willingness to pay exchange bond holders and is likely to find ways to fulfill such promises.

"The price action on the pars tells you a lot about how people are positioned," said a hedge fund manager. "They are priced at the potential recovery value and are the most likely to be accelerated in the event of a default."

Yet arguments that Argentina is willing and able to pay may ultimately prove flimsy should a default spark a dramatic reduction in foreign reserves.

"If we have a few months like we had in December and January when reserve levels collapsed, you might have an inability to pay," said the US-based investor. (Reporting by Paul Kilby; Additional reporting by Joan Magee and Davide Scigliuzzo; Editing by Matthew Davies)

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