August 20, 2014 / 9:01 PM / 5 years ago

Argentina's default strategy raises debt acceleration risk

BUENOS AIRES (Reuters) - Argentina’s plan to restructure its external debt to skirt a U.S. ruling that prevented it paying its creditors boosts the risk of investors demanding the accelerated payment of their bond holdings.

People walk past Argentina's Central Bank in Buenos Aires' financial district, August 20, 2014. REUTERS/Marcos Brindicci

Its second default in little over a decade opened Latin America’s No. 3 economy to the possibility of creditors declaring the principal value of their bonds and interest due immediately - a process known as acceleration.

An acceleration could leave Argentina facing claims of up to $30 billion, more than the government holds in foreign reserves.

Argentina slid into default last month after a U.S. court blocked an interest payment owed to holders of debt restructured in the wake of the country’s record 2002 default until it had settled with a group of hedge funds that rejected the haircut.

Wall Street had been split over the risk of an acceleration, with some fund managers, including those holding Argentine debt, arguing it would only harden Argentina’s stance against the holdouts when there remained hope for a negotiated settlement.

But President Cristina Fernandez’s announcement late on Tuesday that Argentina would push to make payments on its sovereign bonds via a state-controlled bank poured cold water on any lingering expectations of a deal that would allow the resumption of the debt service payments blocked by a U.S. court.

Bond market analysts said there would likely be no resolution of the debt saga until after next year’s October presidential election, in which Fernandez cannot run, prolonging the country’s banishment from global capital markets.

“The clear strategy to not pay the holdouts and to not cure the default may trigger the acceleration of the bonds,” said analyst Siobhan Morden at Jefferies.

Argentina defaulted on part of its restructured debt after U.S. District Judge Thomas Griesa blocked a $539 million coupon payment after ruling exchange bonds cannot be paid until holdouts are paid in full.

Those funds remain held up with intermediary Bank of New York Mellon (BK.N). Draft legislation set to be debated in the Argentine Congress next week seeks to remove the U.S. bank as trustee, replacing it with Banco Nacion to ensure future payments go through local banks.

“The good news is that Argentina is finally proposing how they will pay bondholders. The bad news is that it is the more complicated local law conversion or local payment that carries high execution risk,” Morden said.

Defying the veteran U.S. judge, Argentine Economy Minister Axel Kicillof on Wednesday said paying the holdouts in full would be “madness”.

Kicillof said he did not know what changing the jurisdiction of bonds or place of payment would mean for the risk of an acceleration.

PAR BONDS VULNERABLE

An acceleration occurs if investors holding at least 25 percent of the nominal amount of any single restructured bond series demand immediate payment.

    Of all the bonds eligible for acceleration, one of the dollar-denominated Par series maturing 2038 US040114GK09=R has been the focus of investor attention, with just $95.3 million outstanding, Thomson Reuters IFR reported last week.

Trading at a bid price just below 48 cents on the dollar on international markets on Wednesday, the Par note offers more upside gain than the dollar-denominated Discount bond US040114GL81=R if an accelerated payment of 100 cents on the dollar is demanded. The Discount bond was trading above 80 cents on the dollar.

Rune Hejrskov, senior portfolio manager at Jyske Invest, said a sharp sell-off on the Par series would be the most likely trigger for an acceleration.

“If prices start taking a serious hit from this, then (Par investors) could start considering an acceleration as a viable option,” said Hejrskov said, whose firm holds Argentine debt.

“It wouldn’t make sense for the Discounts to consider an acceleration with prices in the low 80s. I think they would need to trade down to the mid 60s,” Hejrskov said.

Other market players disagree and argue that an acceleration on one series will trigger a cascade effect.

One fund manager told IFR on condition of anonymity that “once there has been (an acceleration) on one series, everyone else will follow.”

SETBACK

The tough-talking Fernandez, who appeared tearful toward the end of her televised speech to the country’s 40 million people, said bondholders would have the option of switching their debt held under foreign legislation to Argentine law.

The proposal stopped short of what analysts had considered the nuclear option of a mandatory bond swap, but it may still carry legal risks.

“The government is aware many investors will not be willing to enter this kind of transaction,” said Alejo Costa, strategy chief at local investment bank Puente in Buenos Aires, referring to the push to bring foreign debt onshore. “I don’t think they expect a large participation rate.”

Costa said some investors might consider attempts to change the trustee and place of payment a violation of their debt contracts, prompting them to demand accelerated claims.

Asked how he expects the government to react to an eventual acceleration, Costa said it would likely challenge the move in court, raising the specter of more lengthy and expensive legal battles.

That in itself, analysts said, might deter some investors from demanding immediate payment on their bonds.

Argentina’s black market peso fell hard on news of the government’s strategy, dropping to a record low 13.5 to the U.S. dollar. The country’s benchmark dollar-denominated bonds due in 2033 slumped more than 2.0 percent in price.

Some analysts said there might be no full resolution of the country’s debt fight with the holdouts until after a new government takes office at the tail end of 2015.

“It’s clearly a setback from a country risk standpoint,” said Kevin Daly, portfolio manager at Aberdeen Asset Management in London. “This does nothing to get them closer to regaining market access.”

Additional reporting by Hugh Bronstein in Buenos Aires and Sujata Rao-Coverley and in London; Editing by Dan Grebler

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