(Note: unfortunately, Medium does not support the footnote/endnote function; for all references, please see the bibliography at the end of the article)
Introduction
The 2001–2016 Argentine restructuring saga will be forever remembered as one of the most dramatic events of modern economic history. Its intricacies have changed the international restructuring landscape, specifically highlighting the potential impact of the private creditor: traditionally considered inconsequential in sovereign bankruptcies, a few hedge funds’ holdout proved capable of paralyzing an entire country’s access to capital. Barely three years later, with the country reeling from the impact of a recession, ballooning inflation rates, and IMF loan maturities, Argentina has commenced yet another round of restructuring. Ahead of the process, this article will analyze some of the most prominent covenant changes to Argentine bonds that will determine the outcome of this restructuring.
Background to the Restructuring
Argentina’s economy struggled with growth under the leadership of President Mauricio Macri from 2015 to 2019. After borrowing heavily to stimulate the economy, the country went into recession in 2018 and as of year-end 2019, its annual inflation rate was over 50%. The inflation, heavy foreign borrowing, and recession led to Argentina’s debt-to-GDP to peak at over 86% in 2018 — the highest level ever in the country’s history. With Macri’s austerity measures to the debt crisis being deeply unpopular, central-leftist Alberto Fernandez took office on December 10, 2019. His vice-president is Cristina Kirchner, the 2007–2015 president who oversaw much of the last restructuring’s theatrics; his Minister of Economy: Martin Guzman, a former Brown economist with extensive experience in restructuring academia. The new government has begun to focus on rebuilding the economy, curbing inflation, cutting back on global trade, and reprofiling debt maturities as a preferred method of restructuring.
The recession, the plunging value of the peso, and the political instability have all cast doubt on the country’s ability to service its existing debt. While Argentina has honoured all 2019 debt obligations, Guillermo Nielsen, an economic advisor to the new administration, has hinted that the government may run out of liquidity in four months. Even if Argentina does not default in 2020, there are $44bn worth of IMF loans due between 2021 and 2023. These bonds have preferred creditor status and their refinancing may only come with a hefty haircut for bondholders. Thus it is of no surprise that Argentina’s foreign currency bonds currently trade between 30 to 60 cents on the dollar. Historically, the average loss taken by private creditors during a sovereign restructuring is estimated to be 27%. Argentina’s deep discounts, therefore, reflect the market expectation that this restructuring will be troubled by holdouts, failed negotiations, and further value reduction for bondholders.
The new government has been doing everything it can to prove that this is not the case. Guzman and Fernandez have repeatedly emphasized their goal of leading this restructuring with voluntary extensions instead of forced haircuts. The administration has pointed towards Uruguay’s 2003 restructuring, where the principal was preserved due to voluntary extensions, as the model for its restructuring plan. So far, Argentina has either extended or paid in full for all 2019 debt and promises it will continue to act in good faith as it negotiates to refinance its IMF loans. These creditor-friendly signals have led minor rallies in Argentine bonds, but most creditors remain skeptical. After all, for a country with over $275bn in foreign currency debt and $11.2bn in 2020 foreign currency debt service payments, but a mere $8.9bn in net foreign reserves, it is questionable how long Argentina can sustain this approach. Argentina is also notorious for being historically creditor-unfriendly. With Cristina Kirchner, whose administration oversaw the implementation of the “Lock Law” and a hard-line restructuring stance, being the vice-president, and the Fernandez administration having no intention of reducing its social spending, the question is not whether creditors and Argentina will butt heads, but when and how.
CAC Provisions: an Overview
A major reason why the last Argentine restructuring dragged on for so long was due to a lack of solutions against holdouts. For Argentina, the covenant languages did not have procedures in place to enforce exchanges upon a small pocket, seven percent, of bondholders who simply refused the offers. Hence, sovereign bonds issued thereafter began including a feature known as the Collective Action Clause (CAC). The clause enables the sovereign to enforce exchanges upon all bondholders within a voting class as long as a majority threshold is met. In previous sovereign restructurings, such as the aforementioned Uruguay bankruptcy, these provisions proved to be of great assistance to not only the debtors but also the creditors by encouraging them to align objectives as a united front.
All outstanding Argentine bonds currently feature CAC provisions. However, depending on when the bonds were issued, the actual CAC mechanisms could be different. Argentine foreign currency bonds can be grouped into two categories by their date of issuance: the “Kirchner bonds” and the “Macri bonds”.
As the names would suggest, these bonds were issued by their respective administration. The Kirchner bonds were the exchanged bonds from the last restructuring in 2005 and 2010, while the Macri bonds were issued after 2016 by the Macri government. The intricacies of their CAC provisions are summed up below:
- Any Kirchner and Macri bond series can be restructured on its own with the consent of 75% of outstanding bonds
- If two or more series of Kirchner bonds are being restructured in aggregate, the aggregate consent has to exceed 85% with any individual series’ consent being no less than 66.67%
- If two or more series of Macri bonds are being restructured in aggregate, the aggregate consent has to exceed 66.67% with any individual series’ consent being no less than 50%; or, the combined vote has to exceed 75% with no threshold on the individual series consent
- For any Kirchner series in aggregate voting, if the combined consent threshold is reached but any individual series does not reach their threshold, then that series is not restructured while the rest of the group still receives the voted treatment
- Argentina can “gerrymander” as it can combine any bond series it wishes for aggregate voting. It can even aggregate Kirchner bonds with Macri bonds, but the Kirchner aggregate voting thresholds have to be satisfied (85% overall and 66.67% for individual Kirchner series)
- A “uniformly applicable” clause also applies to Macri bond restructurings: all bond series in an aggregate vote that passes has to receive the same exchanged securities
How do these differences hold up in terms of valuations? As Bloomberg News reported in November 2019:
‘…Investors are taking positions in notes issued in 2005 and 2010 (Kirchner bonds) that require sign-off from at least 85% of holders of all bonds affected to make changes, versus the 66.67% or 75% threshold on securities issued more recently (Macri bonds)…[one of the top holders of the euro-denominated bonds issued in 2010] said investors buying notes with the higher CAC levels are gearing up for a “long, long” process to protect their interests and get a fair deal.’
When Bloomberg published this article, the “Kirchner-Macri spread” was quite high, with some Kirchner bonds trading at 12 extra cents on the dollar to a comparable Macri peer. Since the change of administration, there has been a minor rally that saw the spread close. As of January 2, 2020, Kirchner and Macri bonds are trading at similar levels: the average Kirchner bond trades at 49.59 cents on the dollar, while the average Macri bond trades at 49.64 cents on the dollar.
The natural question is whether these CAC provisions, along with other differences between Kirchner and Macri bonds, can affect valuation and the outcome of restructuring. This will be examined in-depth in the following section.
The Kirchner-Macri Difference
Aside from CAC provisions, there are two other important differences between Kirchner and Macri bonds: time to maturity and definition of “pari passu”.
While Kirchner bonds mature either in 2033 or 2038, Macri bonds mature anywhere from 2020 to 2117, with most series (29 out of the 33 bonds) maturing between 2021 to 2048. The market sees time to maturity as an important valuation factor: the 3.375% Macri series maturing in 2020 is trading at 60.47 cents on the dollar, while the 6.875% Macri series maturing in 2021 trades at 53.98 cents on the dollar. There is thus a noticeable premium compared to Kirchner and Macri bonds that mature after 2038, which have an average price of 45.60 cents on the dollar.
For most distressed situations, this premium is logical. The nearer-term bond has a higher yield to maturity and is paid out sooner (assuming the liquidity can last through the short term). After all, if Argentina can last until 2022 before defaulting, the 2020 and 2021 series can still get paid off at par, a luxury not afforded to, say, 2046 bondholders.
However, I think the opposite is true in Argentina’s case. While the 2020 bond deserves to command a premium because there is a sizeable chance Argentina will only default after their maturities are honoured, for the other series in question, the longer-term bonds should deserve to trade higher than the shorter-term bonds.
For one, Argentina is primarily seeking maturity extensions rather than haircuts. The exemplar that the Fernandez administration seeks to model is Uruguay’s 2003 restructuring, where the principal value was preserved in return for extensions. This indicates the bonds maturing in early-mid 2020s will be the primary target of the restructuring — after all, the biggest catalyst for this restructuring is Argentina’s questionable ability to meet IMF maturities from 2021 to 2023. Moreover, even if one were to believe that Argentina has a solvency rather than liquidity issue, maturity extension will still be far more important than the actual principal haircut. We can use the last restructuring — when Argentina was indisputably in a worse financial position — as a point of reference, where the face value reduction was only 20.5% on an adjusted basis.
Aside from it being a higher priority to restructure the nearer-term debt, due to the “uniformly applicable” clause, it is within Argentina’s interest to offer the longer-term bondholders deals that are more attractive on an NPV basis. This will be discussed in detail shortly.
The Kirchner and Macri bonds also have a key difference in their documentation of defining “pari passu”. The Kirchner bonds define pari passu as being “at all times rank at least equal with all its other present and future unsecured and unsubordinated External Indebtedness”. As seen in the last restructuring, this was hotly contested. A refresher on what happened:
After the Kirchner government has successfully exchanged 93% of the outstanding bonds in 2010, a group of hedge funds still holding out sued the Argentine government for violating the pari passu clause in 2012. The hedge funds’ interpretation of pari passu was that it should mean ratable payments for all bondholders and the Argentine government violated this by paying interest to the new, exchanged bondholders while ignoring the old bondholders who held out. The court controversially ruled in the hedge funds’ favour and, through international injunctions, forced Argentina to ultimately pay the hedge funds in full.
With these theatrics having closed barely three years ago, the new Macri bonds’ pari passu clauses feature additional descriptions that prevent such interpretations. Kirchner bonds, meanwhile, still feature the old, standard definitions that got the country in trouble in 2012–2016. Thus, it may seem that distressed activists could exploit this to their advantage by holding out with Kirchner bonds and suing Argentine in the same way as the last time.
Yet, whether this actually translates to meriting a higher valuation is questionable. Judge Griesa’s controversial interpretation was not merely based on legal documentation. As he explained, the 2012 interpretation was only made when considering the “extraordinary conduct” and “recalcitrance” of the Argentine government. His decision should not be a blanket interpretation of pari passu clauses. Consequently, Judge Griesa himself ruled against later similar lawsuits in 2016, citing that the “extraordinary conduct” was no longer applicable given Argentina’s new co-operative spirit with the restructuring. The US Court of Appeals also reinforced Griesa’s decision by stating that the sovereign would only violate the pari passu clause if it acted in a “uniquely recalcitrant” manner. Stalling payments to holdouts while paying exchanged creditors, unfortunately, does not fall within this category. As such, whether additional descriptions are in place to prevent ambiguity should no longer matter now that the context behind Judge Griesa’s ruling is fully transparent.
The last factor is, of course, the CAC provisions. While it seems obvious that a higher CAC threshold is equivalent to being more creditor-friendly, contrary to Bloomberg and other reporting on the issue, I do not believe it indicates Kirchner bonds deserve a premium as it is ultimately unlikely to lead to higher recoveries.
Superficially examining the CAC provisions, it can be seen that the differences between the bonds make Kirchner bonds seem “superior” for three main reasons:
- Capacity to “freeride”: Argentina can pass aggregate exchange offers for the rest of the bonds even if an individual Kirchner series in the pool does not pass the consent threshold, allowing the bond in question to “free ride”
- No uniformly applicable (UA) clause: offers given to Kirchner bonds can be tailored in a way that allows different series to exchange for different securities, while Macri bonds are bound by the UA clause
- CAC thresholds: required consent is higher in aggregate voting (85%/66.67% compared to 66.67%/50% and 75%/- ), so it is much easier to block unsatisfactory offers
(It should be noted that the single series voting threshold is the same for both Macri and Kirchner bonds. If Argentina wishes to offer an exchange to a singular Kirchner series, the CAC threshold is also 75%. In that regard, both types of bonds are equivalent in the creditor’s ability to holdout.)
While these provisions do work in the Kirchner bonds’ favour, the question is under what circumstances will this actually lead to a preferential recovery. The ideal scenario for a Kirchner bondholder is to holdout in an aggregate voting scenario, and when the rest of the bonds are restructured — thus allowing Argentina to recover economically and regain the ability to service their debt — maintain their holdout and be paid off at par.
The issue is that if all Kirchner bondholders think this way, then a restructuring will never be successful. The ideal situation for a holdout creditor is when enough of their peers restructure to allow economic recovery. If too much debt remains in a holdout, then everyone will be worse off. The holdout creditors were only able to receive their payout last restructuring because over 93% of the original debt has been exchanged. Currently, $87bn of the $206bn in outstanding foreign currency bonds are from the Kirchner era. Thus, if any were to succeed in their holdout endeavour, that would have to be a tiny fraction of the entire $87bn.
Some may argue that the holdout creditors do not need to be paid off at par. As long as the holdout results in a better offer, then a higher valuation is justified. The issue then becomes whether Argentina will play by the aggregate voting game. As past sovereign restructurings have shown, it is much easier to engage bondholders series-by-series as they would have less leverage in these negotiations. In that aspect, Kirchner bonds have no advantage over their counterparts. This is particularly relevant because both types of bonds have provisions that dictate in exchange offerings, Argentina is obligated to disclose their restructuring plans for the rest of their debt. This further decreases Kirchner bonds’ supposed leverage at holding out because they know that other Macri bondholders know the recoveries they are receiving, and hence similar Macri bondholders may vote to reject knowing Kirchner bondholders are getting a better offer.
Furthermore, if aggregate voting is being held, then the higher voting thresholds (85%/66.67% compared to 66.67%/50% and 75%/- ) are not as relevant unless there is a creditor that holds enough of the tranche to veto the vote with (33.34%). For institutional creditors that do not hold that much in the same tranche, it can be argued that due to a lack of UA clause, the Kirchner bond is less desirable than a Macri bond with the same maturity/coupons. Consider the exchanges that Argentina made in the 2010 round of offers of their last restructuring: retail investors — those who held less than $50,000 of defaulted bonds — were given a much more generous offer than their institutional peers. This was a tactic to solicit participation from retail investors and without the UA clause to protect them, even with higher voting thresholds, an institutional investor may end up being worse off.
Finally, even if a holdout is achieved and the bond in question rejects the exchange, it is unlikely that the creditors have the leverage to receive a more desirable offer. As shown in the last Argentine restructuring and virtually all other sovereign restructurings, without extraordinary circumstances, private creditors lack legal remedies to enforce their demands as there is no formal bankruptcy mechanism to be relied upon. A good example of what may happen was darkly hinted in the 2005 Kirchner bond prospectus, which expressed that holdout investors will remain in default “indefinitely”. If the holdout creditors did not have the pari passu clause to fall back to — which they certainly do not in this restructuring — that may have well been their end outcome. This is particularly relevant given in recent years, the sovereign restructuring community has become increasingly unfriendly toward holdout creditors. As long as Argentina could demonstrate it is trying its best to find a viable solution with the creditors, and that the holdouts are being intentionally difficult to negotiate with, then it is in the clear in the IMF’s book.
An important restructuring milestone that can significantly increase or decrease the creditors’ leverage is the IMF refinancing. This predicates on the findings of the Debt Sustainability Analysis (DSA) that will be conducted before the refinancing: if the DSA shows that Argentina has an “unsustainable level of debt with a high probability of default”, then the IMF will mandate Argentina to pass severe haircuts onto its creditors. In that case, the holdout creditor’s power will be the same as what I have alluded to earlier: virtually non-existent. If the findings are optimistic, on the other hand, then holding out may yield better results — but still, there is no real leverage as the success of negotiations is dependent on Argentina’s generosity. It is important to note that despite all the ominous talk on Argentina’s economy, the last review that the IMF has conducted in July 2019 noted Argentina’s debt levels to be “sustainable but not with a high probability”. As long as this rating does not deteriorate, then there may be value from holding out.
To sum up my analysis on the Kirchner bonds, I believe that unless the creditor in question has enough of an individual tranche to veto voting, holding out will be substantially harder than what Bloomberg and other sources are suggesting. Even if the creditor is successful in holding out, it will be even more difficult to obtain a better offer due to a lack of legal leverage. From a valuation perspective, there should not be a difference from CAC clauses alone.
There is one important Kirchner-Macri distinction that we have not expanded upon yet: the UA clause that the Macri bonds have but Kirchner bonds do not. As shown earlier with the Kirchner bonds, whether the UA clause is present can impact voting within a singular series, but this is even more important within the context of an aggregate voting procedure: even if there are multiple bond series with different maturities and coupon rates, the UA clause mandates Argentina to offer them with the same selection of exchange securities.
The original intent of the clause was simple: ensuring equality of outcomes and transparency for creditors. Everybody must be given the same options, and no one within the same exchange should be offered different treatments to solicit consent. However, with the low CAC thresholds, this could be abused. Consider the following example:
Argentina wants to give a 2024 tranche an offer where the principal and interest payments are preserved, but the bond’s maturity is extended to 2035. Argentina is unsure if the 75% threshold can be reached, and so includes a 2033 tranche to vote on the same exchange. The 2033 tranche, of course, eagerly votes in favour of this offering as their NPV loss is minimal; the exchange offer ends up passing the 75% aggregate threshold.
Unfortunately, because this will be the first sovereign restructuring where these provisions are being tested, creditors and courts alike have a very ambiguous understanding of how these will apply to them. It is palpable from this example, though, that the UA clause can accomplish the contrary of what it has set out to do. It creates a lot more downside risk for bonds maturing in the early-mid 2020s: if they are assigned to vote in the same pool as longer-term bonds — this assignment, however ridiculous, is unfortunate within Argentina’s power as set out by the covenants — then their vote would be significantly diluted and be forced to accept exchanges that, without the longer-term bonds pulling up the vote, would not satisfy the 75% threshold.
Because of the lack of precedent, whether this can practically play out to Argentina’s advantage is questionable, but this is a significant risk factor that should not be ignored for Macri bondholders.
What Opportunities Exist Given What We Have Discussed?
Here are my main takeaways for distressed investors looking into this situation:
- Caution with Macri bonds maturing in the 2020s due to Argentina’s emphasis on pushing back their maturities specifically, as well as their disadvantage from the UA clause
- Consider the spread between Kirchner and Macri bonds; if it exists, there is a chance for arbitrage
- For investing in Kirchner bonds, either accumulate enough of a position to veto or keep the stake small (within the “retail investor” limit); both can lead to a better offer
- Longer-term bonds (both Macri and Kirchner) may get the best offers as due to the UA clause, Argentina will want to gerrymander by grouping their votes with the short-term Macri debt
- Again, because of the UA clause, consider a long/short arbitrage structure to capture the fact that most tranches will receive the same exchange despite having different maturities/coupon rates
As I mentioned earlier, the Kirchner-Macri spread that Bloomberg has reported on has disappeared over the past month and at the moment, the average price is similar. However, some Kirchner tranches are trading very low at the moment, with the 3.75% USD tranche maturing in 2038 trading at 30.09 cents on the dollar and 4.33% JPY tranche maturing in 2033 trading at 34.68 cents on the dollar. Meanwhile, Macri tranches maturing between 2022 and 2026 trade at an average of 49.70 cents on the dollar. While it is difficult to estimate what recoveries actually will be like due to the enormously uncertain nature of sovereign restructurings, I believe this is an attractive arbitrage opportunity and look forward to hearing other opinions from actual investors in Argentine debt.
Conclusion
With the IMF refinancing and some private creditor negotiations already underway, it will be interesting to see how events unfold in 2020. The complexities from the documentation standpoint alone foretell that this will be a worthy addition to the Argentina restructuring saga. Overall, the new covenants in place should prevent holdout creditors from obtaining leverage and lead to an Argentina-friendly outcome. The vultures are swooping, but the hunters are also ready.
I am a Junior studying at Ivey Business School in Canada with a strong passion for distressed debt, restructurings, and special situations. I am always looking to speak with and learn from individuals within these fields. I am currently looking for summer 2020 internship opportunities and have previous work experience in investment banking and equity research. You can reach me via email at roy99zh@gmail.com or through LinkedIn. Thank you for reading.
Sources
CIGI Papers: an Analysis of Argentina’s 2001 Default Resolution
MercoPress: Argentina will continue to honor its debt, and has cleared all 2019 payments
SEC filing: prospectus for Macri bonds
SEC filing: prospectus for Kirchner bonds issued in 2005
Bloomberg News: Fine Print on Argentine Bonds Becomes Crucial as Default Looms
Court Transcript: Bison Bee LLC v. Republic of Arg.
Credit Slips: Imagine Riding the Ceteris Pari-bus into the Sunset … in Argentina
Credit Slips: Interpreting Argentina’s “Uniformly Applicable” Provision and Other Boilerplate
Congressional Research Service: Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts”
IMF: The Sovereign Restructuring Process
Buenos Aires Times: Argentina Debt Restructuring May be Shaped by Just Two Words
