Jefferies Spots 93% Profit Exploiting Loophole: Argentina Credit

Photographer: Diego Giudice/Bloomberg

Argentina will pay 5.1 billion pesos on the peso warrants and $2.9 billion on the dollar warrants next year, according to a July 25 report by Buenos Aires research company Empiria Consultores. Close

Argentina will pay 5.1 billion pesos on the peso warrants and $2.9 billion on the... Read More

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Photographer: Diego Giudice/Bloomberg

Argentina will pay 5.1 billion pesos on the peso warrants and $2.9 billion on the dollar warrants next year, according to a July 25 report by Buenos Aires research company Empiria Consultores.

A loophole in Argentina’s currency controls is giving buyers of securities linked to economic growth a chance to almost double their money within 18 months.

At a time when Argentina is implementing the harshest foreign-exchange restrictions in a decade, a clause in central bank rules lets foreign investors convert coupon payments on peso-denominated warrants to dollars at the official exchange rate. With that rate forecast to fall to 7 pesos per dollar by the next payment in December 2014, holders who buy $1 of warrants now will be entitled to receive a 13.5-peso payout -- or about $1.93, based on estimates by Jefferies LLC.

The 93 percent implied return based on the increasing dollar value of the coupon payment alone compares with a 5.9 percent decline for Argentina’s dollar-denominated government bonds this year and 5.7 percent drop for local-currency sovereign notes in emerging markets, according to JPMorgan Chase & Co. After official data showed that economy expanded 7 percent and 7.8 percent in April and May, the nation is now on track to grow 4.8 percent this year, surpassing the threshold needed to trigger a warrant payout, according to Jefferies.

The peso warrants are attractive because “most people don’t know about the ability to get the official exchange rate so they trade a bit cheap,” said Ray Zucaro, who helps oversee $350 million of emerging-market debt at SW Asset Management in Newport Beach, California.

‘Huge Upside’

Argentina will pay 5.1 billion pesos on the peso warrants and $2.9 billion on the dollar warrants next year, according to a July 25 report by Buenos Aires research company Empiria Consultores.

Jefferies’ estimate is based on a 20 percent annualized rate of depreciation in the official exchange rate for the peso. Investors would own securities that are eligible for payments until they expire in 2035.

“There could be huge upside,” Siobhan Morden, head of Latin America fixed-income at Jefferies, said in a telephone interview from New York. “You have to assess regulatory risk that you will in fact be compensated at the official foreign-exchange rate, the risk of a maxi devaluation and forecast risk for GDP growth.”

Morden said that while “there’s value” in peso warrants, she prefers the euro-denominated securities because the payment is vulnerable to less regulatory and currency risk.

Euro Warrants

Morden forecasts that by the end of next year, the dollar warrants will return 45 percent and warrants denominated in euros are poised to gain 60 percent.

SW Asset Management estimates a coupon payment of 12 pesos and an exchange rate of 8 pesos per dollar by the end of 2014, resulting in a 50 percent return for local-currency warrants.

Last year, foreign investors were able to exchange their peso coupon payment at the official exchange rate, reaping a return of 51 percent. Barclays Plc recommended the trade at the time, saying the securities had “meaningful upside potential.”

According to the central bank’s latest summary of currency controls, which is dated February and posted on its website, non-residents can exchange payments on “revenue of government bonds and loans issued in local currency” at the official exchange rate and take the funds out of Argentina.

‘Don’t Trust’

After her re-election in 2011, President Cristina Fernandez de Kirchner banned most foreign-currency purchases, restricted imports and forced companies to bring money held abroad back to the country. Her measures reduced outflows of capital, which had almost doubled to $21.5 billion in 2011, to $3.4 billion last year.

Diego Ferro, co-chief investment officer at Greylock, which oversees $500 million in emerging-market debt, including euro-denominated GDP warrants, said the rules governing the peso warrants are susceptible to change as they were issued under Argentine legislation.

“I don’t trust Argentine law,” Ferro said in an e-mailed response to questions. “In fact, I don’t trust any law that’s not New York or London. So even if they’re cheaper, I prefer foreign-legislation warrants.”

The extra yield investors demand to own Argentine bonds instead of U.S. Treasuries rose eight basis poiints, or 0.08 percentage point, to 1,147 basis points at 9:08 a.m. in Buenos Aires, according to JPMorgan’s EMBI Global Diversified index. The spread is the biggest among 57 emerging markets.

Most Expensive

Argentina’s five-year credit default swaps, contracts that protect holders of the debt against non-payment, are the most expensive in the world, data compiled by Bloomberg show. The swaps rose 38 basis points to 2,487 basis point at 8 a.m. in New York, according to data compiled by CMA Ltd.

Securities issued under Argentine law may be safer than those governed by New York legislation, according to Zucaro.

The country is appealing a U.S. court order to pay $1.3 billion to owners of bonds on which it defaulted in 2001 at the same time it makes payments on performing securities. Fernandez’s promises not to pay the holdouts any more than it paid bondholders in 2005 and 2010 restructurings have fueled speculation she may opt to default on the New York-law debt.

Payments on the GDP warrants, which were issued as part of the restructurings, are triggered when growth surpasses annual targets set in the securities’ contract. No disbursement is due this December, the month payments are made, after an expansion of 2 percent in 2012 fell short of the threshold.

Warrant Payment

Last December, the government made a $3.5 billion payment, based on 2011 growth of 8.9 percent. Peso warrants have risen 39 percent since the Dec. 14 payment.

Even if the economy stagnates in the second half, growth in the first semester was sufficient for GDP to expand 4.5 percent this year, Empiria Consultores said in a report titled, “A Statistic that Costs $3.6 Billion” -- a reference to the amount the research company calculates the government will disburse in December 2014.

To fall short of the 3.22 percent threshold, the economy would have to contract 1.6 percent in the second half, which would be the slowest expansion for the second six months of any year since 2002, according to Hernan Lacunza, a former central bank general manager who runs Empiria.

Legislative elections in October make such a contraction unlikely as the government will want to present a thriving economy to voters, Lacunza said.

“The peso warrants are attractive,” Lacunza said in a telephone interview. “Everything is pointing to a warrant payment next year.”

To contact the reporter on this story: Camila Russo in Buenos Aires at crusso15@bloomberg.net

To contact the editors responsible for this story: Michael Tsang at mtsang1@bloomberg.net; David Papadopoulos at papadopoulos@bloomberg.net

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