Defaulted Dollar Bonds Safer Than Local Debt: Argentina Credit

Even in default, Argentina’s dollar-denominated bonds are proving to be a safer bet than the peso debt that the nation continues to honor.

While Argentina missed a deadline to pay $539 million in interest on its overseas bonds last week, its local-currency notes are getting hit harder on concern the default will weaken the peso as foreigners pull money out of the country and investment dries up. The losses have pushed yields on its peso bonds due 2033 to near the highest since February and 1.1 percentage point above its dollar debt. As recently as June 20, investors demanded a premium to own the overseas securities.

“Default means faster devaluation in people’s heads,” Sebastian Vargas, an economist at Barclays Plc, said in an e-mail. The peso bonds will “have to offer higher yields to compensate for a weaker currency down the line.”

The disparity in bond yields shows that even after four straight days of losses, investors in the now-defaulted dollar bonds still have a better chance of getting their money back than holders of Argentina’s local-currency debt.

Traders in non-deliverable forwards anticipate the peso will drop 17 percent in the next six months after depreciating more this year than any currency in the world, apart from those of Ukraine and Ghana.

Fund Loss

Peso bonds are underperforming because higher NDF yields show that either the government will have to raise interest rates to boost peso demand or let the currency drop faster, said Ezequiel Aguirre, a strategist at Bank of America in New York. “That makes peso debt less attractive,” he said.

Bank of New York Mellon Corp. said a Brazil-based investment fund lost 51 percent of its net asset value because of writedowns on investments linked to Argentine government debt. The Brasil Sovereign II Fundo de Investimento de Divida Externa FIDEX took a loss on Aug. 1 of 197.9 million reais ($87.2 million), according to a regulatory filing yesterday by BNY Mellon DTVM, the bank’s Brazilian fund manager.

While Argentina deposited the interest due on overseas bonds at Bank of New York Mellon, Standard & Poor’s declared Argentina in default for a second time since 2001 after the payment was blocked because of a legal dispute with creditors who refused to participate in earlier restructurings.

U.S. District Judge Thomas Griesa prohibited Argentina from making the payment until it settles unpaid debts owed to the so-called holdouts demanding payment in court, led by billionaire hedge fund manager Paul Singer’s Elliott Management Corp.

Debt Relief

Unlike current overseas bondholders, who agreed to provide debt relief to Argentina after its record $95 billion default in 2001, the holdouts sued in court for full repayment and won a $1.33 billion judgment from Griesa. The U.S. Supreme Court declined to hear Argentina’s appeal in the case in June, leaving that order intact.

After last-minute negotiations between Argentina and the holdouts failed to avert default on July 30, Griesa at an Aug. 1 hearing ordered the parties to continue talking.

In a court filing that day, Griesa said his ruling preventing payment on Argentina’s dollar debt doesn’t “prohibit payments on the peso-denominated bonds.”

Yields on the local notes due 2033 have climbed 0.44 percentage point to 9.8 percent since July 30. The bonds, which are linked to the country’s official inflation index, rallied in February after the government improved its data reporting.

Capital Flight

The default will probably deter foreign investment and spur capital flight, making dollars scarce and putting pressure on the peso to weaken, according to Alejo Costa, a strategist at Buenos Aires-based brokerage Puente Sociedad de Bolsa SA.

Argentina already devalued the peso 19 percent in January in a bid to shore up foreign reserves that sank $12.7 billion last year, the biggest slide since 2002. At $29 billion, reserves are still down 3.6 percent this year.

“Corporate and provincial bond sales will decline, there will be less foreign-direct investment, and exporters will hold off on some of their sales as they await a weaker peso,” Costa said. “The exchange rate has to adjust to curb this drain in foreign currency.”

The peso will fall to 10 per dollar from 8.26, near the weakest in six months, trading in the forwards show.

Argentina may support the peso to bolster its case that the default is the result of a legal impasse and not a lack of funds, according to JPMorgan Chase & Co.

‘Policy Response’

“Authorities will defend the currency aggressively amid debt payment problems to provide signs of stability,” Joyce Chang, JPMorgan’s global head of research, and economist Vladimir Werning, wrote in an Aug. 1 report. “The policy response will be biased to displaying a stable official peso, to support the government’s narrative that debt problems are ‘technical’ and not meaningful.”

The central bank sold $20 million to defend the peso and buy imports yesterday, the biggest sale since May 29, according to preliminary data from a bank official who asked not to be named because he isn’t authorized to speak publicly.

Foreign banks including JPMorgan are in talks to buy the holdout creditors’ defaulted bonds, according to a bank official who asked not to be identified because the information is private. The agreement would allow Argentina to continue paying its overseas debt.

Argentine Economy Minister Axel Kicillof said July 31 that the government “wouldn’t be opposed” to a third-party solution. He reiterated that the country can’t offer Elliott and the other holdouts better terms than it did in the 2005 and 2010 debt swaps without making the same deal with exchange bondholders. The clause in the restructured bonds that prohibits such a deal expires Dec. 31.

Dollar bonds will continue to outperform “on speculation there will either be a third-party agreement this year, or a settlement in 2015,” Costa said.

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