Today's the Day for Argentina and Its Vultures
Will Argentina, or its friends, be able to reach a settlement with its holdout creditors in time to prevent a default today? I am going to go with the answer "no, because Argentina has probably already defaulted," but I acknowledge that there's plenty of murk there. As best as I can tell, though:
- Argentina had to make payments today,
- on peso, dollar, euro and yen-denominated bonds,
- in the relevant places,
- that made it to investors.
Each part of that is murky, and you can wade through the murk in those footnotes, 5 but the point is: It is no longer today in Japan, the yen bonds don't seem to have been paid, so that sounds like a default. But who knows.
Anyway, even if that's wrong, it seems somewhat unlikely that money will actually move between now and midnight in Europe. Argentina would need to reach a settlement with its holdout bondholders, go to Judge Thomas Griesa with the settlement, get him to write an order lifting the injunction preventing Argentina from paying its exchange bondholders, bring that order to its paying agents and trustees, and get them to transfer money -- after business hours -- in time to meet the midnight deadline in Europe, which is less than four hours away. I don't see it. Best guess: There is or was or will be a default.
Of course, nothing particularly happens on a default. I mean, if you own Argentine exchange bonds, you didn't get paid yesterday, and you didn't get paid today, and tomorrow isn't looking great exactly, though it is looking up. And if you're Argentina, you didn't have great access to international capital markets yesterday, etc. etc. The difference between "default" and "unpleasant but not technically default" is, you know, pretty technical. It's mostly three things:
- Exchange bondholders will have the right to accelerate the bonds upon default. 6
- Credit default swaps will be triggered upon default.
- Ratings agencies will downgrade Argentina to "selective default" if it selectively defaults.
If you care about the ratings agency thing then you are a weirder person than I am. But I'm weird enough to be interested in the first two.
First, acceleration. Acceleration means, you go to Argentina and say, "hey you're technically in default, so you actually have to pay me back the full face amount of my bonds right now," 7 and then they laugh maniacally for like five minutes. They're not going to pay back your bonds at par right now. They don't really have the money, for one thing, and Judge Griesa's order prevents them from paying you back without also paying back the holdouts, for another. And there's nothing you can really do about it. There's no bankruptcy court for sovereign debt that can make them pay you. That's what the last decade or so of litigation has been about.
So no one thinks the bonds will be successfully accelerated. In particular, the actual holders of those bonds really want a deal, and are doing their best to make life easier, not harder, for Argentina. One big impediment to the deal is what's called the RUFO clause -- for "rights upon future offers" -- which provides that the exchange bonds can basically participate in whatever Argentina gives the holdouts now. 8 Various exchange bondholders are offering to waive the RUFO in order to facilitate a deal. If the bonds default(ed) today, and those bondholders accelerated, that would probably just create further delay and litigation and reasons to avoid settlement. Best to sit quietly and make it easier for Argentina to work things out with the holdouts, rather than create another holdout situation.
This is especially true because, whatever you think about whether Argentina will default, or has already defaulted, the more important question is, will things be fixed soon? If Argentina defaults today, settles with its holdouts tomorrow, and pays its exchange bondholders on Friday, everyone will be pretty happy. Between the possibility of a RUFO waiver (making it easier for Argentina to settle soon), the possibility of private buyers for the holdouts' bonds (making it easier for the holdouts to settle soon), and, you know, the fact that Argentina is finally showing up to negotiate, the odds of a near-term settlement seem to be as high as they've ever been. 9 There's not much point in accelerating if Argentina is likely to cure the default tomorrow.
There's one weird little wrinkle on that. When Argentina did its 2005 exchange offer, it offered two sorts of new dollar and euro-denominated bonds, Pars and Discounts. Pars -- which, confusingly, trade much further away from par -- mature in 2038 and have fairly low interest rates (currently 2.50 percent for dollars, 2.26 percent for euros). Discounts, which trade at much less of a discount, mature in 2033 and have much higher interest rates (8.28 for dollars, 7.82 percent for euros). Here's how they've done over the last year: 10
Discounts are trading right near par, while Pars are still trading at a big discount. As you'd expect.
But here's how that looks on a yield basis:
The lower-dollar Par bonds are trading at a much tighter yield -- under 8 percent today in both euros and dollars -- than the high-dollar Discount bonds, which are around 9 percent today and were north of 10 percent as of yesterday. That's a little weird: The Discount bonds have a shorter duration (both a shorter maturity and a higher coupon) than the Pars, yet they trade cheaper than the Pars. 11
This happens all the time in corporate distress situations: If a company defaults, all its bonds accelerate, you go to bankruptcy court, the court divides up the assets, and every bondholder gets back the same amount of money. So a long-dated low-coupon bond is worth as much as a shorter-dated or higher-coupon bond: In bankruptcy, they'll all get paid back in the same amount at the same time.
I suppose something similar is possible with Argentina -- default, acceleration, grand bargain in which all the exchange bonds are replaced with new, even exchange-ier bonds, with everyone getting new bonds based on their current par amount and not the existing terms of their bonds. (That's how Argentina's previous exchange offer worked, and Greece's more recent exchange.) But that is ... really unlikely, no? Still, the fact that low-dollar bonds are trading at lower yields than high-dollar ones suggest that the market is putting at least some probability on a "real" default in which Argentina stops paying and, rather than quickly resuming payments, instead ends up in a protracted total restructuring. And then we do all of this again in ten years.
Second, CDS. There are about $1 billion of credit default swaps outstanding on Argentina, and it seems reasonably evident that CDS will trigger (has triggered?): It triggers on a failure to pay, and Argentina (will have?) failed to pay. Bank of America has an argument that CDS might not trigger but that argument is pretty weird. On the other hand, CDS triggering is not a strictly mechanical event; a determinations committee of ISDA decides if it's actually triggered, and it is relatively unconstrained in its decision. You could imagine the committee looking the other way at a couple of hours of default in Japan. 12
If CDS triggers, it runs off on its merry lonesome, oblivious to whatever Argentina and its holdouts get up to. Even if the default is cured in a couple of days, there will still need to be a CDS auction, and writers of CDS will need to pay buyers of CDS based on the recovery computed in that auction. That will be, very roughly speaking, 100 cents on the dollar minus the value of the cheapest deliverable bonds at the time of the CDS auction. 13 As it happens, those yen bonds include a Par maturing in 2038 with an unexciting 0.45 percent coupon. That bond doesn't seem to trade much at all, but Bloomberg has it at 16.25 cents on the dollar. Double that to be conservative, and figure the CDS recovery is in the 30s -- not because of the default, but just because Argentina has some very long-dated low-coupon bonds outstanding, and no one wants to be delivered them on a CDS event.
So if you own CDS on Argentina, and it defaults even for a day or two -- even if the bonds don't lose value -- even if they gain value, as they have today -- then you stand to get paid back something like 70 cents on the dollar. The point remains that sovereign CDS is weird, and functions much more as a way to bet on the workings of CDS technology than as a hedge for sovereign debt holdings.
The other point is that if Elliott Management Corp., as is sometimes rumored, still owns a big chunk of CDS on Argentina, then defaulting today and curing tomorrow would work out rather well for them. If Argentina settles today, CDS pays out nothing. If it settles tomorrow, CDS pays out a lot. Probably.
All in all though I suspect that's the only important binary outcome. Derivatives require clear rules and bright lines, and use those bright lines to produce weird results. The rest of the world mostly muddles along. Argentina will probably default, and has maybe already defaulted, but that's not that big a deal. The important thing is what they do next. If they can fix the default quickly, then for Argentina that's almost as good as not defaulting at all.
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That is, it had to make a payment by 1 p.m. local time on June 30 (see Section 3.5 of the indenture), and it's an event of default not to pay where "such failure continues for 30 days" (Section 4.1(i) of the indenture). Arguably the event of default occurs at 1 p.m. today but let's be generous and say it's 11:59 p.m.
Here is the prospectus for the peso, euro and dollar bonds. The yen bonds were issued pursuant to a different prospectus -- available on Bloomberg, anyway; look up the bonds (e.g. ISIN ARARGE03E634 or ARARGE03E642), CF <go>, and the prospectus is listed. It is in Japanese though. I don't read Japanese. So I'm just gonna guess it reads something like the English one?
Again see Section 3.5 of the dollar/euro indenture. Maybe the Japanese one is different. Here is a letter from JPMorgan, whose Tokyo branch has some frankly mysterious connection to the bonds. The point is it got some money from Argentina for the purpose of sending to the trustee to pay interest on those bonds, and it doesn't seem to have moved that money yet.
The dollar stuff happens in New York, obviously. The euro stuff happens in ... based on this letter, I'm going to say Frankfurt and Brussels and maybe a bit in London and Luxembourg, but if you have another theory I'm open to it.
This is the infamous (in certain circles) language in the prospectus that says:
Holders of New Securities will be paid in accordance with the procedures of the relevant clearing system and its direct participants, if applicable. Neither Argentina nor the trustees shall have any responsibility or liability for any aspect of the records of, or payments made by, the relevant clearing system or its nominee or direct participants, or any failure on the part of the relevant clearing system or its direct participants in making payments to holders of the New Securities from the funds they receive. Notwithstanding the foregoing, Argentina’s obligations to make payments of principal and interest on the New Securities shall not have been satisfied until such payments are received by registered holders of the New Securities.
Emphasis added. Here is Adam Levitin interpreting that language. The point is that Argentina can't say, "well, we sent money to the trustee, it's not our fault if you didn't get it." I mean -- they can say that! They say that a lot! But that doesn't mean it's not a default. Probably.
And this one: Most notably, not having read the yen bond indenture, I am just assuming it works like the dollar and euro indentures. For all I know there's like a 45-day grace period there and this is all moot. In that case, just re-run the above analysis when it's midnight in Brussels.
Including cross default (see Section 4.1(iii) of the indenture), so a default in Japan triggers the dollar and euro bonds too.
The mechanics are in Section 4.2 of the indenture. It takes 25 percent of the holders of any series of bonds to accelerate. If Argentina cures the default before the notice of acceleration is delivered then there's no acceleration, and if it cures the payment default after the notice of acceleration then 50 percent of the holders can rescind the acceleration. So there are a lot of ways out.
See page S-69 of the prospectus. The RUFO runs until December 31, 2014, so there's a lot of speculation that the best time for a settlement is early next year.
One good question is: How important is it for Argentina to settle quickly? Breakingviews thinks, quite important, and the Financial Times says, "most economists predict a deepening of the existing recession, higher inflation (already among the highest in the world), and pressure on foreign exchange reserves (which are dangerously low) probably causing a second devaluation this year" if there's a default. Felix Salmon thinks, not that big a deal:
What would the costs of such a default be? We’ve already seen that loss of market access isn’t really a cost of default, since Argentina doesn’t have market access anyway. And while sovereign bond defaults are often extremely damaging politically, it’s hard to see this one hurting Argentine president Cristina Kirchner, especially since it’s very easy for her to blame US judges for the whole thing.
Indeed, there might even be a benefit to default: Argentina could stop making its coupon payments for a while, and use the money instead on desperately-needed projects back home.
My own guess is that the consequences are not binary on a default, but rather depend on the length and messiness of the default. If they pay tomorrow, it's not much worse than paying today. If they never pay, things get progressively worse.
As of noonish today. In New York.
Also weird: The euro and dollar bonds trade quite close to each other. But it seems to me that there's a decent argument that the euro bondholders can go to court in Europe and demand that their coupons be paid, notwithstanding Judge Griesa's order, and that that would work. So you'd expect the euro bonds to trade tighter than the dollar ones -- unless everyone figured that they'd get paid pretty soon so there's no reason to worry more about dollars than euros.
Also Bank of America is on the determinations committee.
Oh it's way more complicated than that. Here's a lot of background.
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