Did you miss this boat?

Hedge Fund Thinks Fighting Argentina Over Bonds Looks Fun

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
Read More.
a | A

Here is one of the wildest sentences ever committed to PowerPoint. It's from a presentation that Owl Creek Asset Management gave about its efforts to round up investors to declare Argentina in default on its bonds and demand immediate repayment. Here it is:

This would lead to a seat in settlement negotiations in January, likely resulting in an exchange into new bonds which trade closer to par.

OK fine I guess that sounds like pretty normal corporatese. But imagine wanting a seat at the table in bond negotiations with Argentina! Elliott Management has been sitting at that table for a decade. Argentina is rarely even in the same room as the table. Argentina couldn't pick the table out of a lineup of tables. And when Argentina does show up to the table, everything is much worse. Remember when Elliott forced Argentina to miss a payment on its bonds, and declared its desire to negotiate, and a court appointed a mediator to help them negotiate, and Elliott and the mediator sat at the table for a month twiddling their thumbs, and at the end of the month Argentine economy minister Axel Kiciloff waltzed into the room, bellied up to the table, opened his briefcase, pulled out a single sheet of paper, looked at it intently and said, very slowly, "We are prepared to offer you .... NOTHING, SUCKERS," or words to that effect? That table is a terrible place.

Or: "likely resulting in an exchange into new bonds which trade closer to par." Owl Creek seems to own a chunk of the (ironically named ) U.S. dollar "pars," 2.5 percent bonds due in 2038 and currently trading at about 55 cents on the dollar. The last time Argentina defaulted on its debt and was accelerated was in 2001. That resulted in an exchange for bonds worth about 30 cents on the dollar, in 2005 or 2010 (for different groups of holders). So, "Oh, we'll get 100 cents on the dollar in three months" -- and yes, Owl Creek "said in a presentation that accelerating the so-called par bonds may generate gross returns of 100 percent in a restructuring" -- seems like a triumph of hope over the last decade or so of experience.

What is going on? Argentina stopped paying interest on its debt in June, when a U.S. judge forbade it from doing so without first paying off Elliott Management and other holders of the pre-2001 debt that was never exchanged into the post-2005 bonds. Owl Creek is apparently trying to round up 25 percent of the holders of one series of post-2005 bonds, the dollar pars, so that it can accelerate them and demand immediate repayment. "Demand immediate repayment" is, of course, just an expression. No one's getting immediate repayment. What actually happens when sovereign bonds accelerate is, normally, that everyone gets in a room and looks at each other glumly, and a few years later they end up with a negotiated restructuring of the bonds in which everyone exchanges their old bonds for new bonds.

Owl Creek's theory might be that that would happen here too. Traditionally, when that happens, $100 face amount of old bonds turns into $X of new bonds, for some fixed X -- regardless of the terms of the old bonds. In particular, $100 face amount of Owl Creek's 2.5 percent bonds, which now trade for about $55, would turn into the same amount of new bonds as $100 face amount of the 8.28 percent U.S. dollar "discount" bonds, which trade for about $87. Owl Creek's guess might be that, in the levelling process of a restructuring, everyone will turn in $100 face amount of old bonds and get back say $70 worth of new ones -- leveling the discounts down, and its pars up.

That is a normal way to think about corporate bankruptcy, and even a reasonable way to think about sovereign restructurings generally. It's a relative-value trade: In a restructuring, the discounts and pars should trade closer to each other, so you can buy the discounts, force a restructuring and have them trade up towards the pars. But it seems like a wild gamble here. First of all, generally, why would you assume that Argentina will have a "normal" restructuring? But second, the hypothesis here is that, in January 2015, Argentina will be sitting down with its last remaining holdout creditors to complete the restructuring process that was put in motion in 2001. Imagine telling them to start all over! That doesn't sound like fun.

Here's a more reasonable theory:

An acceleration may be a bid to pressure Argentina and the holdout creditors into negotiations, according to Patrick Esteruelas, an analyst at Emso.

“The $5.4 billion question is would par holders use the threat of acceleration to force a resolution of the holdouts, or are they choosing to accelerate simply to get better terms on their bonds,” he said by phone from New York.

If the group that demands immediate repayment holds 50 percent of the securities, it can undo the acceleration once Argentina resumes payment.

Building a majority position in the bonds beyond the 25 percent minimum would “lend some credence to the idea that they want to use the threat of acceleration as leverage to force a resolution,” Esteruelas said.

The idea is that the prospect of blowing up the 2005/2010 restructuring, putting everyone into default, and then sitting down at the same glum table with Argentina and Elliott, would be so unpalatable to Argentina and Elliott that it would focus their minds on reaching a resolution that would allow Argentina to start paying Owl Creek -- and everybody else -- again. And once the resolution is reached, you don't have to accelerate -- or, if you already did, you can rescind it and go back to normal, without the whole restructuring rigmarole.

That is a more reasonable thing to think than "Ooh, we'll get paid off at par." It is not, though, reasonable in any absolute sense:

“Putting more fuel on the fire and forcing any kind of debt repayment through legal enforcement will not please the Argentines,” Butikofer said. “I’d rather watch it with some distance.”

Me too!

Here's an idle and extremely speculative thought, though. It's not strictly true that an acceleration of Owl Creek's bonds will re-open the 2005 restructuring. Owl Creek's exchange bonds were issued in 2005, 30 cents' worth for every dollar of pre-2001 bonds. Elliott's bonds were issued before 2001, and never exchanged, leaving it with one dollar for every dollar of pre-2001 bonds. In a restructuring, Owl Creek would come to the table with 30 cents' worth of claims for every pre-2001 dollar of bonds; Elliott would come with a dollar.

But there are no rules in that restructuring. Argentina could offer some bondholders more than it offers others. It's just Argentina negotiating with creditors, in the shadow of a U.S. district court. That U.S. district court has told Argentina, in no uncertain terms, that it can't do any sort of exchange to pay off its Owl-Creek-type exchange bond holders without first paying its Elliott-type holdout bond holders. Most of the loony workarounds that I and others have proposed, to allow Argentina to pay the exchange holders without paying Elliott, probably don't work.

But ... an acceleration, default and restructuring is yet another loony workaround, right? I mean, even loonier. But if Argentina actually gets accelerated, and does a restructuring, and offers a new exchange to everyone, then there's a decent case that it's treating Elliott equally with the exchange bonds, in accordance with Elliott's pari passu clause and the judge's orders. And if that restructuring offers everyone value based on their equivalent pre-2001 claims -- treating Owl Creek's 30 cents of post-2001 claims as being worth the same as Elliott's pre-2001 dollar -- then, if you squint, that might also look like equal treatment. If Owl Creek's actions could actually reopen the 2005 exchange offer, then in a sense Elliott would lose the value of having held out for the last 10 years. Everyone would be back to the pre-2001 position, and Elliott's claims would be a smaller percentage of the total, with a smaller value.

This is probably fanciful; it's complicated to do and unlikely to persuade that U.S. judge. And of course, even if it worked, Elliott could say no to the new restructuring, and go right back to court like it did for the 2005 deal. But I doubt Elliott wants to start all over either.

  1. There's some poetic license here but, seriously, the guy came to New York to offer them the deal that they'd rejected since 2005, that they'd been litigating for years and that the U.S. Supreme Court had told them not to take. It was wild stuff.

  2. In the 2005 exchange offer, you could basically exchange 100 cents of old bonds into 100 cents of new bonds that traded at 33, or 33 cents of new bonds that traded at 100. (Sort of, not really.) The first option was called "Pars," and the second "Discounts," though really it's kind of the reverse.

  3. Pages 204-205 of the exchange offering describe the acceleration mechanics. You need 25 percent to accelerate upon a default (including non-payment of interest). Holders of a majority of bonds can rescind acceleration once the default has been cured.

  4. This is based on the theory laid out in footnote 9 of this post.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net