UBS: Argentina: Set low expectations

Argentina: Set low expectations

• On 31 March 2013, a payment is due to holders of a bond issued by
the government of Argentina, in US dollars, under New York law.

• A US court ruling due on or before that date may result in Argentina
not being able to make that payment.

• Even if the payment does go ahead, further legal uncertainties
remain. We advise long-suffering holders of defaulted or
restructured government bonds from Argentina to set low
expectations, not least because there will be protracted legal and
political battles. Investors who don't want to deal with this drama
and uncertainty should sell.

• There is also another scenario. Argentina could show more
willingness to reach a compromise that pleases the court. Such a
compromise would give significant upside to the affected bonds,
depending on the terms of the deal, though the ride could be
volatile.

A short history

In 2001, Argentina defaulted on USD 82 billion in bonds (including bonds
issued under New York law). After two debt swaps in 2005 and 2010,
some 93% of the creditors exchanged those defaulted bonds for new
instruments that paid around 35 cents on the dollar. Under Argentinean
law, the government is prohibited from making a new debt swap offer. The
investors who did not participate in those bond exchanges (the "holdouts")
are pursuing litigation for a better settlement in courts throughout the
world.
The latest court case to attract attention is in the US. The United States
Court of Appeals for the Second Circuit has ordered the government of
Argentina to inform the court "on or before March 29, 2013... the precise
terms of any alternative payment formula and schedule to which it is
prepared to commit." The court directed "that, among the terms specified,
Argentina indicate: (1) how and when it proposes to make current those
debt obligations on the original bonds that have gone unpaid over the last
11 years; (2) the rate at which it proposes to repay debt obligations on the
original bonds going forward; and (3) what assurances, if any, it can provide
that the official government action necessary to implement its proposal will
be taken, and the timetable for such action."

Argentina either needs to change its law to make a new debt swap offer
possible or find ways of circumventing the US payments system (so as to
prevent payments passing through it from being claimed by the holdouts).
The possibility of a new default occurring due to technical reasons (the
money not reaching the holders of restructured bonds) is therefore not
insignificant.
Structural outlook is challenging
Another factor that could trigger a default (a lack of hard currency) is also
no longer improbable, given Argentina's deteriorating economic situation.
Recently, there have been mass protests against the government. The country
remains in default on USD 9 billion in loans from other countries, which
means it cannot easily get access to official sector loans (for infrastructure
investment or trade finance); neither can it tap the international capital
markets.
The export sector (a source of the government's dollars) remains vulnerable
to the vagaries of commodity prices, especially soybeans. Poor policies,
which include severe government interference in the economy (e.g.
nationalization of privately held assets and draconian capital controls), are
deterring foreign investment (keeping dollars out). The current international
legal action is making Argentina's investment climate worse, in that the
outcome of it on government finances is not predictable.
We have come to the conclusion that investors who don't want to deal
with this drama and uncertainty should sell.