Argentina’s bond, stock markets and currency dropped on Thursday after Latin America’s third largest economy defaulted for the second time in 12 years.
The default came after Argentina did not strike a deal with lead holdout investors NML Capital Ltd, an affiliate of Elliott Management Corp and Aurelius Capital Management, in time for a midnight Wednesday EDT (0400 GMT) payment deadline.
The government maintains that it has not defaulted because it deposited an interest payment on one of its bonds due 2033 that is governed by New York law. U.S. District Judge Thomas Griesa in Manhattan said in June when the payment was made that it was illegal because it violated his ruling.
At that time, Griesa deemed the $539 million deposit with the Bank of New York Mellon, Argentina’s trustee bank, was illegal because it did not include a concurrent court-ordered payment of $1.33 billion plus accrued interest to the holdout investors.
Argentine Economy Minister Axel Kicillof warned on Thursday that the country could bring more lawsuits to challenge the contention that it is in default.
Bondholders who participated in the two prior restructurings of the 2002 default now have to decide whether or not to seek immediate full payment of principal and interest on their restructured debt, a process known as acceleration. This process requires 25 percent of the bondholders on each of 16 bonds issued in the 2005 and 2010 restructurings to ask BNY Mellon for a formal decision on default. The bank has 60 days to decide.
“Let’s suppose that the bank considers it as a default, Argentina is sure that this is not a default, so it will appeal it to a judge,” Kicillof said after returning to Buenos Aires from the failed talks in New York.
Another formal declaration of a default could come as soon as Friday from a committee of buy and sell side investment firms organized by the International Swaps and Derivatives Association (ISDA). They will decide if a side-bet made on insuring Argentine government debt is payable.
The cost of insurance on the South American country’s sovereign debt surged on Thursday.
Argentina’s default is not seen unleashing financial turmoil abroad because it has been isolated from global credit markets since its 2002 default on about $100 billion of debt. It has foreign currency restructured debt worth about $35 billion, including $8 billion under local law, while its foreign exchange reserves stand at $29 billion.
Lengthy Legal Travail
Buenos Aires has dubbed holdout investors “vultures” for picking over the carcass of their broken economy. Even a short term default would raise local companies’ borrowing costs, pile more pressure on the peso, drain dwindling foreign reserves and fuel one of the world’s highest inflation rates.
Thursday’s market moves reversed a strong rally from Wednesday when investors had widely anticipated a last-minute deal. Argentina’s dollar-denominated Discount bond due 2033 fell 8 points in price to bid 88 cents on the dollar, driving the yield up to 9.85 percent. The peso fell 2.6 percent to 12.65 per dollar on the black market in early afternoon trading after paring losses.
The Merval stock index fell 8.4 percent. Shares traded locally in Argentine energy company YPF were down 9.18 percent at 356 pesos per share. The default is likely to raise borrowing costs for YPF, which issued a $1 billion, 10-year global bond in April.
Asset prices were down sharply but market participants said they still expected either the government or third parties to reach a deal eventually with the holdout investors. As to whether Argentina had suffered a credit event, the ISDA said it had received its first request regarding the issue, according to its website
Swiss bank UBS asked the 15-member ISDA-facilitated Determinations Committee (DC) to consider whether a “failure to pay” credit event had occurred. Its ruling applies only to those investors who purchased Argentine CDS. The committee is independent of ISDA and due to convene on a conference call at 1100 EDT (1500 GMT) on Friday.
There is no set time frame for a vote on whether or not to declare a credit-event has occurred, an ISDA spokeswoman said. If a supermajority of 12 member firms on the DC vote that a credit event has taken place then a payout process would start for holders of these CDS contracts.
UBS cited a missed deadline to deliver interest payments to creditors holding the restructured debt from the 2002 default. Credit Suisse has said CDS were “likely to be triggered.” Emiliano Surballe, fixed-income analyst at Bank Julius Baer said, “It is still not clear whether the credit default swap of the country will be triggered. The situation that generated the default was a lawsuit, not the failure of the country to transfer the proceeds to pay existing debt.”
Prices on Argentine CDS surged on Thursday. An investor wanting to insure a $10 million trade for one year would need to spend $4.04 million as an upfront cost plus an additional $500,000, according to data provider Markit. At the start of July the upfront cost was $2.77 million.
The yield spread between U.S. dollar-denominated Argentine debt and benchmark U.S. Treasury yields widened by 75 basis points to 635 basis points on the JPMorgan EMBI+ index. Total returns for Argentina were down 7.63 percent versus a drop of just 0.65 percent for the index overall. Credit rating agencies downgraded Argentina as a result of its missed payment to a half-step before declaring absolute default. Fitch Ratings said on Thursday Argentina was in Restricted Default and Standard & Poor’s on Wednesday pushed the country to Selective Default.
Griesa scheduled a new hearing in New York for Friday at 11 a.m. EDT to discuss Argentina’s default. Argentine banks had scrambled on Tuesday and Wednesday to put together a proposal to buy out the non-performing debt held by the holdouts and avert the default. That attempt at a deal collapsed in the final hours.
Some Argentine newspapers reported that JPMorgan Chase & Co and other banks might be involved in a private-sector deal with the holdouts to help resolve the default. A JPMorgan spokesman said the U.S. investment bank had “no comment” on the reports.
Aurelius said it had received no proposals on a private-sector debt purchase “worthy of serious consideration.” In Buenos Aires, Argentine Cabinet chief Jorge Capitanich urged holders of Argentina’s exchange bonds to demand their money from Judge Griesa. Capitanich also lashed out at U.S.-court appointed mediator Daniel Pollack, calling him “incompetent”.
Even so, some holders of Argentine debt were optimistic the government would seek a resolution.
“It’s probably going to be more a soft-default scenario where prices will slide a bit. There is confidence in what the government is going to do,” said Rune Hejarskov, senior portfolio manager at Jyske Invest, which holds Argentine debt. The default could get a lot messier and take longer to clear up if creditors force an “acceleration” for early payment on their bonds.
Some investors saw this as unlikely.
“I don’t think at the moment there is a clear answer to whether bondholders will accelerate a deal. It’s probably not something most bondholders would like to see,” said Olivier De Timmerman, fixed income fund manager at KBC Asset Management in Luxembourg.
“Very particular default”
The relative calm surrounding Argentina’s current debt crisis is a far cry from the mayhem in 2001-2002 when the economy collapsed around a bankrupt government and millions of Argentines lost their jobs. Argentina has a population of 40 million.
This time the government is solvent. How much pain the default inflicts on Argentina, which is already in recession, will depend on how swiftly the government can extricate itself from its obligations.
“This is a very particular default, there is no solvency problem, so everything depends on how quickly it is solved,” said analyst Mauro Roca of Goldman Sachs. Buenos Aires argues that agreeing to the hedge funds’ demands to pay them in full would break a clause barring it from offering better terms to them than to those who accepted to steep writedowns in the 2005 and 2010 swaps. The clause expires on Dec. 31, after which the government would also be able reach a deal with the funds.
Many investors and economists hope for some solution after the end of the year. “Our base case is that a default would be cleared by January 2015,” said Alberto Bernal, a partner at Miami-based Bulltick Capital Markets. He projected that a default would cause the economy to shrink 2 percent this year compared with a previous market consensus for a 1 percent contraction.