As Talks Falter, Bond Default by Argentina Appears Likely

Posted on July 30, 2014 by

Barring a last-minute deal, Argentina will default on billions of dollars of bonds on Wednesday.

It would be Argentina’s second default in 13 years. But unlike the last time, when scores of unhappy Argentines took to the street as unemployment rose to 25 percent and inflation soared, this default would look decidedly different.

Argentina’s equity, bond and currency markets, which have been volatile in recent days, would certainly feel a jolt. The government and Argentine companies, which have been largely locked out of global markets since the last default in 2001, would find it even harder to raise money. And the economy, which has struggled with stagflation for years, would most likely slow further.

But the reaction will probably be muted because this default is not a surprise.

“This is kind of a chronicle of a default foretold,” said Arturo Porzecanski, director of the international economic relations program at American University, referring to the novella by the Colombian writer Gabriel García Márquez, “Chronicle of a Death Foretold.”

A default has been in the making since a group of New York hedge funds gained significant victories in American courts, where they are demanding that Argentina pay them in full on government bonds that defaulted in 2001.

As in Mr. García Márquez’s books, the hedge funds’ battle against Argentina is full of unusual twists.

In a pivotal ruling, Judge Thomas P. Griesa of Federal District Court in Manhattan said that Argentina could not continue to make regular payments on its main class of bonds — whose investors had agreed to accept a lower amount than they were owed — without paying the hedge funds. A payment is scheduled for the main class of bondholders on Wednesday. Argentina, however, has insisted that it will not cave into the demands of the hedge funds, which it has called vultures.

“It would be a shocking surprise,” Mr. Porzecanski said, “if Argentina pulled out their pocketbook and paid” the hedge funds.

But even as it fights the hedge funds, which are led by Paul E. Singer’s NML Capital, Argentina also risks angering its main debt holders and prolonging its legal and financial woes.

The country’s predicament today is inextricably linked to its default in 2001 and events after it. Argentina’s economy in 2001 was in dire straits after four years of recession. Unable to continue making payments on loans from foreign creditors, it was engulfed in debt before it declared a formal default.

Through two restructurings, the government eventually struck a deal with a majority of its bond investors, who are now called exchange bondholders because they exchanged their bonds for ones that were worth as little as a fourth of the value of the original securities. The hedge funds, known as the holdouts, declined to participate in the restructurings. Instead, they are seeking $1.5 billion in repayment, including interest.

Judge Griesa’s ruling in 2012 was later upheld by the United States Court of Appeals for the Second Circuit. Then in June, the United States Supreme Court refused to consider Argentina’s last appeal. Judge Griesa gave Argentina a 30-day grace period on a scheduled June 30 payment to its main exchange bondholders.

Yet after a series of unsuccessful and hurried last-minute mediated talks between representatives of the Argentine government and the holdouts, both sides appear to have failed to settle their differences.

In defiance of Judge Griesa’s ruling, Argentina in June deposited $539 million into the Bank of New York Mellon, the trustee handling the bond payments, in an attempt to meet its exchange bond payment.

But Judge Griesa ruled that if Bank of New York Mellon made the payment, it would be in contempt of court.

Argentina has also asked the judge for a stay on his 2012 ruling, arguing that a delay would help it to negotiate a deal. On Tuesday, a group of investors of Argentina’s euro-denominated exchange bonds urged the judge to issue an emergency stay on his ruling. But this is unlikely to be granted unless the holdouts request it, analysts said, or the court-appointed mediator, Daniel Pollack, recommends it.

In depositing the next installment of bond payments, the Argentine government has said that a default would not be its fault, a claim that has gained it political mileage. In a speech last week, the country’s president, Cristina Fernández de Kirchner, conveyed this belief. “They’re going to have to come up with a new name,” she told an audience, referring to the word default, “a new term that reflects the fact that the debtor paid and someone blocked it.”

Also last week, Judge Griesa ordered the Argentine delegation and the holdouts to meet with Mr. Pollack and talk “continuously” until an agreement was reached.

The response from Argentina was tepid; the delegation met twice with Mr. Pollack last week before returning home to Buenos Aires for the weekend to consult with the government.

When a group of lawyers returned to Mr. Pollack’s offices on Tuesday, they arrived more than 15 minutes late. And despite Mr. Pollack’s insistence that they engage in “face-to-face conversations with the bondholders,” as of Tuesday evening, the Argentines had yet to sit down across the table from the holdouts.

Argentina’s lack of enthusiasm has prompted some lawyers and analysts watching the case to question whether Argentina actually wants to avert a default.

“If you’re picking a default as a rational avenue, it is because you have decided two things,” said Marco E. Schnabl, a partner at Skadden, Arps, Slate, Meagher Flom who is not directly involved in the case. “One, that picking a fight with the American legal system is politically convenient, and two, that the cost of settling with holdouts and everyone else who still has unpaid bonds is vastly greater than the costs of having to take a default.”

But even with that thinking, the picture is anything but clear because some of the legal theories behind the contracts governing Argentina’s debt have not been tested.

Argentina has said, for example, that if it agreed to a settlement, it could be on the line for as much as $15 billion in holdout investors’ claims. That is because any deal would have to include all holdouts, even those not represented in the case.

In such a case, bondholders who exchanged their defaulted bonds for discounted ones might also have the right to demand the same compensation terms, according to a clause in the bond restructuring terms that expires at the end of this year.

On the other hand, if Argentina does default, it runs the risk of more lawsuits, said Siobhan Morden, head of Latin America strategy at Jefferies. In many ways, this is perhaps the most significant implication of a default.

If enough bondholders from one class of exchange bondholders agree, they have the right to “accelerate” their bonds after Argentina misses its July 30 payment. They could then pressure the government to pay the full amount of their discounted bonds quickly, Ms. Morden added. This could mean a payment of as much as $28.7 billion to those bondholders, according to estimates by JPMorgan.

“With acceleration, you know everyone has a gun,” said Anna Gelpern, a law professor at Georgetown University. “The question is. Will they shoot?” But, she added, if Argentina agreed on a settlement with the holdouts, that could prompt lawsuits from exchange bondholders seeking the same terms. In that case, she said, “You don’t know if there is a gun, but if there is, it is a bazooka.”

Peter Eavis contributed reporting.

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