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Tuesday, May 11, 2010

Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts”

J. F. Hornbeck
Specialist in International Trade and Finance

In December 2001, following an extended period of economic and political instability, Argentina suffered a severe financial crisis, leading to the largest default on sovereign debt in history. It was widely recognized that Argentina faced an untenable debt situation that was in need of restructuring. In 2005, after prolonged, contentious, and unsuccessful attempts to find a mutually acceptable solution with its creditors, Argentina abandoned the negotiation process and made a one-time unilateral offer on terms highly unfavorable to the creditors. Although 76% of creditors accepted the offer, a diverse group of "holdouts" opted instead for litigation in hopes of achieving a better settlement in the future. Although Argentina succeeded in reducing much of its sovereign debt, its unorthodox methods left it ostracized from international credit markets for nearly a decade and triggered legislative action and sanctions in the United States. 

Argentina still owes private creditors $20 billion in defaulted debt and $10 billion in past-due interest, as well as $6.2 billion to Paris Club countries. Of the disputed privately held debt, U.S. investors hold approximately $3 billion. The more activist investor groups have lobbied Congress to pressure Argentina to reopen debt negotiations. Some Members of Congress have introduced punitive legislation in both the 110th and 111th Congress, but to date it has not received any legislative action. Nearly five years after the original debt workout, however, a confluence of circumstances has persuaded Argentina to restructure the holdout debt, particularly the need to secure long-term public financing. 

On April 15, 2010, Argentina announced the key features of the proposed bond deal, which will be made in a formal offer on April 30, 2010. Argentina expects to complete the process in June 2010. Two offers are proposed, one for retail (small) investors, the other for institutional (large) investors. Retail investors will receive replacement bonds for the full face value of the defaulted bonds they currently hold. Past due interest will be paid in cash. Institutional investors will receive a discount bond equal to a 66.3% reduction in the face value of the defaulted debt they currently hold (the so-called "haircut"). Past due interest will be covered by a separate seven-year "Global" bond. Interest rates vary depending on the bond. Both groups of investors will receive a GDP-linked security called a warrant that provides for additional payments should the Argentine economy grow at rates higher that anticipated and stipulated in the final prospectus. Analysts value the deal at between 48 and 51 cents on the dollar, compared to 60 cents for the 2005 exchange. 

For Argentina, a successful restructuring requires a sufficiently large participation rate to eliminate most of the existing judgments and attachment orders. Argentina expects, with no guarantee, that such an outcome will lead to renewed access to the international credit markets. Historically, sovereign debt workouts with at least a 90% participation rate have achieved this goal. Since holdouts compose 24% of the original bondholders, a 60% participation rate of this group would allow for the total participation rate to reach the 90% threshold, including the 2005 exchange. If the exchange succeeds, Argentina will have completed a sovereign debt restructuring with the deepest write-off of principal in history. Many original bondholders were severely hurt by this deal, as was Argentina by the crisis. Secondary market participants may see a sizable profit. If there is a legacy to the Argentine case, it may be in the changes to bond contracts that seek to improve outcomes for creditors. One option is the use of collective action clauses (CACs), now standard for sovereign debt, which require all creditors to bargain collectively, with a compulsory majority decision applicable to all bondholders.

Date of Report: April 28, 2010
Number of Pages: 17
Order Number: R41029
Price: $29.95

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