Debt Restructuring – Uruguay vs. Argentina
By Win Thin
With markets now contemplating some sort of debt “re-profiling” by Greece, we thought it would be helpful to summarize the two most recent major debt restructurings by an EM borrower for some guidance on what such a move could imply for ratings, debt trajectories, and triggering CDS events. To us, it is clear that “re-profiling” is a euro zone euphemism for a soft debt restructuring that extend maturities and lowers rates, while “restructuring” now refers to a hard one that involves principal haircuts as well as potentially adjusting maturities and coupons too.
Uruguay Gets It Right
Uruguay underwent a voluntary debt exchange in 2003, lengthening maturities by 5 years while keeping coupons and principal constant. The process was widely viewed as a collaborative exercise between Uruguay and its creditors. The exchange offer was announced April 10, and was completed on May 29 with 93% participation. $5.0 bln out of a total $5.4 bln of eligible bonds were exchanged, while the IMF estimates that Net Present Value (NPV) dropped 20%. Incredibly, Uruguay was able to access international credit markets later that year, reflecting that the voluntary, “friendly” approach most likely leads to a quicker return. Uruguay is a fallen angel, getting investment grade ratings back in 1997 from all three agencies before losing them all in 2002. However, it has been steadily upgraded and stands on the cusp of investment grade. Indeed, our rating model puts Uruguay at an implied rating of BBB+/Baa1/BBB+ and so actual ratings of BB+/Ba1/BB are subject to upgrades.
Although Credit Default Swaps (CDS) have been around since the 1990s, they were not widely used back in 2003 and so there was no debate about whether the Uruguay debt exchange would trigger a CDS event. However, we note that the rating agencies considered it a default, with S&P downgrading Uruguay to SD (Selective Default) and Fitch downgrading to DDD in 2003. Uruguay inserted a Collective Action Clause (CAC) in the new bonds as well, which many believe would trigger a CDS event because it changes the underlying structure of the debt. CACs began to be used widely in 2003 by EM issuers to foster orderly crisis resolution by allowing a supermajority of bondholders to agree to a debt restructuring that is binding for all. This seeks to minimize the risk of holdouts in a restructuring.
Argentina Takes A Different Approach
Uruguay’s approach stands in stark contrast to that taken by neighboring Argentina. In December 2001, Argentina halted all debt payments to both domestic and foreign bondholders. Earlier that year, it took on an IMF loan to try to stop the bleeding and also did a bond swap to extend maturities, but to no avail. Close to $100 bln in debt had to be restructured, but a restructuring deal was not proposed until 2004 and was not completed until 2005. Then, Argentine officials basically rammed the restructuring down the throats of its bondholders with a take it or leave it offer. Only 75% chose to participate in a deal that saw effective haircuts of close to 65% (through maturity extension, principal haircuts, and lower coupon rates).
Due to the absence of CACs, the standoff between Argentina and the 25% holdouts continued until 2010, when the country struck a similar deal with them to get 70% participation as investors basically capitulated to Argentina’s hardball deal. However, Argentina still cannot return to the markets until it has settled $7.5 bln owed to the Paris Club countries. In the Argentine case, there is of course no doubt that a CDS event would have been triggered. S&P downgraded Argentina to SD (Selective Default) and Fitch downgraded to DD in 2001.
CDS Event Or Not?
With regards to triggering a CDS event in Greece, we note that the answer will depend on how the new bonds are structured. To us, it would appear that a maturity extension (even a voluntary one) that cuts NPV without haircuts on principal would trigger a CDS event. In Uruguay’s case, it did everything right and the rating agencies still moved it to SD. The case for a CDS event is not determined by the rating agencies, however. Instead, the International Swaps and Derivatives Association (ISDA) relies on panels called Determinations Committees that are made up of sell-side and buy-side firms to decide if an event should trigger a CDS event. These Determinations Committees were created in March 2009, when ISDA sought to standardize many CDS market conventions, including the way the contracts would trade and pay out. These Committees make binding decisions on whether a CDS event is triggered, as well as which debt instruments should receive CDS payouts. Who would have thought five years ago that the next major CDS event might likely come from the Developed Markets and not the Emerging Markets?
Did It Work For Uruguay And Argentina?
After its restructuring, the Uruguayan economy rebounded quickly and averaged 8% real GDP growth from 2004-2008. Part of that ironically was that Argentina was rebounding too, boosted by high commodity prices. During that same period, Argentina growth averaged 8.5% and the economy has continued to perform well despite ongoing economic mismanagement and no access to global capital markets. Due to the strong trade and financial ties between the two countries then, the synchronized recessions and recoveries were not unusual. Both countries were simply extremely lucky to be able to bounce back to such high rates of growth quickly, and making moot the point of what type of debt restructuring they used. Still, that brings us back to the view that peripheral euro zone cannot count on EM rates of growth to help debt ratios, and so a Uruguay-type “soft” restructuring would not be a lasting solution for the periphery. We would view it as another stop-gap measure until euro zone banks have strengthened their balance sheets enough to undertake a “hard” restructuring that involves significant principal haircuts. Whether that eventual hard restructuring is “friendly” likely Uruguay or “unfriendly” like Argentina will have a big bearing on how markets react to what we see as the inevitable end-game for Greece.
Baker Plan or Brady Plan?
Lastly, markets must also be prepared for other countries to follow suit. If Greece can restructure and lower its debt burden, why shouldn’t Portugal and Ireland also line up for the same treatment? As we have seen in the past, the stigma of defaulting/restructuring can sometimes wear off quickly, depending on the treatment of creditors. If the periphery can obtain significant debt relief AND undertake significant economic reforms (the often forgotten part of the Brady Plan that was just as important as the debt relief), then a path to long-term prosperity can be imagined. The Brady Plan of 1989 with its combination of debt relief and IMF/World Bank structural reforms is why much of Latin America is now investment grade and prosperous. The less-known Baker Plan, which in large part relied on extended maturities and lower interest rates coupled with austerity, cost Latin America its Lost Decade. Let’s hope the euro zone makes the right choice.
Global Head of Emerging Markets Strategy