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July 2001

Bankers celebrate as Cavallo buys a little time


Argentina's $29.5 billion sovereign debt exchange deal was a great coup for the banks lead-managing it. Liability management deals are making up for a slowdown in the emerging-market debt business. How much it helped Argentina is less clear. Investors participated for technical reasons, not out of faith that the economy is improving.




       
Executing a multi-billion debt deal is always a daunting prospect, but when a country's entire economic survival plan depends on it, the exercise can be hair-raising, as the seven lead-managers of Argentina's voluntary debt exchange discovered in June.
If the bankers needed any more motivation to make every call, to consider every technical twist to make the deal work, they might have considered that the near-term prospects of the business in which they work - emerging-debt capital markets - also depended on the outcome.
The $29.5 billion deal, undertaken by CSFB and JPMorgan, was a tremendous success in its structure and execution. It achieved its prime objective of giving Argentine economy minister Domingo Cavallo some breathing space to concentrate on economic reform by staving off a meltdown in the sovereign's bonds and an imminent liquidity crisis.
The deal was bigger than the $20 billion originally expected, and eventually involved replacing $29.5 billion of old dollar and peso debt with a new $11.5 billion 2008 global bond, a $931 million 2008 peso-denominated bond, a $2.03 billion local pagare or promissory note maturing in 2006, a $7.45 billion 2018 global and a $8.5 billion 2031 global.
Default fears overcome
By offering the new bonds, which featured either step-up coupons or interest capitalization in the early years, the deal deferred $16 billion of interest and principal payments over the next five years, $7.8 billion of which was to have fallen due in the next 18 months. With that sort of relief in sight, fear subsided that Argentina was hurtling towards default later this year, local interest rates came back down to more manageable levels and an emerging-market crisis on a scale not seen since Russia's 1998 collapse was averted.
"This is about the best deal the market could do," says Tulio Vera, debt strategist at Merrill Lynch. Investors piled into the new bonds and sent their prices soaring as much as 800 basis points in their first week of trading at the beginning of June.
But the joy was short-lived.
A day before the transaction's June 19 settlement date, however, bankers involved in the deal stood by helplessly as Argentine bonds suffered their worst plunge in two months, taking the price of the new globals to below their re-offer levels.
"I felt sick to my stomach," says one banker who had worked on the exchange. "When I left work on the Friday everything was fine and then as soon as I walk in on Monday someone tells me the 08s are down something like five points. I said, 'What?'"
Surprising the leads as much as everyone else, Cavallo had announced a controversial exchange rate for trade that would fix the peso's rate for importers and exporters at the mid-point between the US dollar and the euro. The move weakens the peso by about 8% for exporters and has prompted fears among international investors that it is the beginning of a creeping devaluation.
"It seems that the Cavallo economic team is testing the waters to see what would be the reaction to a possible devaluation," says Walter Molano, debt strategist at BCP Securities.
The big, liquid 2008 bonds, which had substantially outperformed FRB Brady bonds in the first week of trading, were one of the hardest hit by the news. They had begun trading at 78.55 on June 4, soared to 84.5 by June 11 - during which time FRBS remained around the 88.00 level - and then plunged to 76.75 bid on June 18. FRBS dropped to 83.00 in the same period.
All Argentine bonds, including the 2008s, recovered a few days after the announcement as Cavallo did some heavy explaining to local business leaders to boost confidence in the plan.
Nonetheless, the violent reaction in the international capital markets underscored one of the unavoidable consequences of doing voluntary debt exchanges of this magnitude: No matter how well a deal is structured and distributed initially, its subsequent success is at the mercy of politicians battling to keep a country afloat. A large liquid deal is driven by euphoria at one moment, panic the next.
"The success or failure of this deal will ultimately be decided by the economic policy programme that Cavallo and his team implement," says Cindy Powell, managing director and co-head of emerging market syndicate for JP Morgan.
Given the size of the new bonds, it is very difficult for the leads to control price movements after launch. The only practicable way to ensure good trading support is to structure the new bonds so that they will be technically stronger than the old ones. Often they take on a life of their own, soaring wildly on good news or strong technicals and plunging on what can often be a greater weight of bad news, given the precarious position the issuer had to be in to warrant the exchange in the first place.
Cavallo's misperception
Cavallo should have been aware that the risk and expense of doing such a high-profile voluntary debt restructuring could only be justified if the market confidence it created were sustained by a consistent flow of positive economic initiatives. Apparently he thought the trade currency news would bolster confidence, not undermine it.
       
Domingo Cavallo
If Cavallo doesn't get the economy going, and fast, the swap's positive impact on the markets will be wiped out and the naysayers will once again question the wisdom of Wall Street-engineered debt exchanges that are done in desperation rather than from a position of strength.
"A lot of academics have been very critical of this transaction because they say it doesn't make sense for an over-indebted country to increase its indebtedness," says Mohamed El Erian, chief emerging-market debt portfolio manager at Pimco.
Bankers involved in the deal appear perplexed by criticism of the added burden on Argentina and their own profits on the trade. "It's almost as if it's a surprise to some people that voluntary debt exchanges don't come for free," says Powell. "This is a voluntary debt restructuring. That means you have to work within the constraints of a voluntary transaction and pay market rates. The only way to pay below market rates would be to force investors into an involuntary exchange."
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