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Investment bankingMarch 10 2009

Searching for a revival

The worsening global financial outlook combined with a troubled economic environment at home have shaken Argentina’s government, and stalling over its debt negotiations has isolated the country further from international markets. Writer John Rumsey.
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In early 2008, a rare ray of light was seen in Argentina’s capital markets. The government of Cristina Kirchner, elected in October 2007, started working to reach agreement with the Paris Club and those bondholders who declined to participate in a 2005 agreement, and then a large initial public offering (IPO) was placed. The closure of global debt markets led the Kirchner government to shelve negotiations and focus on spending to stimulate a slowing economy. No one is predicting any further primary equity activity.

Debt negotiations seemed genuine enough and involved three investment banks: Barclays Capital, Citigroup and Deutsche Bank. The reward was a hoped-for reprofiling of government debt, says Marcelo Blanco, co-head of Latin American capital markets and sales for Deutsche Bank in Buenos Aires. Argentina faces a clustering of maturities over the next three years as well as an inverted yield curve, which meant that lengthening out maturities would have helped the government to not only smooth its debt profile but also cut costs, he says. He believes that the deal is still a strategic aim of the government and will be undertaken once credit markets re-open.

The initiative may have been undertaken in good faith, but reaching a mutually agreeable deal was never going to be easy. Terms remained unclear, says Erich Arispe, associate director at Standard & Poor’s. Even the amount to be settled with the Paris Club remained contested, with the Argentine government claiming $6.9bn and the Paris Club citing $7.9bn, he adds.

Argentina also wanted to offer bondholders a deal that was in many ways worse than the 2005 deal that they initially rejected, says Mr Arispe. Terms included provisions that investors would have to re-invest a portion, perhaps as much as 25%, in new government securities with longer maturities, he adds.

Argentina restructured about $104bn in outstanding debt in 2005 with 76% of creditors accepting an offer of just less than 30 cents on the dollar. Those who declined the deal, holding some $20bn, have to-date received nothing.

As hopes for the deal faded and the global economy turned down, prices for benchmark dollar-denominated bonds such as the ’12s have collapsed with a depreciation of more than 30%, says Mr Blanco.

Prospects for bond markets

A worsening global and national economic outlook and the failure to conclude an agreement meant the government faced the unfavourable prospect of relatively high debt maturities at a time of sharply falling tax revenues.

In the short term, this may not have mattered. With a relatively meagre $700m in debt to roll over for 2009, there was little danger that the government will run out of resources to honour repayments. The hit to Argentine sovereign bond prices has not deterred all investors. Jerome Booth, head of research at Ashmore Investment Management in London, focuses on the relative health of the under-leveraged Argentine banking system (credit to gross domestic product [GDP] is tiny at 15%), years of strong economic growth and long-term isolation from international capital to which the country has adjusted. He also believes that the slowdown in emerging markets will be rapid and V-shaped. Investors will have a much clearer picture later this year, he says, adding that default risk is not high.

Ashmore has some large positions in Argentina, particularly in real assets, but also in selected, illiquid corporate bonds in high-yield and special-situation mandate funds. These are trading at less than 20 cents to the dollar, at highly appealing spreads of more than 1300 over US Treasuries. The fund also invests in energy companies in the country. Ashmore invests $32bn in emerging markets.

The government is taking no risks. In October, it took the drastic measure of announcing it would bring private sector pensions into the public sector. Ostensibly a bid to save pensioners from the volatility of capital markets, the move handily brings $29bn-worth of assets under government control.

“From a fiscal point-of-view, the government is getting 1% of GDP and has reduced to zero its roll-over risk,” says Gabriel Torres, analyst at Moody’s. In the short term, the move is positive. But longer-term negatives outweigh these advantages and include damage to Argentina’s reputation for institutional stability, admittedly long evanescent and the reassuming of expensive long-term pension liabilities, he says. The combined impact of these decisions amid a general drift to more state intervention in the economy, including the proposed takeover of airline Aerolineas Argentinas, has hit investor confidence, which is shaky at the best of times.

Secondary market

Benchmark equity investor Nicholas Morse, Latin America fund manager at Schroder Asset Management in London, sold his final Argentine holdings in November. He was already only half-weighted.

Argentina is now less important than Pakistan in the MSCI Emerging Markets index, according to Mr Morse. He says that the reclassification of one of two investable firms in the country (joint-listed firm Tenaris is now tracked on the Italian exchange) means there is only one investable Argentine company, and liquidity there is not great. Mr Morse adds that last year was a very different environment and it seemed that Argentina could be a more interesting location for investment banks and investors.

Mr Morse does not share Mr Booth’s optimism about the economy – comparing it to “a slow-motion car crash” – and predicts a recession. The peso is expensive too, especially when compared to Brazil and Chile, where devaluations against the US dollar have been far greater. Mr Morse also worries about the debt burden and adds that government revenue is extremely reliant on suffering agricultural commodities.

With spreads at about 1900 in early December, credit markets consider that in terms of risk, Argentina is more dangerous than the Dominican Republic and not far off Pakistan. “They are saying we don’t want to lend money to Argentina; it is not credit worthy,” says Mr Morse.

Capital Markets

Argentina’s capital markets were crippled by the 2001 devaluation but in 2007 started to show some signs of life. The successful IPO of media group Clarin in October last year raised $463m and prompted some to talk about a wider market revival.

That hope has been buried. “Forget about primary equity markets, they will be non- existent this year,” says Mr Blanco. He believes that the government did not take into consideration the effect on capital markets when it nationalised pension funds.

Debt markets face a similar fate. The strong economy and low leverage made it appealing for Argentine companies, particularly banks, to place debt internationally in a yield-hungry environment. They were increasingly using securitisation and international capital raising, says Andrea Manavella, bank analyst at Moody’s in Buenos Aires.

By 2007, the top five banks using securitisation were lending on average $63m a month against about $17m a month in 2000. Foreigners were particularly eager buyers of such instruments and Banco Hipotecario was able to issued peso-linked notes in international markets in 2007. The bank placed debt at tenors of more than five years at rates of less than 10%, says Ms Manavella.

Even with the closure of international markets, banks and corporates could console themselves as they had competing local pension funds to buy assets. The amalgamation of these private funds into the national pension fund system presents a number of dangers. Mr Torres says that in a country with extremely weak governance, this new nationalised investor will encourage politically directed lending, cronyism and make company executives that need financing think twice before criticising government policies.

Most market watchers are focusing on the peso-dollar rate as a source of weakness. The government’s measures have led to another round of deposit flight out of banks, and, says Mr Arispe, the dollar is the thermometer of confidence. Banks have been forced to hike rates with the benchmark Badlar rate, increasing from 13% at the beginning of September to 18.3% in early December.

Mr Blanco fears that the future for investment banking in Argentina seems bleak and if the country continues to isolate itself from international markets, there will be less and less interest from investment banks.

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