Bloomberg News

BofA Rejects Euro Haven Before Default Ruling: Argentina Credit

January 21, 2013

Speculation that Argentine euro bonds will be shielded from claims on the nation’s defaulted debt is pushing relative yields to a two-year low, prompting Bank of America Corp. to say it’s time to sell.

Yields on euro bonds due in 2033, issued under the country’s 2010 debt restructuring, have dropped 3.8 percentage points to 14.2 percent since climbing to a record on Nov. 28. That’s cut the so-called spread over similar-maturity dollar debt to 0.32 percentage point. The gap fell to a 29-month low on Jan. 10 and compares with the average difference of 1.38 percentage points since the debt was sold.

Euro bondholders asked a U.S. court last month to exclude their investments from a legal dispute between Argentina and so- called holdout creditors from its $95 billion default that want to be repaid in full. While the appeals court still has to decide whether to require institutions outside the U.S. to withhold payments from holders of Argentina’s euro debt, investors should sell before the court reconvenes on Feb. 27, according to Bank of America’s Jane Brauer.

“The euro assets ran up too far on the hopes that there would be a distinction,” Brauer, a strategist at Bank of America in New York, said in a telephone interview. “Just because there’s been a brief and someone asked for it, doesn’t mean the court will agree. Take profits on the euros.”

Euro Returns

The 1.9 billion euros ($2.6 billion) in outstanding notes, which were sold under English law, have returned 31 percent from their low on Nov. 28, the day the appeals court blocked District Judge Thomas Griesa’s decision to pay the holdouts by Dec. 15.

That exceeds an average return of 20 percent on Argentina’s restructured dollar debt and the 1 percent gain for emerging- market bonds, according to JPMorgan Chase & Co.

The appeals court isn’t likely to distinguish between bondholders or the way they get paid, which will cause euro bond prices to fall, Brauer said.

If the court decides that financial firms responsible for transferring Argentina’s interest payments to bondholders aren’t legally required to withhold that money, dollar bonds will rally, she said.

Holders of the euro-denominated debt, including Knighthead Capital Management LLC, Redwood Capital Management LLC and Perry Capital LLC, joined Argentina in challenging Griesa’s orders. In a brief filed Jan. 4, the group said the injunctions are “vastly overbroad” because the interest payments they receive from Argentina aren’t routed through the U.S. and the court doesn’t have jurisdiction over foreign financial firms.

Euroclear Plea

Argentina deposits the creditors’ bond payments in a local account of Bank of New York Mellon Corp. (BK:US), which transfers the money to its account in Germany. The funds are then distributed to investors through clearing houses, including Brussels-based Euroclear SA/NV. Euroclear submitted an amicus brief asking for the reversal of Griesa’s orders, which they claim would be in violation of Belgian law.

“I’d rather own euro paper because it should have no legal issue with U.S. Courts,” Diego Ferro, who helps manage more than $500 million in emerging-market debt at Greylock Capital Management LLC, wrote in an e-mailed response to questions. “The U.S. ones do, and a fairly serious one, and until these problems are resolved” he will hold onto the bonds, he said. Ferro also said he will sell the euro debt when yields fall below those of the dollar notes.

Cross-Atlantic

The appeals court would also have to distinguish between BNY Mellon’s New York and European-based entities for euro bondholders to get paid, according to Henry Weisburg, a partner at New York-based law firm Shearman & Sterling LLP.

Even if Argentina is able to pay creditors in Europe, a blocked payment to dollar-bondholders could result in the acceleration of payments for the euro notes because they have a so-called cross-default clause with their dollar counterparts, according to the bond prospectus.

“A whole bunch of things have to happen for you to get to a scenario where you are better off in the euro bonds,” Joe Kogan, the head of emerging-market debt strategy at Scotia Capital Markets in New York, said in a telephone interview.

The implied probability of default in the next five years based on trading in credit-default swaps is 74 percent, according to data compiled by Bloomberg. The cost to protect against an Argentine default using the swaps fell 15 basis points to 1,892 basis points at 6:52 a.m. in New York.

Default Protection

The extra yield investors demand to hold Argentine government dollar bonds instead of Treasuries widened eight basis points, or 0.08 percentage point, to 1,070 basis points, according to JPMorgan. The peso was little changed at 4.9503 per dollar.

Siobhan Morden, head of Latin America fixed-income strategy at Jefferies Group Inc. in New York, says it’s more practical to sell the euro bonds now than to risk navigating the potential legal pitfalls.

“The best thing to do at this stage is if you made money trading around these legal risks, to probably take profits and head to the sidelines,” Morden said in a telephone interview from New York. “You need real expertise on the legal side to take commitment or show commitment to trade the view now.”

To contact the reporters on this story: Katia Porzecanski in New York at kporzecansk1@bloomberg.net; Danielle Verbrigghe in New York at dverbrigghe@bloomberg.net

To contact the editors responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net; Michael Tsang at mtsang1@bloomberg.net


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