All Lose on Argentina Default, Except Hedge Funds

By Antonio Perez
Antonio Perez
Antonio Perez
August 4, 2014 Updated: August 4, 2014

After years of courtroom battles, someone finally threw in the towel. Argentina defaulted on its debt for the second time since 2001 last Friday.

Argentina was unwilling to give into the demands of a few holdout investors who own its un-restructured debt. But that means the country was also unable to pay current bondholders.

The result of the standoff? Argentina finally gave up and swallowed the consequences—it chose default. Nobody gets paid, except a handful of hedge funds and banks that bet on this exact outcome.

Holding Out

Argentina’s current debt crisis had its roots in 2001, when it was in the middle of an economic crisis. The South American nation defaulted on $80 billion of debt.

Most of its debtholders exchanged their bonds for restructured bonds on two separate occasions in 2005 and 2010. Investors who accepted the restructured notes took massive haircuts—with most receiving roughly 30 cents on the dollar.

But some investors didn’t bite. They held onto their old bonds; some even bought more at fire-sale prices.

Two such investors, Paul Singer’s Elliott Management and Aurelius Capital Management, snapped up the distressed bonds and prepared for a fight. They demanded full payment of principal and interest, totaling up to $1.3 billion.

Last-Minute Default

Last month, Argentina deposited $539 million with the Bank of New York Mellon, an intermediary, to make an interest payment due June 30 on its restructured notes.

The plot thickened after U.S. federal Judge Thomas Griesa halted those plans. Griesa ruled on June 27 that Argentina couldn’t pay holders of its restructured debt, unless it also paid the investors who own the original, un-restructured bonds. Its choices were to either pay everyone, or pay nobody and be in default. It was the latest outcome of several lawsuits filed in U.S. courts by the holdout investors to obtain full payment (the bonds were originally issued under New York laws).

A 30-day grace period and negotiations began, culminating with a face-to-face meeting between Argentine government officials and the hedge funds last week.

Adding to Argentina’s difficulties was a Rights Upon Future Offers (RUFO) clause in its restructured debt agreement. The clause prohibited Argentina from offering anyone a better deal than the restructured creditors received, unless they get the same treatment. In other words, Argentina couldn’t offer a settlement to the holdouts that was more beneficial than what it gave owners of restructured debt back in 2005 and 2010.

The last minute talks failed after Argentine President Cristina Fernandez de Kirchner held firm, and Argentina was in default. It could not make the $539 million interest payment on its restructured debt.


The finger pointing began shortly after the default announcement.

Fernandez de Kirchner called the holdout investors “vultures,” and expressed that the country had lost confidence in the U.S. judge, and the ability of the court-appointed mediator. The Argentine government also argued that it cannot be in default if it is willing to pay its restructured debtholders.

Others blamed Argentina’s hard-line attitude, stating that it refused to meet face-to-face with the holdout investors until the day before the grace period deadline.

Disruptions to global capital markets should be minor. Argentina, due to its 2001 default, had been locked out of global capital markets, with its bonds making up a small proportion of global indices and overall trading activity. The biggest impact will be felt domestically, where its central bank may need to print more money, fueling inflation in a country already in a recession.

The bond markets seemed to be fairly confident that the default would be short lived and a settlement will be reached. Dollar-denominated Argentina bonds due 2033 were down 4.5 percent last Friday. Investors were also optimistic of a bailout of Argentina by a consortium of private banks that could purchase the bonds at par and restructure the debt directly with the government.

Hedge Funds Win?

The default is a bitter pill to swallow for Argentina. But for some hedge funds and banks, there’s a silver lining.

Those holding credit default swaps (CDS) on Argentina debt will stand to collect money.

The International Swaps and Derivatives Association (ISDA) ruled last Friday that entities, which sold CDS (essentially insurance contracts) on Argentine debt must pay the swap holders, deeming last week’s default as a “credit event.”

According to MarketWatch quoting settlement firm DTCC, the payouts could total up to $1.04 billion.

It’s unclear who bought Argentina CDSs, but it’s a good bet that hedge funds that held out on Argentina bonds would have hedged their bets with such swaps. If that’s the case, they would profit on distressed bonds, or get paid on swaps upon default.

For them, it could be a win-win situation.

Antonio Perez
Antonio Perez