Argentina has leaned heavily on domestic banks this year. They are its last hope of support when international investors cut off lending for fear the country will default on nearly $130 billion of debt. Argentina issued $1.1 billion of three-year notes from its outstanding $15 billion Euro medium-term note program in May. The notes are in four series allowing investors to trade the bonds’ interest and principal value for a tax credit, if Argentina defaults on its debt. “This is a special deal that was offered to several participants here [Argentina] and was subscribed to by 50% Argentine banks and 50% Argentine companies,” says economy vice-minister Daniel Marx.
Investors could choose between two sets of notes with tax credit options (TCOs) and two standard bonds with a higher element of risk. Holders of the TCO series have several payment options and recourse upon default. They can receive a tax credit for the coupon amount to offset Argentine taxes, sell the coupon to another party, or swap into the series of notes that can be accelerated or cashed in early. If Argentina defaults, the holders of the standard bonds cannot swap into the tax credit bonds.
Argentine institutions rallied to help the government raise cash for the year-end financing in April. The government raised $2 billion locally and then went to the bond market for the final $1 billion. “This bond was initiated because there is no open market available [either inside or outside of] Argentina,” a banker close to the deal explained. This is not the first time the government has asked for the private sector’s help. In 1995 after Mexico’s peso crisis bled into Argentina, the government issued a similar TCO bond. However, bondholders did not exercise the credit because no default occurred.
Conrado Tenaglia, partner at Linklaters & Alliance, legal advisor to the lead banks on the deal, believes local investors were willing to forgo the default risk because of their extensive operations in Argentina and because they are more comfortable than foreign investors with the country’s history of economic crises. “The tax credit option was appealing to Argentines because if they have business in Argentina and if Argentina defaults, the investor will benefit from tax credits throughout the life of the bond,” says Tenaglia. Citibank (Buenos Aires), HSBC Bank Argentina, Banco Frances, Banco Rio de la Plata and Banco de Galicia y Buenos Aires participated as subscriptions agents. Bruchou Fernandez Madero Lombardi & Mitrani advised the agents on Argentine law and Cleary Gottlieb Steen & Hamilton advised the Republic of Argentina on US law.
Tenaglia points out that the bond was issued at a time when Argentine investors felt they were nearing the end of the crisis, not leaning further towards default. Argentina has flirted with default throughout the year but secured another $8 billion bailout loan from the International Monetary Fund (IMF) in August (see Promulgations).
The beauty of the structure is that it gives the bondholders more flexibility and encourages the government to honor the TCO. Marina Bericua, associate of Bruchou Fernandez Madero Lombardi & Mitrani explains that if investors are confident the tax credit will be honored, they will not swap the bond out for one that can be cashed in sooner and expose the government to the short-term debt they want to avoid. Also, if the government decided to scrap tax credits for businesses, bondholders would swap into the standard note series and cash in their bonds.
“The bondholders are protected [by the ability to swap bonds] if any federal, state, judicial or regulatory body amends or alters the law that would render the TCO null and void. This provides a solution that acts as a deterrent to Argentina’s determination to annul or make ineffectual the TCO,” says Bericua.