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Summary of the LATIN AMERICA STRATEGY Report: Argentina

Core Content

This report provides an in-depth analysis of Argentina's financial situation and proposes a strategic investment approach based on credit default swap (CDS) positions. The focus is on the country's public and provincial debt dynamics, FX outflows, and the impact of the 2019 presidential elections on its financial stability.

Main Concerns

• Public Debt Dynamics: Argentina's public debt is on a concerning path, with a significant portion denominated in USD. The depreciation of the Argentine Peso (ARS) is expected to worsen the debt-to-GDP ratio.
• FX Outflows: The document emphasizes the need for a reversal in FX outflows before reassessing the financial outlook.
• Economic and Fiscal Challenges: The financial situation is complicated by the high cost of debt rollover, rising real interest rates, and the impact of negative real GDP growth.
• Provincial Debt: Provincial debt is also a concern, with a high proportion of foreign currency-denominated debt and a projected increase in debt-to-GDP ratio by 2022.
• Political Risk: The 2019 presidential elections are expected to reduce investor appetite for Argentine assets.

Key Financial Indicators

• Debt-to-GDP Ratio: Already at 70%, with a projected increase due to high debt servicing costs.
• Hard Currency Debt: Represents 69.9% of central government debt as of Q1 2018.
• Interest Payments: Expected to reach USD 21.2bn in total until Q4 2019, with 59.5% being hard currency debt.
• Debt Maturities: High concentration of debt maturities in H2 2018 and 2019, particularly with the private sector.

Strategy Proposal

• Buy Argentina 5y CDS at 428bp: Allocate USD 20mn (~USD 8k DV01).
• Sell Protection in a Basket of Brazil, Mexico, and Colombia 5y CDS:
  • Brazil: 211bp (~USD 8.3k DV01)
  • Mexico: 113bp (~USD 8.8k DV01)
  • Colombia: 102bp (~USD 8.9k DV01)
• Carry: ~0bp/month.
• Target: USD 500k.
• Stop-loss: USD 400k.

Rationale for the Strategy

• The strategy is carry-neutral and aims to prepare for potential adjustments in the cost of protection for Argentina.
• It was previously effective during Q3 2017-Q1 2018 and is expected to be relevant again due to the current financial challenges.
• The roll-down of the CDS curve is in favor of the strategy due to the relatively flat curve for Argentina and the steeper curve for Brazil.

Debt Maturities Analysis

2018 Maturities

• Capital of Local Currency Debt: Highest in September and October 2018.
• Capital of Hard Currency Debt: Concentrated in August and September 2018.
• Interest Payments: Highest in September 2018.

2019 Maturities

• Capital of Local Currency Debt: Peaks in March 2019.
• Capital of Hard Currency Debt: Highest in March and April 2019.
• Interest Payments: Highest in March 2019.

Additional Insights

• Lebacs and Letes Maturities:
  • Lebacs total USD 35.4bn, with USD 19.4bn maturing in August and September 2018.
  • Letes total USD 18.2bn, with USD 6.0bn maturing in the next 60 days.
• Rollover Rate: Average rollover rate since May 2018 is 61.2%.
• Implied Default Probability:
  • 2y: 15%
  • 5y: 24%

Provincial Debt Overview

• Debt to Revenue Ratio: Ranges from 1% to 70%, indicating significant variation.
• Provincial Debt Growth: Expected to rise to 7.3% by 2022.
• FX Sensitivity: High proportion of foreign currency debt (60%) means any FX adjustment could increase the debt burden significantly.
• Fiscal Consolidation Risk: Lower transfers from the central government and economic decline could exacerbate provincial financial stress.

Legal and Compliance Notice

• This document is a marketing communication and not independent research.
• It is not intended for use by persons who are not "Relevant Persons" as defined under MiFID II.
• The content may contain "Research" as defined under MiFID II unbundling rules, which is only available to those who have signed up to BNPP Global Markets Research packages.
• BNPP disclaims any liability for the accuracy or completeness of the information provided.

Conclusion

The report highlights the financial fragility of Argentina, driven by high public and provincial debt, FX outflows, and political uncertainties. The proposed strategy involves a carry-neutral position in CDS to hedge against potential default risks, leveraging the relative stability of Brazil, Mexico, and Colombia. The document serves as a risk assessment and investment recommendation for professional clients and relevant market participants.