Bond chaos in Argentina sparks traders’ rush to provincial notes

Just two years after Argentina’s latest default, traders are all but sure the country is heading toward another debt disaster. But amid all the doom-and-gloom, a surprising trade has popped up that’s produced rich rewards.

Investors are snapping up securities issued by the provinces of Córdoba, Neuquén, Mendoza and Chubut, turning them into the nation’s top performers this month. The rally has extended this year’s returns on some of the notes to as high as 13 percent, a somewhat remarkable feat given that dollar bonds globally suffered their worst quarter in almost six years. Sovereign debt has dropped 2.4 percent this month and 4.8 percent this year.

After the gains for the provinces, the securities now yield less than the sovereign, implying they’re less risky. That’s the opposite of most countries, where federal government bonds are usually seen as the safest option. But junk-rated Argentina has dodgy finances and a track record of three defaults since the turn of the century, and investors are signaling they expect a fourth.

Another factor driving interest in the provinces is that their bonds amortise – that is, begin paying back principal before the final maturity. The theory is that if bondholders can hold on for just a few payments, they’ll be able to make their money back much faster than they could have with sovereign notes.

“Investors will get value from the cash flows,” said Juan Manuel Pazos, an analyst at TPCG Valores in Buenos Aires. “History shows that provincial defaults only happen after the sovereign defaults, not before. So it made no sense for provinces to have a higher, steeper probability of default than the sovereign.”

To be sure, buying the junk-rated provincial bonds isn’t for the faint of heart given the high probability the federal government will default over the next few years. Sovereign defaults in the past have been followed by missed payments by many of the provinces months later.

“The risk is still skewed to the downside,” said Ezequiel Zambaglione, an analyst at Balanz Capital Valores in Buenos Aires. “Revenue is almost 100 percent correlated with the sovereign, and spending or potential restructuring decisions are highly affected by politics.”

Investors seem all but certain that Argentina will default after 2024, when its debt payments are set to increase significantly. Despite a programme with the International Monetary Fund to reduce a yawning fiscal deficit and reduce money printing from the Central Bank, they see inflation and a weakening currency eroding the country’s ability to pay and impeding its return to international markets.

But even if a default will be hard to avoid, the provinces have a track record of offering better restructuring terms than the sovereign. While the federal government’s US$65-billion debt workout two years ago left investors with about 55 cents on the dollar, some provinces offered deals worth as much as 80 cents.

Outperformance

Mendoza’s 2029 bonds, which begin amortizing in March, have climbed 3.6 cents this month to 70.2 cents on the dollar, while oil-backed notes from the southern province of Chubut that begin paying principal this month have jumped 4.4 cents to 81.5 cents on the dollar.

Bonds from Córdoba Province due in 2027 have also climbed more than 4 cents in April to 70 cents on the dollar. The province, which restructured its notes last year without missing payments, also boasts the nation’s top performing government notes, according to Bloomberg’s Emerging Markets Index, returning 13 percent year to date.

The outperformance is a result of provinces like Cordoba and Mendoza being more fiscally sound than the national government, according to Nathalie Marshik, a managing director for fixed income at Stifel Nicolaus & Co.

“It’s a combination of the sovereign being a mess and the provinces having better balance sheets,” Marshik said. “It’s creating some demand.”