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Credit FAQ: Challenges And Opportunities Await Argentine Provinces After Their Debt Restructuring

The conclusion of Argentina's US$100 billion sovereign international and local law debt restructuring has created space for subnational governments to move ahead with their own restructuring deals. 12 of the 24 Argentine provinces plan to restructure about $13 billion in international law bonds. All of the 10 local government entities rated by S&P Global Ratings, except the city of Buenos Aires, have indicated they intend to seek debt relief amid the severe recession due to the COVID-19 pandemic that has heightened fiscal pressures, and following the sovereign's debt restructuring.

The following report answers frequently asked questions about the Argentine provinces' debt exchange offers, where they currently stand financially, and the key structural challenges and opportunities post-pandemic.

Frequently Asked Questions

What is the status of the provincial debt restructuring?

The COVID-19 pandemic exacerbated Argentina's already weak economy. The pandemic compounded the effects of a two-year recession, persistently high inflation, and lack of market access for LRGs. Although liquidity pressures at the provincial level were present before the pandemic, the deepening recession and uncertainties about future market access have set the stage for most provinces to seek debt restructurings.

Over the course of 2020, provinces have been negotiating new terms with bondholders. Negotiations are still open and subject to modifications. However, the provinces' approach is mainly to extend maturities, smooth debt amortization profiles, and materially lower the cost of debt. This strategy has been backed by national government: the "Unidad de Apoyo de Sostenibilidad de la Deuda Pública Provincial" unit created within the Ministry of Finance is providing general guidance and support to provinces on their restructuring processes. The stage of the negotiations is different for each province--some have already presented their offers to bondholders, or have even partially finalized debt exchanges, while others are still outlining their offers with financial and legal advisors (see table 1 below).

Facing a severe liquidity crunch, many Argentine local and regional governments (LRGs) missed debt service payments this year. Currently, we rate six provinces at 'SD' (selective default; see Table 1). The largest of these is the province of Buenos Aires, which has $7.1 billion in debt that accounts for more than half of the LRGs' total debt restructuring. Given that the provinces that missed debt service payments and defaulted are currently negotiating with bondholders, we don't expect bondholders to trigger debt acceleration clauses in the near term. In contrast, some provinces such as Cordoba and Jujuy have decided to negotiate new terms with bondholders while remaining current on their debt service thus far, with the aim of protecting their reputation in the market.

Table 1

Argentine Provinces' Debt Restructuring
Province S&P Global Rating Amount to be restructured (Mil. $) Offer presented?
Province of Buenos Aires SD/--/SD 7,100 Yes
Cordoba CC/Negative/CC 1,929 Yes

Neuquén

CC/Negative/CC 704 Yes

Mendoza*

SD/--/SD 590 Yes

Entre Ríos

SD/--/SD 500 No

Salta**

SD/--/SD 380 No

Río Negro

SD/--/SD 300 No

La Rioja

SD/--/SD 300 No
Jujuy CCC-/Negative/CCC- 210 No
Chaco N/A 250 No
Chubut N/A 650 No
Tierra del Fuego N/A 200 No
*Mendoza has completed its foreign law debt exchange, although local law debt restructuring is still open. **Salta made a late payment on its $350 million bond.

Debt restructuring processes are usually complex, because each market participant or bondholder has their own assessment of the issuer's capacity to pay. We expect that restructuring negotiations that encompass more bond series and/or different indentures will take longer to conclude as provinces work to reach potentially varying collective action clause (CAC) thresholds to mitigate holdout risks. Some provinces might also look to restructure not just foreign law debt, but also local law debt or debt backed by royalties, although the latter might prove to be more difficult given the more complex structure.

What are the key factors that have driven restructurings?

Budgetary inflexibilities, limited liquidity buffers, and a weak debt payment culture have led to restructurings--not high deficits and debt levels.

Argentine provinces entered the pandemic in an already vulnerable position, although their fiscal position differs greatly from the sovereign. On a consolidated basis, LRGs' fiscal deficit decreased from 1% of GDP in 2015 to an almost balanced position in 2019, with improvements explained by increases in transfers from the national government and decreases in real salaries amid high inflation (payroll represents almost 50% of total spending). Nonetheless, local governments are highly sensitive to Argentina's economic woes and to sovereign interference. The deepening recession had already started to erode part of those gains in the second half of 2019 and was exacerbated by the pandemic and the strict lockdown measures put into place since March 2020.

Despite the worsening trend in finances, overall provincial fiscal stress was less severe than at the national level. Their debt burden is much lower, partly reflecting more limited access and less diverse sources of financing than the sovereign historically. LRGs' consolidated fiscal deficit was barely 0.6% of GDP in 2019, or 4% of their revenues (compared to a central government [CG] deficit of 4.5% of GDP in Argentina). Their interest burden was 2.9% of operating revenues in 2019 (versus 20.5% at the national level) and debt burden was 7.4% of GDP, below 82% of the CG (see Chart 1).

However, low deficits and debt masked underlying weakness from limited cash buffers. LRGs' liquidity levels were not robust enough to withstand the economic shock from the pandemic and timeframe that it took to restructure the sovereign debt, which was in default for almost a year.

Provinces saw local revenues collapse, while support from the national government amid the pandemic was limited for most entities and not sufficient to compensate for the steep drop in revenue. With mostly inflexible budget structures, many administrations decided to stop servicing debt obligations in order to deal with rising spending pressures and/or to initiate restructuring processes, signaling weak payment culture. Notably, the same administration had issued the debt in most cases.

Chart 1

image

What does S&P Global Ratings expect will be the key takeaways from the debt restructurings?

Given that provinces' deficits and debt levels are generally smaller than those of the sovereign, we expect debt relief to be lower. Based on published offers and using our estimate of a 12% exit yield, we think most provinces are likely to close deals with net present value (NPV) losses of 25%-35%--below the 45% NPV loss reached in the sovereign deal. Significantly lower NPV losses at the provincial level compared to the sovereign aren't an unusual event. The same occurred in the 2005 restructuring.

We expect the various debt restructurings to provide important cash relief over the next four years given the more favorable interest and amortization profile. Based on published offers, debt service payments for four key provinces would decrease from about $7.7 billion in 2021-2024, to barely $1.2 billion (see chart 2).

Chart 2

image

Nonetheless, provinces will still face difficult economic conditions as the nation faces a complex near-term growth and inflation outlook, along with longstanding structural issues. Fiscal sustainability and avoiding future defaults will partly hinge on factors external to the provinces, but also on the commitment and efforts from provincial administrations toward fiscal consolidation and building resilience to macroeconomic swings. This would involve spending containment measures and proactive debt and liquidity management. The city of Buenos Aires' fiscal strengths, combined with its administration's efforts to lower foreign currency exposure and maintain a good reputation in the local market, were key factors in avoiding default.

Because most provinces have not proposed haircuts on the face value of debt, we don't expect the overall debt level to decrease. Considering that some provinces are proposing to add past-due interest to the new securities, debt stocks could even increase. This is separate from the higher debt due to valuation effects associated with the depreciating Argentine peso (ARS), because an average of 77% of debt is foreign-currency denominated.

Although debt stocks will increase, current debt levels in relation to provincial revenue aren't the provinces' main rating weakness. In the next couple of years, as access to international markets remains restricted and pressure from external debt service payments drops, we expect provinces to mostly rely on local market funding to cover financing needs.

Why does S&P Global Ratings consider these exchange offers as defaults and what will the ratings be after the restructurings?

We view these restructurings to be distressed, rather than opportunistic. The compounded effects of COVID-19 and the Argentine recession before the pandemic drained LRGs' liquidity. This, along with uncertain market access in coming years, has rendered the debt amortization profile unpayable without the current debt restructuring. Furthermore, we consider these transactions equivalent to default because of the proposed terms and conditions that entail NPV losses to bondholders versus the original promises. Both these aspects are materially different from some past Argentine corporate debt restructurings that we didn't consider as tantamount to default.

We've lowered our issuer credit ratings on the provinces to the 'CC' from 'CCC' range as defaults became a virtual certainty, either through a potential missed payment or debt exchange. In cases where the entity continues to service its debt, we will lower the ratings to 'SD' when the province agrees to the terms of the restructuring with bondholders. Once the transaction is completed and the province issues new bonds, we will remove the ratings from 'SD', absent risk of a default in the short-term from debt not included in the exchange. According to our methodologies, we typically assign post-default ratings in the 'CCC' or low 'B' categories. However, ratings on the provinces would be capped by the sovereign credit rating and transfer and convertibility assessment, currently at 'CCC+', reflecting the very challenging economic and financial conditions in Argentina and the risk of the sovereign further restricting access to foreign currency for debt service payments. In the medium to long term, key structural differences among provinces will play an important role to differentiate creditworthiness.

Will there be negative intervention from the federal government or will the government prioritize some provinces ahead of others?

Argentine provinces share some of the key structural deficiencies present at the national level (see "Argentina Faces Challenges And Opportunities After Its Restructuring", Sept. 18, 2020) and haven't been able to separate themselves from the sovereign's economic woes, which stem from low and volatile economic growth, low private investment, persistently high inflation, and lack of consistent government policies especially through changes in administration.

For example, lacking the political support from all LRGs to modify the transfer distribution mechanism, the national government has often resorted to discretionary transfers to compensate for imbalances across different jurisdictions, often favoring those politically aligned with the national government ahead of others. Different governments have signaled the need to discuss and revamp the Coparticipation Law--the main distribution mechanism across provinces--but with little progress. The current law was passed in 1988 as a temporary bill, but a new version requires full approval from all provinces in Argentina, therefore constituting a disproportionally high political challenge for any administration that attempts to pass a new version. Transfers are determined through fixed percentages and not a formula considering the local governments' population, socio-economic profile, and revenue generation capacity like in other countries.

Until 2017, the national and subnational governments had made efforts to increase the predictability and transparency of subnational revenue. The resolution of the Conurbano Fund and the Fiscal Pact were the most important milestones after years of accumulated distortions in intergovernmental revenue distribution. However, as the economy weakened, both national and provincial administrations backtracked on some measures. The national government unilaterally eliminated the Fondo Federal Solidario (a fund that it transferred to provinces and earmarked for capital expenditures) in 2018, while provinces agreed to put the gradual reduction of gross receipt taxes on hold.

The national government recently reverted 1% of co-participation revenue (and an additional 0.9% recently approved by the national senate and pending approval by the lower house) to the province of Buenos Aires from the city of Buenos Aires through a decree. In our view, this signals ongoing sovereign interference and lower predictability in the federal system as the recession persists and the government has limited capacity to support LRGs. The lack of follow-through in policies leads to hard-to-predict outcomes, discouraging longer-term planning and private investment.

What are the key structural challenges for provinces?

Along with the central government's expenditures, provincial spending has expanded over last 15 years, especially during the commodities boom. Consolidated provincial spending as a share of GDP increased 4.4 percentage points between 2007 and 2017. While spending grew in various Latin American economies at that time, the trend in Argentina and its provinces continued even after commodity boom ended. Moreover, the composition of the additional spending contributed to increased fiscal rigidities and, because it was mostly for higher payroll rather than infrastructure spending, did not boost economic productivity. Although many provinces resorted to this strategy as a way to compensate for the lack of private employment, this policy hasn't promoted growth, and has become a burden that's increasingly difficult to finance. Argentine labor laws are very restrictive and public employment regulations are even more rigid. Consequently, lowering payroll within public accounts has been a key challenge, and when resources have been more limited, administrations have preferred to resort to short-term solutions such as delaying infrastructure projects or reducing real wages rather than structural reforms.

Chart 3

image

In several cases, local social security systems have also pressured budgets. Similar to the sovereign, provincial social security regimes have accumulated inconsistencies in recent years. Thirteen provinces haven't transferred their systems to the national pension system (ANSES), and many of them have regimes that have parameters even more beneficial to pensioners than those at the national level. Because by law local governments receive compensation from the sovereign to cover social security imbalances (at least partially), administrations have delayed deep discussion of their systems' sustainability. Pension expenditure has consistently increased, pressuring fiscal accounts. In some cases, annual pension deficit rose to about 9% of operating revenues in 2019 from 6% in 2015.

Consolidating fiscal accounts and reducing operating spending would allow provinces to create liquidity buffers to make them more resilient to recessions, in our view. Over the longer term, it would also allow provinces to increase infrastructure spending, which currently averages 8.8% of overall spending across provinces, with infrastructure spending as low as 2.4% in some cases. This would help boost economic development and expand the revenue base.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Carolina Caballero, Buenos Aires (54) 114-891-2118;
carolina.caballero@spglobal.com
Constanza M Perez Aquino, Buenos Aires (54) 114-891-2167;
constanza.perez.aquino@spglobal.com
Patricio E Vimberg, Buenos Aires (54) 114-891-2132;
patricio.vimberg@spglobal.com
Research Contributor:Tomas Marinozzi, Buenos Aires + 54-11-4891-2153;
tomas.marinozzi@spglobal.com

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