The Pari Passu Bet
Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Yesterday, February 27th, we added a new chapter in the "Pari Passu" saga between the Argentinean government and the holdouts from the 2005 and 2010 defaulted debt exchanges. The New York Court of Appeals heard the arguments given by Argentina and the holdouts. We should have a final resolution in a few days.
Some Recent History on the Saga.
On November 29, 2012, a last-minute stay order from the New York Court Of Appeals stopped what was surely going to be a technical sovereign default. The judge, Thomas Griesa, had ordered Argentina to fully pay the $1.3 billion that were originally owed to Elliot Management, the hedge fund owned by billionaire investor Paul Singer. The main problem was not the actual order to pay holdouts, but the fact that Mr. Griesa tied up this $1.3 billion immediate cash payment to all the payments that Argentina owed with its currently performing bonds, without exception. That meant that Argentina had to pay everyone, or no one.
The reason to think Argentina would default is simple. Given the 2005 and 2010 exchange bonds prospectus, if Argentina were to pay in full to Mr. Singer before 2014, the country would have to review the offer it did to exchange bondholders. This would ruin the whole debt restructuring Argentina made after its 2001 default.
My risky saga bet
I hold Argentinean bonds and no equities (yet.) But, in the short term, Argentinean bank equities will follow the same fate as sovereign bonds. Banks like Grupo Financiero Galicia (NASDAQ: GGAL), Banco Macro (NYSE: BMA) or Banco Frances (NYSE: BFR) can be thought as leveraged proxies of Argentinean debt securities. The reason is simple: they are major holders of Argentinean New York law debt. Henceforth, they represent an instrument to bet on the result that will exist very soon.
After yesterday's hearing, one of the following possibilities will emerge: (1) The New York Court of Appeals will reaffirm Judge Griesa's ruling or (2) The New York Court of Appeals will change Griesas's ruling benefiting the position held by Argentina and its exchange bondholders (such as our three banks: Frances, Galicia and Macro).
If the result is the first option, then the stock prices of all Argentinean banks will plunge. On the contrary, if the second were to be the case, then Argentinean banks shall soar in price.
Current Argentinean bank valuations and the price recovery that took place after the Court of Appeals ordered a stay on Griesa's ruling on November 29th, seeing all three banks' shares go up by more than 30%, make me think that a 20% upside is in the cards for Galicia, Macro and Banco Frances if the Court of Appeals rules in favor of exchange bondholders. The reason to explain a 20% upside from current levels is simple:
- Argentinean banks are the cheapest banks in the world
- All banks in the country trade at a discount to forward book value while exhibiting wonderful profitability levels
Just to quote some financials, a bank like Galicia trades at 2013 2.5x PE, with a 32% Return On Equity (ROE) and an expected 2.5% Return On Assets (ROA). Banco Macro and Banco Frances are also cheap. They trade at 2013 2.7x and 3x PE multiples, with a ROE which is 27% for Marco, and 26% for Banco Frances.
Placing my bet: options are the way to go
My opinion is that the New York Court of Appeals will ask Argentina to pay holdouts but will refrain from tying the holdout payments to the exchange bondholders payment. As a result, I expect Argentinian bonds and banking stocks to soar in price when the resolution is ready. I think there is one bet to be made and, although risky, it provides a very high expected return.
Let's take the case of Galicia (falling over 8% on February 28) since its the one bank that has a relatively liquid options market in New York. We can use the volatility that is expected to exist to make some money in the short term. Here, the bet that I am thinking of is buying April call options in Galicia with a strike at $5, at no more than $0.40. Since Galicia is currently selling for $5.25, the call option will be "in the money." The premium we are paying here is just 3% and the expected return, if there is a 50/50 probability of the court ruling "our way" (and we expect Galicia shares to soar or dip by 20%,) is 10%.
In the following days, valuations shall not matter. That said, and as I mentioned before, Argentinean banks are cheap, but a new default will surely cripple them for years to come. A new Argentinean default will push the country further into its ten year long ostracism. This is a very relevant fight for the fixed income world and, above all, to all of us who are involved in emerging markets. The good news for everyone is that we can actually make money through all this mess. I hope I am right. We shall soon see!
martinzaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
