Sovereign Debt Restructuring, Banking System Liquidity and Financial Entities Restructuring

Decree 1387/2001 set the grounds for the sovereign debt exchange. This Decree regulates different matters, including an option granted to certain stock corporations (basically those with low qualifications under the BCRA regulations), to cancel their banking debts delivering public bonds at technical value. The banks, which could not reject this cancellation, will be able to exchange those public bonds received by the guarantee loans or new guaranteed public bonds to be issued by the Government in its debt restructuring and exchange. So far, it seems to be not so good for the banks, but the BCRA has issued Communication 41838 by which it will enter into repos or other financings for local banks, accepting those guaranteed loans or new public bonds as collateral for those transactions.

However, nothing is for free. In consideration for such financings, the shareholders of the financed banks shall grant a pledge over the bank’s controlling stock and, additionally, consent any future eventual bank restructuring under Article 35 bis (the “Article 35 bis”) of the Argentine Financial Entities Law (AFEL).

In order to avoid the system crisis caused by falling banks, several amendments to the AFEL and the organization act for the BCRA were passed during the 90’s. Additionally, other institutions (such as Sedesa –the local Federal Deposit Insurance Corporation- and the Fiduciary Fund for Banking Capitalization –FFBC-) were created.

When a local bank starts suffering either insolvency and/or liquidity problems, the BCRA generally forces the bank to undergo a plan for regularization. Under these plans the BCRA may grant certain temporary waivers to its regulations, provide liquidity to a troubled bank by entering into repos or other financing tools, and appoint a controller to the bank.

In the event a troubled bank still cannot make it through a regularization plan, then, before revoking the bank’s license, the BCRA may freeze the bank’s business by ordering its suspension (which stops the accrual of interests due by the bank), and force the bank to be restructured under Article 35 bis. This Article allows BCRA to order, among others: (i) the capital increase, capital reduction and/or stock sale or transfer, (ii) the “exclusion” and transfer of the assets and certain senior or preferred liabilities of the falling bank, and/or (iii) the appointment of a receiver.

The exclusion and transfer of assets and liabilities provided under Section 35 bis has become the most used tool by the BCRA. Thus, deposits, BCRA’s repos and financings, labor liabilities and secured credits of falling banks are transferred to one or more healthy financial entities. Assets of the falling bank (for a total value “equal” to the transferred liabilities), specially selected, prior accounting adjustments and reevaluations, are also transferred either to those financial entities undertaking the liabilities or to a trust for liquidation purposes. These Article 35 bis transactions are generally complemented by contributions made by Sedesa, the granting of soft lending by FFCB and special exceptions by the BCRA to technical requirements.

Once the Article 35 bis transactions are executed, the judicial liquidation of the residual bank shall be undertaken. The unsecured creditors of a falling bank have to face a winding up process with few and worthless assets, with little chances to recover any of their credits against the insolvent bank. Furthermore, bankruptcy proceedings against a bank cannot be initiated before the revocation of its license and only 60 days after the revocation of its license following Article 35 bis transactions.

In conclusion, the recent regulations will provide to the banking system the necessary liquidity to undergo the proposed public debt exchange, but if in the attempt some banks cannot make it, the BCRA shall have all the necessary tools to promptly act reducing the adverse effects caused by falling banks. Nevertheless, if the crisis affects the whole banking system, even those tools may not be enough.