Sitting in a “White Palace” in Caracas, listening to state officials like Vice President Tareck El Aissami – a man accused of leading a huge drug-trafficking operation among other things – rant about US and EU conspiracies against their country while receiving gift baskets of cigars and chocolates from them, Venezuela’s bondholders must have thought they had gone down the proverbial rabbit hole in mid-November.
Alas, it was merely another day in the unfolding Venezuelan debt saga, which for years appeared to draw closer to the denouement, yet every time the ailing South American economy seemed stop short of the cliff edge.
The meeting was preceded by a somewhat surprising rally of Venezuela’s sovereigns, which was indicative of just how low the bar has dropped for what was once Latin America’s richest economy: a lack of an immediate declaration of a default was enough to buoy the market.
As many expected, the “bonding session” between Caracas and its creditors bared little fruit and provided no clarity to those investors who risked becoming subjects of US sanctions by showing up at the meeting, called by Maduro, where country’s representatives were expected to elaborate on his plan to “restructure or refinance” the bonds.
The apparent lack of distinction, or care to differentiate between those two very different process, has added fuel to the fire, with some observers speculating that perhaps Maduro was deliberately trying to create a lot of noise around Venezuelan bonds to push their prices down – so as to buy them back at a steep discount.
A similar scheme was executed by Rafael Correa’s administration in Ecuador in 2008, when the government strategically defaulted on two series of the country’s, only to buy them back at 35 cents to the dollar six months later.
Others, though, saw those statements as yet another sign of the administration’s incompetence. “I wouldn’t give them any credit for such sophisticated strategies,” Siobhan Morden, Managing Director and Head of Latin America Fixed Income Strategy at Nomura, told Bonds & Loans, adding that Correa had a PhD in economics. There are “no technocrats in this administration,” she added.
It was telling to see reports suggesting that government negotiators actually asked the bondholders to put their proposals for a restructuring on the table, turning the whole meeting into a farcical non-event.
Downgrade to Selective Default
Predictably, Venezuela’s sovereign and quasi-sovereign notes have seen even more volatility than usual after Maduro’s announcement, although the overall trend has been less negative than one may have expected.
Prices on government and PDVSA bonds actually rallied on Monday 13 November, following a significant slide at the end of the previous week, when Venezuela’s 2018s fell USD0.16 to USD0.63 on the dollar and PDVSA's 2027 notes hit in the region of USD0.20 on the dollar.
After Monday’s marginal recovery, prices across the board slipped further on Tuesday, with benchmark 2027 bonds slipping 2.1 cents to 26.6 cents on the dollar, down from 38 cents at the end of October.
S&P was the first CRA to officially push the country into default territory after Caracas failed to make a USD200mn interest payment once the 30-day grace period had passed – a failure that Maduro’s administration is placing squarely on international regulators, claiming that the transaction was blocked by Western banks. Shortly after Fitch downgraded it to restricted default, while Moody’s sent a statement on Tuesday referencing a default, after previously saying PDVSA was in breach.
Normally, at this stage, holders of the prospective defaulter’s Credit Default Swaps would be waiting for ISDA to signal the pay-out – and they were, with around USD1.6bn of CDSs on the line. The agency initially stalled on the decision, waiting to see if the delayed payments on the 2019 and 2024 bonds really are on their way.
Eventually, on Friday 17 November, ISDA officially proclaimed the sovereign and PDVSA’s default on the outstanding bonds, adding that it would reconvene on Monday at 3PM (EST) to discuss an auction that will eventually determine the amount paid out to buyers of CDS protection. But, remarkably, the market hardly moved.
This reaction is in part due to the market having priced in the default long ago; more importantly, the value of the swaps pales in comparison to the USD60bn worth of debt, mostly owed to US-based investors, with its fate becoming increasingly uncertain, despite (or perhaps because of) a USD2bn in PDVSA amortization payments the country scraped together last week. For now, it seems the market is giving Maduro the benefit of the doubt.
“Maduro is claiming they will pay their debt too,” said Morden. “The problem is, what will they do about the coupon payments, whose grace period expired 15 November – on the PDVSA 2027, Venezuela-2019 AND Venezuela-2024? Why would they pay USD2bn in debt amortizations and commit to paying Elecar coupons while not paying the sovereign and PDVSA coupons? I assume if they paid all the PDVSA bills, they will pay the coupon payments, but until we have certainty, the volatility in Venezuelan debt trades will remain.”
The lack of consistency, clarity and predictability in the Venezuelan authorities’ actions is frustrating to the investment community – but that may be quite deliberate, part of the ploy to postpone the official default and stumble on until the next election. That was the likely motive behind the “for show” meeting with creditors, which yielded very little aside from reaffirming the government’s willingness to pay its dues.
“No specific proposals seemed to have emerged from the meeting but government officials insisted they plan to continue to service obligations,” Yerlan Syzdykov, Deputy Head of EM at Amundi Asset Management, said in a note to clients.
According to Syzdykov, the announcement, while bearing few details, marks a paradigm shift in the market’s view of Venezuela. Earlier expectations of continued debt servicing into 2018, followed by an effort to restructure just the Republic’s bonds, are now shifting to a realisation that more urgent action may be required.
“Maduro’s recent comments confirm that the Republic plans to include PDVSA and other Venezuela quasi-sovereign issuers in the restructuring programme,” the note said. “PDVSA and the electricity company Elecar collectively have USD750mn in coupon arrears on USD66bn of outstanding bonds. It appears that the government is proposing to address these arrears collectively or concurrently with the Republic.”
“Considering the complexity of the government’s position, the decision to restructure may reflect a desire to negotiate a more favourable outcome, which is unlikely, in our view,” Syzdykov concluded.
Limited Options
There may be some method to the madness. Venezuela’s FX reserves have dropped below USD10bn – that is already close to insolvency, especially with as much as USD7bn held in gold, which is highly illiquid. If the government arrived at the conclusion that defaulting on some of its debt is inevitable, it may try to control the damage.
Namely, it could try to shield PDVSA by shifting most of the liabilities onto the sovereign, which has fewer assets to give away and is typically more difficult for creditors to sue. PDVSA is also still the country’s main source of hard-currency revenues (albeit significantly reduced as production nearly ground to a halt during this crisis), so potential loss of its assets, including the US Citgo refinery, would be a double-blow to the economy and would likely result in Maduro’s eventual displacement – an outcome he is desperately trying to avoid.
There are a number of critical obstacles, however, that are bound to undermine the administration’s plans. The growing constraints imposed by the international community’s sanctions against some of the country’s leaders are hitting home. Not only do they complicate the negotiating process (with 70% of creditors coming from the US), but the logistical problems created by international banks’ blockade of the country mean that it struggles to make payments even when it has the cash.
In the past, when the economy was pressed against the wall, Maduro usually managed to secure bail-outs from certain international partners, namely Russia and China, but it doesn’t seem like those options are on the table now. Under the latest debt restructuring proposal announced Wednesday 15 November, Caracas will pay Moscow back USD3.15bn over a 10-year period, Russia’s Finance Ministry said.
But Russia’s MinFin also underlined that no further loans are expected in the foreseeable future. China, which is owed at least USD16bn by Venezuela, has also distanced itself from any further support, meaning that options for Caracas are even more limited.
Another lender of last resort – the IMF – has been “burnt” recently on the Greek bailout, according to Syzdykov, and is likely to take a more cautious approach towards the struggling Latin American country, even if it does get involved.
“Holdouts present a real challenge to any attempted restructuring or re-profiling of maturities. Another wildcard: in the US, a creditor with a court judgement is entitled to attach receivables, which means creditors could seize oil payments.”
As a result, the Fund could attempt to persuade the market to accept an early haircut, but that would be met with scepticism, especially as it is unlikely to commit any funds to the country with the current leadership still in place.
“There is no lender of last resort anymore,” Morden claimed. “If there had been, they would have coughed up by now. Venezuela’s international allies, contrary to gaining priority pay-outs, are the first loans to be restructured. Everybody’s been restructured, rolled-over and deferred – except the bondholders.”
Finally, any voluntary debt restructuring – especially a pre-emptive one – would entail major concessions in terms of economic policy and government strategy going forward, as a way of pacifying investors and bondholders. According to a note from Nomura’s, the main problem is the economic trap of mismanagement and corruption, with debt repudiation insufficient to balance the external deficit and restore a favourable growth/inflation trade-off.
“There are no technocrats within the debt restructuring team and a scarcity of technocrats anywhere within the Maduro administration with investment banks/lawyers necessary for a more aggressive phase of negotiations,” the analysts concluded.
Vultures Circling
Ironically, as Maduro’s regime continues to descend into pariah territory, the sanctions preventing them from hiring experienced legal and economic advisors could actually create opportunities for so called “vulture funds” that specialise in junk and near-default debt – with notable examples of Greece and Argentina attracting plenty of interest in recent years.
For them, the benefits are clear: not only can the country be “raided” while its legal defences are down, but they can also secure the lucrative prospect of gaining long-term exposure to the holder of world’s largest proven oil reserves, at a time when the economy is about to bottom out.
“Venezuela will be the best emerging-market story out there – this is a fabulously wealthy country,” Hans Humes, CEO of Greylock Capital, a hedge fund, told the Irish Times. “We are not looking for Venezuela to become a Switzerland. It just has to stop being Zimbabwe.”
Some, though, caution that getting a piece of this pie may be harder than investors think. Jay Newman, the former hedge fund manager who hounded Argentina’s assets around the world for decades following the sovereign’s default, warned that such a chase is time-consuming, expensive and often fruitless, and in Venezuela’s case is bound to be even more complex, as PDVSA could just shift its assets to the state.
“PDVSA doesn’t own the oil… the oil belongs to the state. If PDVSA is reorganized under local law, external bonds could be a zero. Investors should be thinking about the possibility that they will never see much, if anything at all, on their PDVSA bonds,” Newman told Bloomberg.
Market Repercussions
Currently, Venezuela, with overall public debt thought to be anywhere between USD120-170bn, is facing the daunting prospect of the greatest debt restructuring in emerging market history. With recent jitters in emerging market junk bonds and growing woes about the multiyear EM bond rally petering out, some have naturally wondered what kind of repercussions the default will have, regionally and globally.
For now, experts expect the spill-over to be limited. Amundi’s note stated that creditors include recipients of promissory notes, as well as those with material trapped capital – such as airlines, which creates a potential burden on the state through unresolved claims. It also contributes to uncertainty around bond servicing, as the total size of these claims is not widely known.
Other indirect victims of a full-blown default could include US refineries, which often source crude from Venezuela, and could take a hit in terms of production volumes, along with Russia’s hydrocarbon quasi-corporates like Gazprom and Rosneft; the broader damage to EMs will be limited.
“Fundamentals in EM are currently generally strong and the spreads reflect a healthy macro background. Most countries are not overleveraged, and we see current account surpluses in many EM economies,” Syzdykov affirmed.
Likewise, Morden is not overly concerned, pointing out that the market has priced it in long ago. “This restructuring is a chronicle of a default foretold, the recent drops in high-yield bond prices are not correlated. Venezuela is completely unique in its scale of mismanagement and corruption, unlike any other country, except maybe Congo. EM investors can differentiate between Venezuela and Argentina risk, for example.”
But for those investors already exposed to the Venezuela risk, such optimistic prognosis brings little consolation, and any amount of chocolate or cigars is likely to fix that. Maduro will need to find a resolution quick – or losing his grip on power could quickly become the least of his administration’s problems.
