Venezuela may yet give definition to a new type of credit default: the quasi-default. Once one of the richest countries in the region, it is in now in the embarrassing spot of being the basket case of South America. Shelves in supermarkets are nearly empty. People are fleeing the country. The oil price recovery has simply done nothing for them.
Venezuela entered into restricted default in November, making late principal and interest payments for PDVSA bonds and the sovereign. PDVSA is the number one trade into Venezuela debt, owned by the struggling state-controlled oil company Petroleos de Venezuela S.A.
All Venezuela has left for the year is interest payments. But to the market, it is unclear if they can make them all. The risk is definitely to the upside.
"It’s difficult to assess relative value opportunities through this limbo of temporary/permanent default and no official communication as bondholders begin to organize," says Siobhan Morden of Nomura Securities, one of Wall Street's best Venezuela debt watchers. When bondholders begin to "organize" that can only mean one thing: they are seriously considering accelerating. And that means demanding payment now, something Venezuela cannot do. When bondholders accelerate it usually means a hard default is imminent. So are lawsuits. It's a mess. This is in Venezuela's future, barring a miracle.
Some cowboy hedge funds have been looking at PDVSA bond prices and weighing whether to buy in, hoping they will double their money in recovery value. In the best case scenario, you're buying at 20 and selling at a recovery value somewhere between 40 and 60 instead of par value of 100. It might take 10 years or so to get there, but such is the gamble in distressed asset markets like this one.
Morden says she is closely monitoring the PDVSA 2022 bond as the longest overdue bond and the potential catalyst for a permanent default.
See: A Wild & Crazy Guide To Emerging Markets -- Forbes
The Trade Association for Emerging Markets in New York recommends trading the sovereign flat, believing there will be some short-term relief. They also think relief is temporary and recognize that a default on the sovereign will come after 53 days past the 30 day grace period for the VENZ 2019 and VENZ 2024 bonds.
There has been no official communication on the sovereign bonds since a tweet by the government sent on Nov. 15 that announced payment on both of those maturities. There has been a clear priority to pay PDVSA interest, but the latest delays from November are worrisome. China's Sinopec, a petrochemicals company, is suing as a result of late payments.
The administration of Nicolas Maduro is unwilling to officially recognize the fact that it cannot pay its bills. They are unprepared to restructure. "There are also misaligned incentives with bondholders unwilling to provide liquidity and/or solvency relief without economic reform, especially since policy mismanagement creates large dollar-denominated liabilities while also lowering dollar assets (from oil)," says Morden. "If bondholders provide any liquidity relief it would be temporary. A complete repudiation of external debt would not reduce Venezuela's external financing deficit enough to stabilize inflation," she says. In other words, Venezuela still needs capital. Where will it come from? Probably not Russia as it has in the past. China is getting a bit tired of this dog and pony show, too.
Venezuelan inflation is over 1,000% on a rolling 12-month basis. It gets worse every year.
Current bondholders are waiting to see how litigant-based investors react in the weeks ahead. There might be a higher incentive to initiate litigation once there is confirmation on a permanent default for PDVSA. The markets still recognize the quasi-current status of PDVSA bonds after officials paid $2 billion in October and November. PDVSA is struggling to make coupon payments. Investors holding Venezuelan debt now are basically crossing their fingers. Some are calling their lawyers.
Officials have to be nervous about litigation risks because of the assets PDVSA owns, including oil on ships around the world that could be seized, and important Citgo gasoline stations and refineries in the United States owned by PDVSA's offshore entity.
It remains unclear how much more of this financial crisis Venezuela, and Venezuelans, can take. At this point, it is more likely that the government buckles under the stress before the public. Venezuelans, those that have not fled to Colombia, Brazil, Spain and the United States, have grown accustomed to their ignored protests, a weak political opposition, and food shortages.
Some neighborhoods have created a barter system complete with their own currency to get around the imploding Venezuelan bolivar, now worth less than a stick of gum on the black market.
Maduro recognizes the financial constraints. He wants to launch a cryptocurrency called the petro in an attempt to get around some sanctions and capitalize on the initial coin offering craze sweeping the world. The National Assembly said the coin idea was illegal because it was backed by Venezuelan oil reserves. If investors wanted to cash in their chips for Venezuelan oil instead, Venezuela would be stripped -- in theory -- of its prized possession.
That prized possession has given it a lifeline. The rope is now tearing to shreds.
Trade recommendation, anyone? Here's Morden's pick:
For longer-term investors, there is more value in the VENZ 2027 bond versus similar coupon bonds like VENZ 2023, VENZ 2028 and VENZ 2034. For shorter-term investors there is more value on shorter-term PdVSA’22, PdVSA’24, PdVSA’26, PdVSA’27, and PdVSA’37.
Good luck with that!
