Distress in Venezuela: Will Debt Exchange End Up Triggering Default?

After months of speculation, Venezuela’s cash-strapped government and the national oil producer finally proposed a bond exchange this week to lighten its short-term debt load. But will it be enough to avert a default? Exotix Partners analysts Stuart Culverhouse and Francisco Velasco weigh the prospects

What’s on offer?

While PDVSA has yet to publish a detailed offer, its President Eulogio Del Pino is proposing an exchange of the company’s bonds due in 2016 and 2017. This amounts to $8 billion in principal (although Del Pino says it’s $7 billion).

What does PDVSA need to pay as things stand?

Upcoming principal repayments due on dollar bonds are as follows:

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Repayment date               Bond                             Amount

28 October 2016              PDVSA 5.125%              $1 billion

2 November 2016            PDVSA 8.5%                 $2 billion amortization of 8.5% 2017 bond

12 April 2017                    PDVSA 5.25%               $3 billion

2 November 2017            PDVSA 8.5%                 $2 billion final amortization of 8.5% 2017 bond


What would the payment be under the swap arrangement?

The government is offering a 2020 bond amortizing in four payments between 2017 and 2020, suggesting repayment of principal after the first year. The offer doesn’t mention the exchange ratio or the coupon, but to preserve or enhance the present value, we assume a higher principal amount or coupon will be required.

 Any other incentives for the holders?

Crucially, the offer includes collateral in the form of shares in Citgo – a refiner, transporter and retailer of oil products owned by a unit of PDVSA. This is an innovative inclusion to enhance the value of the new bonds (or put a floor on recovery in a default). But it doesn’t say what percentage of the shares will be allocated to the bondholders. Plus, of course, investors may have their own view on the value of Citgo itself. It’s not clear to us how much Citgo is worth in the offer.

How much would Venezuela save on debt payments?

If there was 100% bondholder participation, or the full $8 billion swapped, the cash saving could be $3 billion this year and the same in 2017. But in reality, the amount will be lower because:

a) the coupon may be higher,

b) the exchange ratio may be higher than 1, and

c) participation will be less than 100%.

Will Venezuela save enough to get itself out of its current mess?

It’s not a huge windfall but to put these amounts in context, Venezuela’s international reserves are $12 billion and imports this year could be around $20 billion, so the offer could save a reasonable sum. If the government can persuade PDVSA bondholders to participate, it will be positive for other bondholders as it might remove the near-term risk of default. It would push back up to $6 billion of bond payments over the next 18 months and buy some breathing space, allowing time to implement reforms and a referendum on whether President Maduro should be recalled from office.

So crisis over for now?

What’s worrying is that the government seems to suggest that the debt service relief provided by the exchange will give them time to win the argument for forcing higher oil prices within OPEC. So what happens if that plan doesn’t work (as it probably won’t)? The next sovereign bond repayment isn’t until August 2018, with about $1 billion owed in two bonds followed by another $1 billion in December 2018. The next PDVSA bond payment is an amortization in November 2019 of the 9% 2021 bonds. So the debt swap would remove near-term refinancing risks.

What’s been the market reaction?

PDVSA’s April 2017 bonds rose three points on the announcement to 72. Holders may participate, if the offer is appealing enough as it could avoid the possible alternative of default. But holders may not like the terms, or prefer to wait for full face value on the expectation they’ll get paid on maturity. The PDVSA October 2016 bond is still trading at 95% of face value, with six weeks to go. Holders could therefore make 5 points in upside at maturity. But non-participants take the risk that without high participation in an exchange, the government will have little alternative but to default on PDVSA’s obligations.

So is a default likely if the swap fails?

 We still think the government could find the money elsewhere, but its finances are coming under increasing difficulty. Even if they pay the October 2017 bonds, concerns would resurface over the bigger November 2017s due a few days later. There is a free-rider and collective action problem here, although it is possible some bondholders may have organized in advance to ensure acceptable terms and guarantee a minimum participation.

How will the ratings agencies react?

If the swap is considered to involve a loss of value to bondholders or necessary to avoid a default on PDVSA’s bonds, i.e. a distressed debt exchange, it might be classified as a default event, or “selective default.” This is a bit like Mozambique’s EMATUM exchange in April, which Standard & Poor’s classed as Selective Default (although Moody’s and Fitch did not).

What would be the consequences of a selective default?

Default could trigger credit default swaps and breach other loan covenants. Whether it would cause cross default to the other PDVSA bonds is unclear, but with a large stock of $31 billion of PDVSA bonds and a probably diverse investor base, it may be difficult to control what happens then. Crucially here, Del Pino has said the swap is voluntary and has not suggested bondholders won’t get paid if they don’t accept.

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