Archive for September 16th, 2014

S&P Downgrade Of Venezuela’s Debt To Add To The Noise

September 16, 2014

As if there was not enough noise around Venezuela’s and PDVSA’s debt, credit agency S&P downgraded Venezuela to CCC+ this afternoon, citing concerns about the economy, inflation and increasing risk. This announcement will certainly add to the confusion of the last week or so, where the default opinion piece of Hausmann and Santos, has generated so much discussion and interpretations of what was said, creating such a stir that President Maduro ordered the Prosecutor to ¨take action¨ against Hausmann for seeking to destabilize the country.

One has to wonder what Maduro will say about S&P now.

But in reality, the announcement by S&P is not surprising, because the rating agency already had placed Venezuela on “negative watch“, suggesting that it was considering downgrading Venezuela’s sovereign debt. (So far, the downgrade only applies to the Republic’s debt, but a similar downgrade of PDVSA is likely to follow base on the criteria usually followed by credit rating agencies that no risk can be higher than the sovereign one)

According to the definition by S&P, this downgrade to CCC+ means that Venezuela is “vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.” S&P is not suggesting that there will be a default anytime soon, but that things are getting complicated. But we are sure that the announcement will be misinterpreted.

And I say this, because during the last week, there have been many misinterpretations of statements made by a number of people (including me) and in both Twitter and blogs, terms have been confused.

As an example, I made statements in Twitter that I did not recommend investing in Venezuela and PDVSA bonds at this time, which was taken by some as an indication that I thought Venezuela would default. As I made clear in the previous post, I do not believe that Venezuela will default in October, or that Venezuela is likely to default in 2015 or even in 2016. What I am saying is that on a risk adjusted basis, the return on Venezuelan and PDVSA bonds are just not high enough for the  lack of transparency on the country’s numbers, the political uncertainty and the volatility that these bonds exhibit.

Take, for example, the PDVSA 2022 bond, one of the people’s favorites because of its high 12.75% coupon. Today that bond was yielding about 16.1% per year if you held it until 2022 and had a “current yield” of 14.66%. The latter means that if you buy the bond today at around 86% and in one year it is still at 86%, you will make 14.6% on your money. This is what that this bond has done since the beginning of the year:

pdvsa22

As you can see, it started the year at about 92%, dropped in six weeks to 75%, bounced back to 104% only to drop to 80% once again with all the default talk and recovered some to close today at 86%. That is a 19% drop, a 38.7% rise and a 23% drop in the space of less than nine months.

To me, this is too risky, too much volatility, given that I am paid less than the last two drops for holding the bonds. Imagine you are a fund or you have a client that buys at 100% and you have to tell him or her, that the bond is down 23% since the purchase. If it stays down there (nothing guarantees it will bounce back) the fund or your client will lose money over the first year and a half of the investment.

Now, if the price comes down below 80% again, I might be intrigued for aggressive investors (including myself). In fact, I did that when it started bouncing back in February, but sold when the yield became too low again for the risk I perceive. (Again, this is my personal perception of what the risk/return should be)

Add to this, what the Government has done (or not) in terms of giving negative signals to make the bonds even less attractive:

-It invited foreign investors to two meetings in New York with then VP for Economic affairs, both meetings were cancelled.

-It said it wanted to sell CITGO

-It has said nothing about whether or not it (or PDVSA) had significant amounts of funds in Banco Espiritu Santo or its affiliates.

-It has said a few times that all foreign currency in parallel funds will be added to international reserves, but Maduro only mentioned US$ 750 million. Analysts believe that there should be much more than that in the parallel funds

-It has done little in terms of the exchange rate and/or gas prices and moved sideways the only Minister proposing changes.

-There was a report that Venezuela was storing heavy crudes in Caribbean islands, while PDVSA “reviewed its pricing structure”. This was never clarified.

None of this gives you any confidence in the strategy of the Government or the bonds.

But whether you invest or not, has nothing to do with believing in default or not. That is a separate question and I don’t think that there will be default this October, even if I understand that this is a political decision in the end.

But I also think that the discussion has become somewhat circular. When I read Hausmann and Santos, I read: “If the authorities adopted common-sense policies and sought support from the International Monetary Fund and other multilateral lenders, as most troubled countries tend to do, they would rightly be told to default on the country’s debts”

This is an extremely hypothetical question, as the current authorities are not considering this even remotely. In my mind, what Hausmann and Santos said was a number of truths to warn investors not to be so complacent about the country’s debt. ( I also think that an IMF agreement and some adjustments would provide ample funds to avoid default)

In the same manner, when Francisco Rodriguez answers back that the real problem is that Venezuela is selling ten dollar bills for one dollar and it should really just change that, this is another highly hypothetical question as the last year and a half under Maduro has shown that there is no intent to sell the $10 bills for ten dollars, but at most for $2 or $3 dollars, which really solves nothing.

And now to make things even more confusing, people will certainly over interpret and confuse what S&P said today. Which, by the way, will not help the prices of the bonds tomorrow or for the next few days. Neither will it help if they announce they sold Citgo or parts of it, nor if they announce little in terms of correcting the distortions in the Venezuelan economy.

The amazing thing is that some simple steps, like talking to the market (not cancelling meetings), moving assets to international reserves and addressing issues like Espiritu Santo, would have done wonders to calm investors down. Even if you lead a “revolution”, if you want financing, issuing debt becomes cheaper the more transparent and communicative you are with investors. In the end, not doing so, becomes very costly for the country and Pdvsa to issue new debt. Ramirez seemed to have understood that, but currently, it appears as if we are back to Giordani’s days of not talking to those that provide your financing.

And in the end, all Venezuelans will have to pay for it.