Archive for December 2nd, 2014

Say What? Venezuela Sold What To Goldman Sachs?

December 2, 2014


Most people ended up looking like the guy above when they read this morning the headline in the Herald : “Venezuela sells to Goldman Sachs part of its oil debt”, an article that is actually not that well written, as it says that Goldman Sachs “earned” 59%, which is incorrect, Goldman Sachs would only “earn” that if it waited 20 years for the Dominican Republic to pay the loans. Time is money and money earns money over time.

What the report claims is that Venezuela sold Goldman Sachs the debt that the Dominican Republic has with Venezuela, because PDVSA has been selling oil for years to this country, whereby, the Dominican Republic pays 50% upfront (which varies) and the remainder for 20 years at 2% interest rate (which also varies, but let’s keep it simple). After all these years, that country has a debt of about US$ 4 billion with Venezuela, which it will have to pay interest of 2% per year and eventually pay all of the US$ 4 billion. What the article claims is that Venezuela sold this debt for US$ 1.7 billion, or a 59% discount.

My understanding is that this is not a done deal, but it is close to being completed and that in the end the buyer is none other than the Dominican Republic itself. Let’s assume it is true and explain it.

Suppose you lend $1,000 to your buddy, you trust him, like him, much like Petrocaribe and Chavismo likes to have the votes of Caribbean countries. Thus, I tell you let’s do this: You pay me 2% (all of twenty dollars) per year and twenty five years from now, you pay me my $1,000. This means that at the end of the 20 years, I will get $500 in interest and my $1,000.

Except that in five years, I am in trouble, lost my job, but you can’t pay me when I ask and you have only paid me $100, still have to give me $400 in interest in the next 20 years as well as my original $1,000. So, I go to another buddy and ask him at what price he would buy this debt from me and you pay him the interest. My buddy says: “Well, I don’t know him, so, for me to be interested, I would have to buy it from you at 40% of its value, so that I get paid 5% per year (the same $20 per year) and in the end he gives me $1,000 for the $400 I paid you, that means I get $600 additional dollars at the end, or about 30 dollars per year additional in interest. I don’t know the math involved, but that is about $30 more per year, so that I got paid in this simple math I use, about $50 per year on my money, which is 12.5% in my dumb and simple math”

We close the deal.

This is what reportedly is happening. Dominican Republic owes Venezuelan US$ 4 billion. Goldman buys it for US$ 1.7 billion and now the Dominican Republic pays Goldman or whomever Goldman sells this debt to eventually. Well, 2% per year is US$ 80 million, so that Goldman will get US$ 80 million a year or 4.25% per year in interest, but at the end of the twenty years, Goldman receives US$ 4 billion or US$ 2.3 billion more, which comes out to US$ 115 million per year the debt was held. That’s another 6.7% per year, or a total of 11.95% (The actual numbers is 11.38% when you do the math properly).

Well, that is about what the Dominican Republic would pay for a twenty year bond. Except that, I am told that it is the Dominican Republic that is behind the whole operation (Your buddy sneaked around and asked the other guy to buy the debt from you). Goldman buys it, it issues a new bond for the Dominican Republic, and voila, the Dominican Republic has reduced its debt by US$ 2.3 billion and Goldman made commissions at every step.

Why would the Dominican Republic want to do this? Well, easy, the Dominican Republic has debt of about US$ 12 billion between bonds and its Petrocaribe debt and other international loans. But its GDP is around US$ 60 billion, that means its debt is 20% of GDP.  By doing this, they chop off US$ 2.3 billion off the total debt, so that it will be easier for that country to make payments in the future. In fact, investors may even decide that they can buy Dominican Republic debt at lower interest rates, since it has improved ts finances. It is win-win for the Dominican Republic.

What does Venezuela gain? It gets US$ 1.7 billion today in cash, and nothing down the line, it buys time without adjusting the economy and maybe losing an election.

This proves how idiotic the whole Petrocaribe thing was, except to buy votes at international venues. Venezuela, which has been issuing debt at yields to maturity of 10-15%, was lending money to countries at 2%, when most of these countries pay less than Venezuela in the international markets.

Think about it this way: we sold that could be sold at $100 at $50 (50% upfront) plus the remainder we only got  40% for or $20, i.e. we gave them a $30 discount per US$ 100 barrel.

Not great business.

In fact, of the top three Petrocaribe debtors, Dominican Republic pays the highest interest of the three. Jamaica and Bahamas actually pay much less. Jamaica pays 6.5% for its 10 year bonds and Bahamas pays 4.6% for its 2024 bonds. Bahamas is “investment grade”, a country with “adequate capacity to pay debt”, versus Venezuela’s “vulnerable position”. Thus, we are giving very easy terms to country’s in much better shape than we are. (In fact, Bahamas’ GDP per capita is close to US$ 22,000 per inhabitant, while Venezuela’s is US$ 14,000 at the official rate of exchange)

There could be additional operations like this with these or other countries, but remember, nothing has been confirmed yet, I just thought I would explain since people have asked so many questions. In fact, others like Jamaica and Bahamas, could yield higher percentages of their debt for Venezuela, as they represent much better risks.