Archive for November 8th, 2015

Making A PDVSA Bond Exchange Attractive

November 8, 2015

People have gotten all worked up about some statements made by Pdvsa’s President (who has other cambures now) that the company may “talk to bondholders to modify the maturities in the next two years in order to make them more manageable”.

What he is talking about is about a voluntary exchange by bondholders, something bondholders always are willing to listen to: Pdvsa would offer people to switch the US$ 1 billion in PDVSA 2016 and the US$ 4.1 billion of the PDVSA 2017 N, which matures in two parts, half in 2016 (US$ 2.05 billion) and US$ 2.05 billion in 2017.

While some form of exchange proposed to bondholders is definitely workable, the key here is the word voluntary: You have to offer bondholders something attractive in order to make the switch. From Pdvsa’s point of view, you want to maximize the number of bondholders that accept the exchange.

As I said above, people have gotten very excited about this possibility, because in the end, Pdvsa’s problem is one of liquidity and moving the Pdvsa 2016 and 2017N maturities two years down the road, would certainly boost the company’s bonds prices.

Except it would be very expensive. Like very, very expensive…

The plot below shows the price of the PDVSA’s 2016, 2017N and 2021 bonds (blue diamonds), together with its yield  to maturity (red squares):


The yield to maturity of the PDVSA2016 is 30%, it goes up to 50% for the 2017 with the low coupon and then drops again to 30% for the PDVSA 2021. I have also plotted the blue triangles which are the bond prices and, since there are no bonds maturing in 2018, 2019 and 2020, I have drawn free hand (using the Venezuela curve as a guide) a yield curve through the three points to try to capture the yield that would have to be offered in 2018, 2019 and 2020 in a proposed exchange. This is shown as large blue circles.

Now, let’s assume (there are many ways of doing this), that the idea is to move the 2016 to 2018 and the 2017N into two bonds, one in 2019 and the other in 2020, since there are no PDVSA bonds maturing in that period.

Let’s just consider the first case: Let’s offer something for the PDVSA 2016 to be exchanged one-to-one for a PDVSA 2018. As you can see from the graph, the PDVSA 2016 today is worth 79%. So, if you are holding 100k of that that bond you can sell it tomorrow in the market for 79k. So, anything the Government offers you, has to be worth 79k.

So, if we assume the 2018 bond has the same coupon of about 5% (I did not do exact calculations), from the graph yo can see that a 2018 bond with a 5% coupon, would have to yield 58% to maturity. In order for that to happen, the bond would be worth 27.5% of its face value.

This means that for it to have the same cash value today as the 2016, you would have to offer me 79k/27.5k= 2.87 times the face value!

This means that for a US$ 1 billion bond, you would have to offer US$ 2.8 billion in new bonds!!!

Sort of expensive, no?

But wait!!! Why would I take it? Where is my incentive? You are offering to give me a bond which is three years longer, that is worth the same as mine is worth today, same coupon. I am not interested, I will just wait until the PDVSA 2016 matures.

So, unless PDVSA offers MORE, this is not attractive. So, PDVSA would have to offer either more coupon or more capital, which would make it even more expensive.

See why this is not a piece of cake? Yu have to offer more capital or more coupon. Or both.

Some expert reader will be thinking: Oh, Devil! You are lying to us, because PDVSA can always offer more coupon and then it does not have to offer triple the amount…

Very true. But my calculations show that if PDVSA offered a 15% coupon for a 2018 bond in exchange for the 2016, it would have to offer you twice (Yes a factor of 2 instead of 3) as much as you have today, which would be cheaper, as three years of the extra 10% would only add up to 30% over the life of the bond. But going higher in coupon would certainly run into problems. And a factor of two is not exactly cheap.

But again, this is a theoretical case IDENTICAL for the investor than what he has today. On top of the double and the higher coupons, investors are going to ask for more. Either more capital, or more interest. Or both.

See the problem? It is very expensive to do this exchange and it means that in the end PDVSA would have a higher debt and the problem will be back in 2020, when PDVSA hopes (and prays!) oil prices would be higher.

Maybe PDVSA will just be running in place anyway.

To do this for the 2017N bond is not as onerous, but is still very expensive, I will not take you through the details, because it is a more complex case, but let’s just say that even at a 15% coupon, the bonds for 2019 and 2020 would be worth 35-40% of their nominal value, which implies you would have to pay people 1.5 times what they are owed today, plus a premium, plus the higher coupon.

Is there a cheaper way of doing this?

Well, yes, but no. Let me explain…

If PDVSA had not committed all that oil to the Chinese to pay for the Chinese loans, PDVSA could issue an oil-backed bond. Let’s say, for example, that PDVSA would sell oil every day to pay for these bonds (principal and interest) and each quarter, you would get paid part of the principal from a trust where the proceeds from the sale of the oil go to daily, plus interest.

If the bond is a two year bond, for example, you would get 1/8 of the principal paid each quarter plus interest. What’s the advantage? That if the bond is backed by oil exports, the interest rate (the coupon) would be much lower. Like way lower…5% maybe (guessing) on a two year bond. Now, an asset-backed loan like this, would be very attractive for investors, much like it was for the Chinese, as the structure is basically how the Chinese loans function: PDVSA sends oil, the proceeds go to a Chinese bank and the Chinese pay themselves from it.

Unfortunately, PDVSA likely has no ability to back the bonds this way, it probably has little spare production for this. But just think, it could offer the production as guarantee, just to lower the interest rate and then pay it with cash, if it has it. There are many ways to skin this cat…

Like the Republic could use some of the gold in the reserves to issue bonds guaranteed by the gold, but this would be just a way of lowering the coupon, the gold would be there just in case.

But, I digress. The main point is that a simple voluntary swap is not that doable due to the low bond prices. This makes it very expensive and seems like just kicking the can down the road.

Hard to get excited…and not as simple as people may think.