The market opened today with a steep selloff in Venezuelan debt; the Republic’s sovereign bonds and those issued by Electricidad de Caracas fell more than 20 points while PDVSA securities dropped about 10 points on the news, according to MarketAxess. The ELECAR notes do not contain any cross-default provisions with other Venezuelan securities. On Oct. 30, the spread between the VENZ 7% 2018 bonds and VENZ 7% 2038 bonds was roughly 30 points. This tightened on Maduro’s announcement, with the 2018s trading off about 20 points to 40/43 from 61.50/62.25 and the 2038s falling just under 10 points to 23/26 from 31.75/32.50.
Investors and traders speculate that Maduro is using the appointment of El Aissami to drive a wedge between the U.S. government and the financial sector to loosen sanctions that have prohibited the regime from tapping the debt and equity markets to raise new financing. By appointing a sanctioned individual to lead talks with bondholders, sources told Reorg Research that Venezuela is sending a message to investors and U.S. officials: Sanctions must be lifted or loosened for a restructuring to transpire or else investors will have to sell their holdings to a party that is willing and able to negotiate. China and Russia have historically served as Venezuela’s lenders of last resort.
El Aissami today called for a meeting on Nov. 13 with sovereign and PDVSA creditors to discuss ways out of or around the sanctions imposed on Venezuela this year. The meeting, if it happens, will take place after the 30-day grace period on the ELECAR notes and one day after the grace period on the PDVSA 2027s.
U.S. Sanctions
In his speech last night, Maduro alluded to the Republic’s attempt to raise between $3.5 billion and $5 billion in new financing before the Trump administration imposed sanctions to prohibit U.S. investors from purchasing new securities and to force a restructuring. The sanctions exempt trading in certain instruments, listed under General Licence 3, but investors agree that talks concerning a restructuring will be nearly impossible so long as the sanctions remain in place.
Venezuela’s El Aissami is one of many sanctioned individuals by the U.S. government, so it will be illegal for any U.S. persons to meet with him to discuss a debt restructuring. In February, the U.S. Department of the Treasury's Office of Foreign Assets Control, or OFAC, designated El Aissami as a Specially Designated Narcotics Trafficker pursuant to the Foreign Narcotics Kingpin Designation Act (Kingpin Act) for “playing a significant role in international narcotics trafficking.” Market participants seem to agree that it will not be in the best interests of private creditors to negotiate with him or other members of the Maduro regime.
Maduro, meanwhile, appears to be positioning in such a way to persuade the United States to lift or loosen the sanctions. In his speech Thursday, he alluded to the need to issue new debt in a refinancing or broader restructuring of the Republic’s global debt. The U.S. government, however, has not responded to those remarks and requests for comments from the U.S. State Department and the U.S. Treasury Department went unanswered as this article went to press.
At this point, it is unclear if or how a restructuring will proceed if the sanctions remain in place. Some restructuring experts have asserted that Venezuela might have to change the jurisdiction of some of its bonds to restructure its obligations outside of the United States. Capital Economics also notes that the sanctions complicate the Republic’s ability to raise new debt as the sovereign bonds contain pari passu clauses that could prevent the government from negotiating debt held by non-U.S. investors without providing for an equivalent change in the terms of debt held by U.S. investors.
To Default or Not to Default
How Venezuela will proceed at this point is unclear; investors are debating the tone and intent of Maduro’s speech, with some market participants arguing the Republic will fall into default and others asserting otherwise. In his speech, Maduro said: “I have ordered that on Friday morning, Nov. 3, the payment of the PDVSA 2017 Bond will be initiated, but after this payment, starting today, I decree a refinancing and restructuring of the foreign debt and all Venezuela’s payments."
“The announcement by President Maduro that Venezuela’s government plans to restructure its external debt essentially amounts to admitting that it will default in the coming weeks,” Capital Economics, a research firm, said today, while adding that “a formal default is now seemingly just a matter of time.” Venezuela’s yield curve also flattened substantially after bonds at the short end of the curve sold off in early trading today and the price of Venezuela’s credit default swaps jumped to all-time highs following the announcement, indicating that investors now consider a default unavoidable.
Still, some participants in the market question if Venezuela will default on its bond. They note that Maduro never explicitly said that Venezuela would cease making payments on its debt while it seeks to restructure or refinance its obligations. Torino Capital, a New York investment bank and broker dealer, circulated a note asserting that Venezuela will continue to honor its debt despite Maduro’s call for a restructuring. Before the amortization on the PDVSA 8.5% 2020s came due last week, Torino had argued that Venezuela would remain current on its debt.
Meanwhile, the Emerging Markets Traders Association determined that trades will settle at an all-in (“dirty”) price, with interest accruing. Buyers of the bonds will be entitled to all unpaid and accrued interest, according to sources.
A Venezuela Restructuring: Additional Considerations
Given the sanctions in place and the appointment of El Aissami to lead the negotiations with creditors, analyzing a restructuring of the Republic’s debt remains highly speculative at this juncture.
Venezuela’s debt restructuring will be difficult to consummate given the plethora of creditors and the conflicting interests of the various parties involved. Even determining the amount of claims could prove contentious. A restructuring will likely involve secured and unsecured Venezuela and PDVSA bondholders, bilateral lenders such as China and Russia, other multilateral organizations such as the Development Bank of Latin America, and companies such as Canadian miner Crystallex International that are pursuing claims in U.S. courts or through the International Centre for Settlement of Investment Disputes against the Republic.
Indeed, Venezuela’s unsecured bonds represent only a fraction of the country’s total external liabilities, Cleary Gottlieb and Millstein note in a report published earlier this year. At that time, the advisors estimated that the Republic has approximately $36.1 billion in sovereign debt, $26.5 billion in PDVSA debt and $650 million in debt issued through ELECAR. Venezuela's total estimated liabilities, meanwhile, amount to roughly $196 billion or more.
While Venezuela’s sovereign bonds and those issued by PDVSA each contain cross-default clauses, there are no such provisions between the PDVSA and sovereign notes. As stated above, the ELECAR bonds contain acceleration measures, but they do not provide for cross-defaults on other Venezuelan debt. So, investors are now analyzing whether the government will prioritize the secured bonds or those containing collective action clauses over other obligations. The Republic’s decision to pay the amortization on the PDVSA senior secured 2020s and the maturity of the 8.5% 2017s this week appears to indicate to the market that Maduro is seeking to protect key assets and perhaps negotiate with creditors outside of a formal bankruptcy process for now.
Indeed, the offering memorandum for the PDVSA 2020s provide for an event of default amid “the failure to pay at final maturity (giving effect to any applicable grace periods and any extensions thereof) the principal amount of any indebtedness of the issuer or any of its significant subsidiaries … if the aggregate principal amount of such Indebtedness, together with the principal amount of any other such Indebtedness in default for failure to pay principal at final stated maturity or which has been accelerated (in each case with respect to which the 30-day period described above has elapsed), aggregates U.S. $100 million or more at any time.”
PDVSA risks compromising the 50.1% share pledge of Delaware corporation CITGO Holdings, which secures the 2020s, if it defaults on at least $100 million of its debt.
With respect to Venezuela’s sovereign debt, all but two issues - the 2018s and the 2027s - contain collective action clauses. This opens the door to possible holdout issues throughout the course of the restructuring.
An extreme scenario could be a hard default that could open the floodgates to numerous legal battles. This theory, however, conflicts with the Republic’s decision to honor the recent amortization payments. “However legally complicated, and however constrained their cashflow, Maduro and El Aissami appear set to try to attempt some kind of negotiated deal with bondholders - at least for now,” a sell-side research note states.
The fall in prices today provides a potential buying opportunity for distressed hedge funds. One source on the sell side told Reorg Research that some activist investors, possibly including Aurelius Capital Management and Elliott Management, added exposure following last night’s announcement. To that end, the makeup of PDVSA and Venezuela bondholders will likely change from passive long-only funds to traditional distressed funds and other activist investors. Still, advisors told Reorg Research that it is still too early to organize formal groups given the lingering uncertainty surrounding Venezuela’s debt position and the way in which a restructuring might transpire.
Upcoming Debt Payments
Venezuela’s next debt payment is due on Nov. 7 when the Republic is expected to pay $90 million on its global 2023 dollar bonds. Grace periods on $778 million in missed payments in September will begin to expire starting Nov. 9. Venezuela and PDVSA debt outstanding is pictured below: