Caracas Chronicles

For most of 2017, complacency reigned supreme in the Venezuelan credit market. Portfolio managers felt like the country was out of the woods and, despite all the warning signs, they kept on buying short-end bonds and betting on a muddle-through Maduro-stays-in-power-and-keeps-paying-bonds scenario.

Now the holiday is over, and everybody is scrambling to get out through a door that’s getting smaller and smaller.

The reason?

It’s the Constituyente; or more specifically, the panic among investors about what could happen now, in the aftermath of that travesty.

Reuters’ Marianna Parraga and Matt Spetalnick published a piece on July 21st showing some of the worst yet to come. The US government is allegedly considering full-blown financial sanctions against the Venezuelan oil industry if the government installs the Constituyente – becoming a fully authoritarian rogue state – in an unprecedented escalation of the hostility between Miraflores and the White House. And as the doomsday clock ticked towards midnight – July 30th – Mr. Market more or less abandoned all hope.

It’s a freakin’ bloodbath out there

Take the Venny 19s, a highly liquid bond that’s popular among traders and investors betting on the ‘muddle-through’ scenario. In hindsight, the selloff started a while ago: prices peaked in early March and are more than 20 points down since then; year-to-date, investing in the bonds has led to a -28% principal loss, most of it since the second week of June.

What’s more worrisome, though, is that the selloff has accelerated in recent days. Over the past week, VENZ/PDVSA bonds fell by around -15% to levels not seen since May of 2016, even though oil prices actually bounced back strongly and current WTI futures are once again trading near the $50 per barrel mark.

Why is the market so weak? It’s easy to point out the culprit. The election of the members of the ANC (National Constituent Assembly, or La Constituyente for us locals) has put an end to hopes for a smooth government transition or a stable status quo. 

Instead, market players are now increasingly worried about a nuclear-level crisis scenario that sounded alien just a few days ago: sectoral U.S. sanctions on PDVSA and its overseas affiliates, forbidding the state oil giant from even doing day-to-day errands such as paying US suppliers with Dollars or receiving payments from cash-generating oil exports.

Maduro & Co has had it coming for years, though

First came the Obama sanctions of 2015 that led to the cheesy #VenezuelaIsNotAThreat backlash campaign. After several other rounds of (not that huge) targeted sanctions, a bomb landed on February of 2017: the country’s VP, Tareck El Aissami was accused by the US Treasury Department of drug trafficking. This was recently followed by an update of the OFAC’s sanctioned individuals list, targeting key heads of government, including some Chavista heavyweights such as Tibisay Lucena, Elias Jaua, Tarek William Saab and Iris Varela, alongside with little-known operators in charge of the nation’s public finances, like Erick Malpica Flores and Simón Zerpa.

In parallel, the year has brought a parade of legal disputes (V. Crystallex, V. ConocoPhillips, V. ExxonMobil) and controversial financial transactions (a Repo operation with Fintech Advisory, Goldman’s Hunger Bonds, and the toxic VENZ 2036 bond) that have tested the willingness of market players to remain invested in the external debts of a government that looks and acts more desperate by the day.

For a while now, market bears have feared that it’s only a matter of time before the US decides to escalate from its current limited sanctions at key individuals, considering the government’s rogue “I’ll do what I damn well please” attitude, as well as its proven ability of finding ‘alternative routes’ (caminos verdes) to continue operating relatively unscathed amidst the targeted sanctions regime.

As the dangerous game of chicken between government and opposition extends towards the July 30th deadline, Venny investors are bracing for the worst.

Ironically, it was Maduro himself who put the looming threat of sanctions over the country’s shoulders. The government is trapped in a situation of its own making. Nobody thought the constitutional crisis the Supreme Tribunal’s Sentences 155/156 might set it off, much less how they’d pave the way to four straight months civil disobedience and then to the Doomstituyente upon us.

Too late to defuse that bomb, Zapatero.

The Nuclear Option and market implications

The consensus among investors is that, of all proposed US macro sanctions, the blockade of US dollar transactions by PDVSA is by far the deadliest. Not only will it severely disrupt the flow of petrodollars in about three months (i.e., the time between closing an oil sale and actually collecting the cash), it would also forbid PDVSA from making debt repayments on dollar-denominated debt. Several coupons are due in August, so if the US government effectively goes on in this course, total uncertainty would surround the Venny bond market.

It’s likely that a transactions ban would be shortly followed by a technical (yet equally traumatic) credit event after the grace period expires and PDVSA finds itself still unable to wire any coupon payments, despite having both the willingness and the capacity to service those debts.

What’s curious about the free fall in bond prices is the timing and lack of volume behind it. Even though the impasse between government and opposition peaked right before the Constituent Assembly election, the stage has been set for weeks and the newsflow that’s driving the market action is not precisely new.

I’ve learned to fear and respect market crashes with very few bonds changing hands, because most of the time they imply that the smart money is heading for the exits as quietly as it can. The price insensitivity of sellers despite bonds getting to double-digit % losses corroborates the theory, in my view.

Damned if you do, damned if you don’t?

Bondholders should be even more scared than Maduro at this point. A government threatened by sanctions and financial blockades is ripe for breaking the explicit contract of external debt financing and servicing. Maduro & Co. might just stop paying altogether, using their old’n’trusty ‘Economic War’ excuse. The worst part is that, this time, they’re not wrong.

On the other hand, the opposition has repeatedly said they intend to seek a friendly restructuring of the nation’s external debt pile. However friendly, though, it’s gonna include a sizeable haircut, worsened by every year that passes without significant macro reform and for every ICSID indictment that adds to the list of debt commitments that any Venezuelan government, no matter their political stripes, will have to take care of to avoid total economic and political isolation.

So, you think Venny is out of the woods? Are you looking to ‘buy the dip’? Or maybe try to pull off another Bachaquero of Wall Street trade with the Nov 2017 maturity?

Think twice.