The Venny Bond Market Contemplates the End

A few weeks ago ago, the conventional wisdom was that Venezuela was the proverbialboiled frog: 17 years of mismanagement screwed the country up so gradually, we lost all ability to react. But in the last few weeks, something has shifted. The boiling frog jumped. And that change, which began after the release of the Supreme Tribunal’s rulings 155 and 156, seems to be driving the smart money into a massive regime-change bet on Venezuelan government bonds.

Let’s connect the dots to try to understand what’s going on.

A  political tsunami with zero payoff

The surprise move undertaken by the Supreme Tribunal on March 29th was intended to allow for Maduro & Co. to have the ability to sign key deals in the Oil & Gas sector. Small detail… no oil agreement ever got signed. (At least none that we know of.)

The government’s attempt to source creative financing backfired, as it looks like whomever was on the other side of the negotiating table got scared by the uproar in the international community of the move. It was just too brazen: striking an elected branch of government in such circumstances. In fact, according to opposition MP Rafael Guzmán, that was precisely the reason Japanese investment bank Nomura scrapped its alleged plans for a multi-billion repo operation with the Central Bank.

In this context, it’s easy to see why the BCV was ultimately driven to a last-resort deal with distressed investor Fintech Advisory; it was last-chance saloon for a government that shut itself out of all other options.

‘Real Money’ is once again betting on regime change

As the backlash to rulings 155 and 156 built, and fears over the government’s capacity/willingness to pay its $2.6bn worth of liabilities in April intensified, Venezuela/PDVSA dollar bonds suffered an episode of panic-selling. Soon after, they rallied massively and have held up ever since.

VENZ 2027s are the perfect bond to buy if you think the times are a-changin’.

A curious pattern has emerged amid the buying spree. It’s no longer the same-old bachaquero on Wall Street shoplifting of PDVSA 17s driving the market. No, the trend is being set by an army of European brokers and desperate NY dealers placing higher and higher bids for ‘size’ in any long-term Sovereign bond they can get their hands on.

The appetite is particularly focused on VENZ 2027s, one of the oldest bonds issued by the Republic (the only one born in La Cuarta, together with VENZ 13.625% 2018) and a magnet for long-term investors mindful of a debt restructuring scenario due to its lack of Collective Action Clauses (CAC’s).

VENZ 2027s are the perfect bond to buy if you think the times are a-changin’.

Coincidentally, every trader your talk to has says the same thing: final customers (Institutional investors and mutual funds, for the most part) are pouring money into Venezuela as the political storm is shattering the status quo at a voracious pace.

Price evolution of VENZ 9.25% 2027, April’s best performing Venezuelan bond

Uncertainty over Venezuela’s future has never been more intense, and this has led analysts to a key conclusion: the probability of a sudden regime change is increasing. The thinking seems to be that a hypothetical new government would pursue a more rational debt restructuring path, and that would increase the recovery rate on these far-off-in-the-future type bonds.

These hopes are underpinned by the intuition that anyone would do a better job of running the country than the current bunch. So any restructuring proposal brought forward —as long as it provides the much-needed fix of ending price and currency controls— could be better for long-term investors even if it leads to the short-term pain of a haircut.

The opposition is bearing its teeth to the Street

The opposition’s tone has changed. It’s now drawing a clear line in the sand for international creditors. The most daring display of this new stance came a couple of weeks ago, courtesy of Julio Borges himself.

Borges went as far as claiming that the Maduro government is negotiating a gold ‘swap’ deal with Deutsche Bank, a veritabletubazo.

In an interview with Deutsche Welle, the National Assembly Chairman reiterated the opposition’s warning: any financing operation signed without the Assembly’s approval will be null and subject to repudiation by a subsequent administration.

Borges went as far as claiming that the Maduro government is negotiating a gold ‘swap’ deal with Deutsche Bank, a veritable tubazo since there’s no publicly available information about such an operation, either before or since the interview. Lastly, and more importantly, Borges sent a strongly-worded letter to John Cryan, CEO of Deutsche Bank. The money quote from the letter (emphasis added):

“I’m obliged to warn you that, by supporting the aforementioned gold swap, you would be acting in favor of a government deemed as dictatorial by the international community […] This would set a negative precedent for investment banks assisting dictatorial governments in their eagerness to stay in power”.

As you can imagine, and to a good extent thanks to the opposition’s steadfastness, potential lenders of last resort for the ruling party are now thin on the ground. This creates a vicious cycle: with the Republic and PDVSA’s illiquidity crisis going to dangerous extremes, the lenders still willing to do business with Maduro are demanding extreme conditions. Remember the Fintech repo we mention early? It implicitly priced PDVSA unsecured bonds at a 23 cents on the dollar. Not even Argentina’s haircut of 2005 (the literal textbook example of a screwed-up debt restructuring) was that harsh.

Outside VennyLand, the streets are on fire

It’s no coincidence that April’s debt service of over $2 bn. came against a backdrop of almost-daily mass protests nationwide: social unrest, episodes of looting and raucous political demonstrations. Venezuela is in the terminal phase of the deepest economic crisis since the Federal Wars. The economy, which was already a case study in populist economic collapse at the end of last year, keeps on falling apart. The IMF’s forecasts are as bleak as they’ve ever been: they gauge a 720% inflation rate for this year and 2000% in 2018, and see the unemployment rate spiking to 25% by year-end. The Central Bank’s coffers are almost bare: based on official figures, they’re down to their last 10 billion after a month of heavy PDVSA debt service payments. Imports of essentials have suffered draconian cuts, resulting in a nationwide food crisis.

Rulings 155 and 156 didn’t just trigger the protest movement, they also signalled the government’s complete detachment from Venezuela’s common folk.

Prioritizing external debt over imports of essentials can only go so far. Once they’re cut down to zero or thereabouts, the people have nothing left to lose. Ask the brave fellows of El Valle who booted out an entourage of SUVs carrying government heavyweights who tried to deliver CLAP bags shortly after the tragic incidents that took place in the borough.

Try to sense the anger running through the Valleros’ veins; how, no matter how hungry they are, the only thing they want is to shout ‘FUERAA!’ and blast their pains at the PSUV honchos that are trying (and failing) to pull off a stale patronage trick.

A lot of anecdotes of public officials getting rekt by the pueblo have joined the ranks after the infamous Villa Rosa incident of last year marked the start of the people’s change of heart. They have gotten worse: Maduro was seen seriously compromised on national TV after what was supposed to be a routine military promotion event in San Felix. These events are reminders of what having 80% of the country deadset against you feels like. It doesn’t look pretty. Or sustainable.

The bottom line

Put it all together and it spells the end of the Bachaquero of Wall Street trade. It’s being supplanted in real time by Regime Change Bets: buying long-end VENZ bonds, a bet on a future that’s better than the past.

The Street is calculating that, as the political crisis escalates, so do the costs of maintaining the status quo and the potential benefits of changing it. The precise timing of a government transition is complicated, but the feeling is that key events shape the course of the political process.

Maduro’s latest attempt to cling on to power via a hard reset of the game is one of those key junctures that will define history. It might be just another salesman pitch to keep shoving Venny bonds into the accounts of overseas pension funds, but it makes sense in the grand scheme of things. As market watchers like to say, sometimes “price leads fundamentals.”

So is the current rally in Venny bonds a sign of the impending resolution of our all-encompassing crisis? Or is it the ultimate ‘bull trap’, luring the credulous into a doomed long-term play? Time alone will tell.

https://www.caracaschronicles.com/2017/05/02/venny-bond-market-contemplates-end/

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