VENZ/PDVSA: The Mixed Martial Arts of Bond Trading

The Indiana Jones-meets-Wolf of Wall Street reality that is dealing in Venezuelan debt instruments. 

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bondsIt’s days like February 10th, 2015, that keep me in this business. To a casual reader, the news weren’t anything earth-shaking that day. Oil was finally showing a bit of life, reaching 52 $ a barrel. The government announced yet another alternative FX system called Simadi, and BCV was promising a press release. But I’m a Venny Trader – a full time PDVSA and Venezuela Sovereign bond trader – and I could feel the buzz in the air that day.

To be clear, trading VENZ is to normal bond investing what mixed-martial-ats is to thumb-wrestling. It’s a crazy, high-risk world where a good day in the WTI oil market, or a couple of anodyne bureaucratic announcements, are enough in to set off a mad bull-rush, with venny traders tripping over one another to snap up paper.

My team had acquired a position about a week earlier, when we saw the first signs of life in oil, but greed tickled us into bidding for some more in the Intra-dealer auction, which requires size to get in (‘Size’ is a bit of jargon: means trading at at least USD 1MM per ticket.)

There was almost no supply, but we managed to grab hold of some PDVSA bonds. The rest of the Street was also in buying mode, to our amazement; they claimed it was institutional demand, but there was no way to tell.

But one thing kept bugging me. This one trader seemed kind of doubtful about the whole operation: a big Wall Street player with competitive prices, but also a cool person to talk to. Just minutes before the event, out of the blue, he sent via his Bloomberg Terminal a blast message: SELLER 15 MM VENZ 26 PRE-PRESSER. That caused quite a stir and put the rest of the market on sour mode. A couple chatrooms on the Terminal were asking if we were watching the Press Release with Merentes and Marco Torres. And boy, were we!

It didn’t take long to realize we were in for the same chavista BS we’re way too used to: Simadi was sure to be another another flop. Just a new name for Sicad. Then came that sinking feeling in the pit of your stomach: we were sitting on a ton of PDVSA 22s that were milliseconds from tanking. We needed to get rid of them fast, now, before they became toxic.

Of course, everybody else in the market was thinking the exact same thing.

One thing anybody who dabbles in this market learns real quickly is that VENZ are extremely one-sided assets. Either everybody’s a buyer or everybody’s a seller. No wonder the market’s so volatile!

The polite term for this is a ‘high beta’ asset. That means that this asset’s price volatility is extremely high compared with, well, almost every other asset you can get your hands on. The volatility is so high in VENZ that regular pricing conventions in Fixed Income just don’t apply. And it makes sense: what’s the point in quoting these bonds in yield terms, when a single day’s change of price can account for several months of interest in either direction? Consequently, this asset class attracts a special community of traders around it.

When you think about Venny Trading, it helps to first forget everything you thought you knew about bond markets: this is no boring, stable market with liquid and transparent trading conditions. VENZ/PDVSA is mainly characterized by Over-The-Counter action (as in, no regulatory oversight, no central clearing, no guarantees… you get the point) on the Street, the guild of investment banks located in New York City that act as market-makers. They are joined by a web of inter-dealer and retail brokers, whose purpose is to bring some clarity into the market by matching buyers and sellers (in return, taking a slice of the trading flow they help to create). Finally, there’s the end customers: a mix of US and European Investment Funds, private banks, and a small group of banks based in Venezuela that participate in the market trading VENZ/PDVSA bonds.

I belong to the last group since 2013.

Everybody knows the VENZ/PDVSA market is a guillotine. It feels rigged against end-clients almost by design. It’s extremely easy to lose money in Vennieworld. First off, there are those outrageous transaction costs (which may amount to 3% of the invested amount, per trade). Second, there’s the out of control volatility: seriously, 5% moves in a single day aren’t for the faint of heart! Third, there’s the liquidity, or rather the lack thereof: it’s usually impossible to trade bonds without moving the price against you. Sometimes, you can’t trade them at all.

Every time I try to buy or sell a bond in this crowd, I know I’m swimming with sharks. Or playing a hand of poker with the Mafia. Why come back for more, you ask? Because I’m hooked on days like February 10th.

To give you a sense, here’s the intraday chart that day. The press release ended at (you guessed it!) 12pm New York time. Before that, bonds rose non-stop for two hours and never looked back. From then, though, it was just a matter of minutes before the bonds started their freefall.

Sin título

We were way too heavy on bonds and the army of buyers suddenly disappeared. We got a final customer arriving at 12:04pm. Our savior. He was a broker-dealer looking for ‘size’ in a bond that we were in fact owning at the moment, and we sold him half of what he wanted from our inventory, and the other half ‘short’. We were able to buy back the bonds 1 point cheaper in less than 5 minutes! Boy, if we had waited… And after that, we had to sell off in masse our other holdings of bonds, before they made us lose money.

At the end of a very tiresome day, I wrote to the street guy who was selling the Venz 26 before the release, asking him how his session ended up. He said that it had been one of the craziest days in his trading career.

And so was mine!

1 COMMENT

  1. “My team had acquired a position about a week earlier, when we saw the first signs of life in oil,..”

    A fun post to read! “First signs of life in oil” moves the Venny market? Now with oil prices hitting record lows I wonder how those Venny Traders feel about the government making those massive upcoming bond payments? Do they really believe that they’re gonna move all of that gold back to London and Zurich?

    • @Dr. Faustus,

      I’m glad you enjoyed my piece. It’s crazy, yes, but there are a lot of ‘non-event’s that move this market, pretty much as what happens in financial markets as a whole.

      And you got it, with oil on the verge of hittting new cycle lows, there’s a lot of fear and bonds are sliding alongside WTI; hence, there’s no much sense in trying to catch a knife here.

  2. I once heard that most of the Venezuelan/PDVSA bonds are held by Venezuelan nationals. Is there any of truth in that?

    There are a couple of people here that really thinks that Venezuela /PDVSA bonds are just another scheme for Chavistas to get rich.

  3. Right now, Houston’s in an economic slump due to the low petroleum prices. Is it going to pick up as well? We’ve been thinking of buying a house, but the prices keep getting better!

  4. This piece was so describing! Nothing like the venny spectrum to never get bored. Of course is easy to lose money (intraday especially), but when you get it right playing with the short end of the curve when you’re “distressed mode on” (i.e.: buying PDVSA’15 in January, February), or if you go with low dollar value and high carry for a while….God, is so worth it. But indeed, you gotta have stomach and be willing to pay some margin calls once in a while. The question is if VENZ’16 will prove to be a good bet at current oil prices, as it happened with PDVSA’15…I think it is. Cannot miss that one.

    On the other hand, Venny Research is like another type of martial art. Or like being bloddy Sherlock Holmes.

  5. Kudos on the excellent piece , its always exciting to have a peek at a slice of real life involving the brokerage of venezuelan bonds in the world markets . I imagine that these brokers have investigative units on the reality of venezuelan oil income and oil production , can they tell us something that official stats keep hidden or distort ??

    Im told the govt is using every spare cent they can get to buy ven bonds maturing in 2015 (of course with a deep discount) to lessen the cost of paying their principal , moreover that 2015 bonds are now very difficult to buy. Can our venny trader confirm whether thats true .?? , some have informed that the govt now holds some 40% of the bonds maturing in 2015 , is that likely??

    What would happen in real life if in 2016 the govt or Pdvsa are unable to pay for the maturing bonds and interests , have the venny traders looked at this scenario , what could we venezuelans expect to happen in such event.??

    • Bill,

      I am not a market-maker so can’t tell you about overall liquidity of the PDVSA 2015. Perhaps the trader mentioned in the article can confirm. However, I can tell you I have had no liquidity problems in 2017 (both old and new) and 2022 when buying/selling but also because I don’t sell a lot and will certainly not do so in a time of stress (unless it is because I want to take advantage of dislocations in certain maturities to increase face value/coupons). But it is also important to remember, it is not like the liquidity of this market is that much more different than that of other EM bonds when the market is under stress and same would apply to all these OTC bonds of EM corporates. Usually, that spreads are very wide in EM OTC bonds is not something unexpected or specific to Venny/PDVSA.

      No one can tell you about stats that are hidden or distorted, but the only thing I can tell you is that regardless of the internal mess the country is in, an investment in Venz/PDVSA bonds in the current scenario is extremely attractive from a risk/reward perspective, especially if you compare this with what is available in the rest of the market (after all, you are seating on the largest oil reserves in the world and debt ratios are not that unmanageable, especially if you take into account the current market price of the overall debt). And the amount the govt. holds is not confirmed (Reuters recently did a piece on it where I think they mentioned some amount which I can’t remember off the top of my head) but I would assume that it would high, merely because it can the govt. quite a lot of money in a short period of time.

      There are certain things that can happen. The govt. could keep paying and stay current (which is what I think will happen), another option would be to do a friendly restructuring (similar to what Uruguay did not long ago but with a much smaller amount at play) or they could default altogether (Argentina or Ecuador style). Now, consequences of a default are difficult to assess but there could be extended legal battles and bondholders trying to recover their assets, chasing down oil tankers, assets abroad, cutting credit lines to the country which could make import of goods more difficult, among other things, so this could somewhat make things more difficult for people living in the country. There is little precedent on this but there was a case in Africa were a fund manager managed to get full payment on its bonds after seizing an oil tanker from an African country who had defaulted. However, the govt. can also do things to avoid the seizure of boats by selling FOB (which they do to an extent). Also, a default might happen in the sovereign bonds but not in the oil company (something which happened in Mexico for example). All in all, recovery values in defaults in the past have been around 30% of the face value of a bond approximately, which makes an investment in bonds priced at say 35-45% paying coupons of 5-13% per annum not completely crazy (which is also why again the govt. is repurchasing). Also, why would they repurchase now if they are going to default later? They would have defaulted already – but that is my view which is subjective and I am obviously biased. There are many other reasons which in my opinion justify such an investment at the present stage but they can’t all be summarised here. The only thing I would say is one needs to remain very focussed and not let emotions trick you. The article is good but I don’t really enjoy a lot the whole “excitement” spin to it and to markets and finance in general. Finance and markets are not supposed to be places for emotions, these are not casinos, they are boring. They can be if you want them to be and in many occasions they are hijacked by collective psychology and unrealistic expectations which might lead to bubbles or might drives prices to very distressed levels (the opposite of a bubble but which is also driven by emotions). Analysis should be conducted with rigueur and emotions should be kept as far as possible. But obviously, Hollywood and media are not interested in selling boring things…

      • Correct – but the govt. performing buybacks (something not unusual for debt issuers) goes all the way back to 2009 or even more I would say (http://uk.reuters.com/article/2009/12/04/venezuela-debt-pdvsa-idUKN0427330520091204). It is not that difficult to do and certainly not crazy.So yes, they won’t lessen anything by buying 2015 now but they certainly would have 6 months ago, for example. And they would certainly lessen their whole liabilities by buying 2016, 2017, etc. now. But hey, you don’t want to tell everyone exactly when do you want to do it, else it defies the whole purpose….

    • @Bill Bass, @Venny Trader:

      I’m glad you appreciated the piece. To be honest, I’m no expert in this market (I’m just 2 y/o into VENZ, and only about 1 year managing prop positions with full autonomy). There is so much to know about this and other markets that I don’t know yet, and it’s a testament to the situación país, that a freshly collegue graduate with very little experience, has trading responsibilities managing a multi-million proprietary book.

      Let me add my two cents based on your questions:

      1. There is little actual intel that we manage aside from official stats, and it comes mostly from the research pieces published by the Street. These are mostly estimates on oil production, fiscal and external accounts, etc. Sometimes, price action is more telling than these pieces..

      2. The government buyback of short-end PDVSA is a reality, both evident from the rally in PDVSA 2015 (last trade at 100% or par), and from government sources that confirmed this a few days ago in El Mundo: http://www.elmundo.com.ve/noticias/economia/politica/suavizan-pago-de-deuda-para-el-segundo-semestre.aspx
      On this, there are some things to consider:
      – These bonds are no longer economically efficient to repurchase, since there’s no discount from face value. So the next logical candidate is PDVSA 2017N (the one which amortizes 1/3rd of principal in November 2015 and last traded at 65.35%). The govt doesn’t touch anything over 2017 in principle and based on what I’ve seen in the market. And I think the 40% ownership of Pdvsa 2015 is a good guess since there’s still paper floating around, but the bonds have become extremely hard to find; there are anecdotes of dealers that are short Pdvsa 2015 and have been forced to cover their positions above par!

      – If VENZ doesn’t pay their next bond repayments, yeah, that’s gonna be ugly for bonds, esp. for the short end, since the rest of the curve (2018 onwards) is trading between 30 and 42 cents on the dollar. Recovery rates are an unknown and depend heavily on the context in which a credit event unfolds, in my opinion.

      – Venny Trader is true in the sense that the reality of VENZ is no different from most EMs, even in price evolution; the difference is that VENZ has way more beta than the other names, so the price volatility is way higher on our bonds. The illiquidity, on the other hand, is increasingly becoming a reality on almost all fixed income markets, and sometimes is not THAT bad in VENZ, especially if your counterparty base is large.

      – I wrote a piece about the emotional aspect of trading the credit since I think it’s a story worth reading by a broad audience, but there’s definitely a LOT of boring, scientific work behind investing in this and any other financial instrument. I have developed some proprietary methodology to analyze VENZ under credit event scenarios to determine this “risk-reward” ratio between collecting the sky-high interest rates vs. facing the possibility of receiving 25 or even 20 cents on the dollar in case of a credit event, for example.

      -(DISCLAIMER: please don’t take this as a recommendation to buy VENZ) The risk-reward ratio is pretty good here to buy low-dollar bonds around 30% anad collect the interest. I’d say that buying high-coupon bonds would be a better bet medium-term if one has the view of a potential rebound in oil, since they are becoming way cheaper in relative terms in this downturn; nevertheless, there are no signals of Oil rebounding anytime soon, and WTI it’s ticking 42.29 as we speak. So you need big cojones and a lax mark 2 market to handle the volatility!

      Appreciate your feedback and would gladly stay in touch with anybody interested.
      Best regards!

      • Thanks for your comments Dauz.

        Welcome aboard then! Don’t be doubtful by just being a freshly college graduate, what matters is the capacity to analyse issues in detail. Don’t think traders in main financial centers are that much more senior or sophisticated either, many of those who are trading right now at bulge bracket banks (not so much in the AM industry) haven’t even gone through various credit cycles let alone seen a rate increase, when the time comes (because it always does), it will get ugly. Just as an anecdote: I don’t really think that the situation with Venny/PDVSA (credit-wise) is that much more worse than it has been in the past, it is just different. Different issues at play, but what has been a constant factor has been the willingness and ability to pay even in times of great stress. I’ve seen far worse situations in terms or Venny/PDVSA losing a lot of market value very quickly. For instance the oil strike in early 2000’s, the crisis in ’09 where I remember seeing the Global 27 lose 20 points in a matter of two days or when Exxon obtained a court order to seize some PDVSA assets and bonds melted, only for the order to be lifted shortly after.

        With regard to recovery rates being unknown, that is true. But in most sovereign default cases, recovery rates of 20-30% are not unusual, so it is a good starting point in terms of assumptions. No one knows everything, so one has to make assumptions to move forward and only time will tell whether one made the right choice or not.

        On your piece, if it is publicly available, I would be very interested in getting hold of it. By the way, I’ve always thought that if one is not obliged to mark-to-market, Venny/PDVSA is a market to buy and hold while collecting coupons. I disagree with those that say it is a market to trade, it is increasingly difficult to trade it and you may be better off buying in the dips and collecting coupons in the long run.

        • Thanks for feedback, I’m mostly on the same page as you then 🙂

          Couple of comments:

          – I think 25% would be the most appropiate recovery rate here (it’s the baseline used on CDS pricing and there’s a lot of gravity around that figure in the investing community), and a view about the recovery rate vs this baseline would be the trading signal (eg. if you think recovery is > 25, then buy Vennies! Forward bond prices imply a recovery of 25% in most cases at current valuations).

          – The mark 2 market issue is a reality of the trading book I trade on. I understand that it is negative for trading the credit, since the changes in profit & loss are huge; and the psychological implications of that are terrible. But it’s the way our desk works, for better or worse.

          – I’m working on the paper. For now, I just have a couple of ugly Excel worksheets cluttered with numbers. I think I’m gonna take this weekend to give it some shape 🙂

          Best regards,

  6. Thanks DAUZ for answering my questions so straightforwardly and precisely, thanks to Venny T for his opinions on the subject , Its absolutely clear now that the regime is buying as many bonds maturing in 2016 and 2017 as they can possibly afford given the steep and continuing fall in its oil revenues and its need to maintain at least a minimum supply of imported basic staples to the population to avoid a social explosion and a stronger increase in the number of its opponents.

    People have this funny idea that just having large oil reserves is enough to assumme a countrys capacity to pay its humongous debts . They dont take into account that what really matters is how easy or difficult and how expensive or inexpensive it is to monetize such reserves to be able pay the countrys debt .

    For example Venezuelas reserves are now mostly in the form of extra heavy faja crude which is very costly and difficult to produce and which yield a much smaller per bl revenue to its producers , For example to be able to transform that crude into a marketable crude it must be either mixed with expensive refinery diesel or naphta , or mixed with the most expensive kinds of light crudes ( of which there is now a short supply in Venezuela) or build upgraders (which cost about 12-18 billion $ per 200k bpd capacity) to transform from extra heavy crude into ordinarily saleable crudes with a 10% loss in volume and at least 3 years of work .

    Acccording to Opec figures Venezuelas daily production (as established as per its independent sources) is of about 2.3 to 2.4 mbd of which 750 kbd go to supply local demand at prices which dont cover the cost of producing them leaving some 1.6mbd for exporting at 40-50 $ per bl . Production costs (also as per official numbers are in the 15$ per bl range) . If you do the math the amoung of US$ left to cover all of Venezuelas import needs , fund govt finances and pay its external financial debt isnt all that much.

    Of course if the Chinese decide to cover the deficit in Pdvsa finances its an entirely different matter , but who can guess how the chinese view the capacity of Venezuela to meet its external obligations !!

  7. When thinking about Venezuelan bonds, I keep hearing this voice in my head with a heavy Alabama accent saying, “That dog will bite you.”

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