Pawning Off the Patria

Don't be fooled by talk of 'repo' deals, Venezuela is pawning assets in international credit markets for pennies on the dollar on genuinely horrendous terms.

The regime took drastic measures to make yesterday’s $2 billion bond payment. Having cut imports by a staggering 73% since 2012, having put up all of CITGO as collateral for loans, having carried out an onerous debt swap with an implicit interest rate of 21%, the regime reached a new low: it started pawning Venezuelan assets.

According to this piece by Reuters reporters Brian Ellsworth and Corina Pons, the Banco Central de Venezuela (BCV) handed over $1.3 billion in previously unsold PDVSA 6% 2022 bonds to Fintech, a Mexican finance firm. In return, it got $300 million dollars cash. The repurchase agreement or “repo” valued PDVSA’s bonds at just 23% of their face value (!).

Let’s be clear, the PDVSA bonds in question are not “collateral”. Collateral is something borrowers own and stand to lose if they don’t pay. Repos don’t work like that —BCV transferred ownership of the PDVSA bonds to Fintech. BCV only gets the bonds back if it returns the money. Until BCV pays —and unless BCV pays—, they’re Fintech’s.

It’s big money and the details sound complicated, but the basic structure of the deal is simple enough to fit on a pawnshop storefront: Compra venta con pacto de retroventa.”

If Venezuela doesn’t show up with the $300 million (+interest) when the contract ends, Fintech simply sells the bonds in the open market.

Instead of a wedding ring, BCV pawned $1.3 billion of PDVSA bonds, that’s all. The structure is the same.

As for Fintech, it’s the finance world’s version of a pawn shop. Wall Street will describe them as “distressed debt lenders” —but let’s be honest, Fintech specializes in dealing with trainwrecks who are out of options. They won’t risk a single dollar without rock solid guarantees.

The contract isn’t public, but think like a vulture and you can pretty well guess what’s in it. If Venezuela doesn’t show up with the $300 million (+interest) when the contract ends, Fintech simply sells the pawned bonds in the open market. That’s why they own them in the first place. All of a sudden, instead of the Central bank owing Fintech $300 million, PDVSA owes bondholders $1.3 billion, creating $1 billion dollars in new external debt. As in POOF! Venezuela gets a billion dollars poorer, ipso facto.

For Fintech, keeping Venezuela’s pawned bonds could actually be the better scenario. As of yesterday, they would fetch about 38% of their face value on the open market (based on trading activity for similar bonds). Divide 38% by 23% and you see that Fintech would get a handsome 65% total return.

If Venezuela does pay the $300 million principal + interest at the end of the contract, BCV gets the bonds back and PDVSA doesn’t have to pay the $1.3 billion in 2022. The question, though, is how much interest?

Again, the deal isn’t public, so we’re left to guess. If the regime is just paying the 6% interest on the $1.3 billion PDVSA bonds for just $300 million cash, that comes out to 26% interest. If they negotiated something else, then it’s the something else. My bet is that Fintech settled for nothing lower than 20% interest. Why? Because they can. The regime is desperate and has no leverage. The Nomura repo failed, the attempt to sell off Petropiar set off a constitutional crisis that snowballed into a diplomatic disaster, and Venezuela was negotiating with its back against the wall days before yesterday’s maturity.  

Why would a country with $10 billion in international reserves strike a deal this terrible rather than just un-saving $300 million?

The whole thing is like a Bugs Bunny coin flip: heads, Fintech wins; tails, Venezuela loses.

Importantly, everything we said about the failed Nomura repo applies to this repo, too. The deal is of questionable legality, since it didn’t go through congress. BCV could still be forced to hand over yet more bonds to Fintech if PDVSA’s bond prices drop below a certain threshold (i.e. the contract might contain margin calls). And if Venezuela doesn’t pay up, the cash-flows will be as bad as if it had issued debt at 30% in dollars.

The operation also feeds doubts about Venezuela’s savings: why would a country with $10 billion in international reserves strike a deal this terrible rather than just un-saving $300 million? How can a country that produces $70 million dollars a day worth of oil be this pressed to come up with such little money? It doesn’t add up.

Reuters’ Marianna Parraga ran a story on PDVSA’s fuel imports that puts all this in perspective. She reports that PDVSA recently overpaid $130 million to British Petroleum for U.S. crude cargoes because PDVSA didn’t have the cash to pay on time and BP’s tankers were docked idly for weeks. You read that right: PDVSA just flushed $130 million dollars —almost half of the money from this repo-pawn— down the toilet because its admin is screwed up. Unbelievable.

Pawning Venezuela’s assets in conditions like these is unsustainable and self-defeating. Everybody loses when the country delays inevitable structural reforms and/or default by refinancing debts at ever-higher rates: Venezuelans desperate for food and medicine, what’s left of the private sector and PDVSA, and yes, even bondholders hoping to get paid someday.