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Battle of the Bonds: PDVSA Versus Venezuela

posted by Mark Weidemaier

Mitu Gulati and Mark Weidemaier

Over at Bloomberg, Katia Porzecanski notes that investors in Venezuelan debt are “worried they’re getting ghosted.” Overdue coupons are piling up, and no one is sure whether it is because the government is done paying or because U.S. sanctions have made financial intermediaries slow to process payments. Meanwhile, the government has maintained radio silence about the restructuring it purported to announce six weeks ago. The fact that a few PDVSA coupons have been paid in the meantime prompts Porzecanski to ask whether Venezuela is capitalizing on bondholder inertia to “quietly, selectively default,” and whether the government “may ultimately prioritize PDVSA’s debt over its own.” This Reuters article by Dion Rabouin answers the latter question in he affirmative, opining that Venezuela is more likely to default on its own bonds than on PDVSA’s, for two related reasons. First, PDVSA’s oil revenues are the government’s main source of foreign currency; second, a PDVSA default may prompt creditors to seize oil-related assets abroad, potentially including CITGO.

Venezuela and PDVSA are massively indebted. Bond debt alone amounts to roughly $60 billion. Functionally, it makes sense to view this all as one giant debt pile, given the close relationship between the government and PDVSA and the latter’s importance to the country’s balance sheet. Formally, however, the two issuers are distinct (at least until they are ruled to be alter egos), with distinct legal status, distinct protections under the law of foreign sovereign immunity, and distinct restructuring options. Moreover, the outstanding bonds have different legal terms, both across issuers (e.g., most Venezuelan bonds have CACs; PDVSA’s do not) and within a given issuer’s debt stock (e.g., different government bonds have different CAC voting thresholds).

An issuer with a large debt stock must choose where to focus its efforts to get debt relief. One possibility is to impose greater losses on bonds with fewer legal protections, because investors in these bonds cannot put up a tough fight. Of course, other factors also matter. All else equal, for example, governments would prefer not to leave investors feeling as if they were treated arbitrarily. Still, investors who bought instruments with weak protections should suffer the biggest haircuts.

As it turns out, it’s not so easy to tell which bonds have weaker legal protections. On their face, the Republic’s bonds look easier to restructure because most have CACs, which allow for supermajority modification of payment terms. PDVSA’s bonds, by contrast, require each individual bondholder to assent to any such modification. This difference is one reason why the Reuters article linked above takes the view that PDVSA’s bonds are safer. But we are less confident in the importance of the CAC/no CAC distinction. PDVSA’s bonds may lack CACs, but other clauses can facilitate restructuring, including through the use of exit consents and by creating new liens consistent with the bonds’ negative pledge clauses. Moreover, PDVSA might be able to restructure in a Venezuelan bankruptcy proceeding, if the government passes bankruptcy legislation that merits recognition in the United States. To quote a prior article by Katia Porzecanski, quoting Jay Newman, formerly of Elliott:

The $30 billion of debt issued by PDVSA, in fact, may be worthless in a default, he says. “PDVSA doesn’t own the oil. It’s some amalgamation of production assets, trucks, offices and rusted pipe,” Newman said from New York. “The oil belongs to the state. If PDVSA is reorganized under local law, external bonds could be a zero. Investors should be thinking about the possibility that they will never see much, if anything at all, on their PDVSA bonds.”

Bond market prices seem to reflect this confusion. Last we looked, short duration PDVSA bonds seemed to be trading at higher yields that comparable Venezuelan bonds, but this relationship inverted for bonds with longer maturities. And the Republic’s recent behavior, which suggests it may favor payments on PDVSA bonds at least for now, complicates matters further still.

All in all, then, it may be a mistake to assume that the absence of CACs, and the need to protect oil-related assets from creditors, make PDVSA’s bonds the safer bet. As Anna Gelpern noted here previously: “I am struggling to see how the unanimity requirement or the pari passu clause in Venezuela 2027s and similar CAC-less bonds could save me from the howling monkeys.”

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