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Venezuelan Bonds: The Game is Afoot

posted by Mitu Gulati

Venezuela began defaulting on its bonds about fifteen months ago and is now in default on almost all of its outstanding bonds (except one that is backed by collateral).  The creditors, for these many months, have shown remarkable forbearance in refraining from accelerating the bonds and seeking judgments. 

The restraint on the part of the creditors for these past many months, I suspect, was not out of any especially benevolent feelings the creditors have towards the Venezuelan government.  Part of the explanation has to do with the different interest rates that applies to unpaid claims if one has an ordinary unpaid claim versus one that has been converted into a judgment (the latter is significantly lower).  On the flip side, the legal protections that apply to a judgment are much stronger (no need to worry about CACs or Exit Consents, and one can grab assets before anyone who has refrained from judgement).  Plus, the reality of most sovereign debt restructurings is that unpaid claims on interest usually don’t get paid out to anyone anyway (since the sovereign can’t even pay the base claims).  For those who want to know more about this, Mark and I talked about these matters here and here, when we were teaching our class on the Venezuelan sovereign debt some months ago.

Once one set of creditors accelerates though, then that puts everyone else who has not done so at a disadvantage because these first guys have an advantage in the litigation/attachment game.  And before today, only a few arbitration claim holders and one Promissory Note had begun the litigation game.  This had been causing anxiety among the bondholders I’ve been chatting with, but they had not made the move to coordinate into blocks of sufficient size to demand acceleration (most of the bonds have a requirement for acceleration of 25% of the holders in principal amount).

Today’s news from Reuters is big though. A group of hedge funds has put together the necessary number of bonds in the Venezuelan bond due 2034.  This is a rather special bond, if memory serves, because an attempt by the sovereign to force a restructuring can be blocked by 15% of the holders (in principal amount) rather than the typical requirement of 25%.  Bottom line: this bond is more litigation friendly.

Other bondholders, we suspect, are having panicky calls to figure out how to coordinate themselves when they had been expecting to be enjoying their X-mas vacations.  The 2034 group that sent the acceleration announcement has been especially clever in that they waited until vacation time – when it is typically hard to coordinate to form a block and hire litigators, etc.  Plus, the 2034 group already hired one of the best in the sovereign litigation business, Mark Stancil (remember Argentina and pari passu).

All of this is particularly interesting in the context of rumors that some financial advisers to the Venezuela's bondholders advised their clients against acceleration and legal enforcement. That advice, now that the 2034s have stolen a march on everyone else, is looking questionable – but perhaps there is some secret strategy that I’m missing.  The fact is that during the period of bondholder restraint, four arbitration award holders have been able to extract settlements from Venezuela by pursuing aggressive legal enforcement of their claims.   And just last week, Conoco Philips was reported to have received half a billion dollars as a down payment on its settlement. The week before Crystallex claimed to have received $425 million in cash and liquid securities as a partial payment of its claim.  (There is a Dec. 12 article from S&P Global Intelligence that suggests that Crystallex is already claiming that there is a violation of its agreement and has returned to litigation).

Now, Reuters is telling us that at least one bondholder syndicate may have internalized the lesson that Venezuela's grease is applied only when the wheel is audibly squeaking.

I’m particularly interested in watching what happens with the bond prices.  Best I can tell, the 2034s are already trading at a price premium vis-à-vis comparables (In our recent article on Veny bond prices Hidden Holdouts, Steve Choi, Bob Scott and I talked about how this premium had showed up earlier this year based just on the rumor that a group of sophisticated players were coordinating to set up a blocking position in the 2034s).  The market presumably recognizes that these bonds are in the driver’s seat. It will be interesting to see how that premium evolves as some institutional investors averse to aggressive litigation exit the bond and litigation-loving activist hedgies enter it.

A couple of points to keep in mind, if you find this drama as fun and  interesting as I do, in terms of what is likely to happen next:

  1. If Santa brings the holders of the 2034 bonds what they want for x-mas, Venezuela will offer these guys their missed coupon payments to persuade them to rescind the steps they have taken already (and maybe something more). That will be a huge win for them over their slower bondholder brethren.
  2. The smart bondholders who read the contracts will realize that because the 2034s are under a Fiscal Agency Agreement, the benefits of acceleration will accrue to every single bondholder in that bond and not just to the ones in the accelerating 25% group. Indeed, there is no need for even them to stay together as a group – at this stage, it is every wolf for himself.

Comments

Interesting stuff, Mitu. Please excuse a somewhat tangential question purely out of curiosity as a secured credit nerd. Are there many examples of judgment creditors on a sovereign bond grabbing assets?

Wonderful question. If we were to go back about fifteen years ago, then the story would have been that enforcing a judgment against a sovereign debtor was near impossible. But since then a combination of increased globalization, courts being increasingly willing to find reduced entitlements to immunity and creditors coming up with creative ways of finding assets to attach have resulted in creditors being able to both enforce judgments and win big victories against recalcitrant sovereign debtors (Peru and Argentina are the prime examples of litigation victories, but there are many others such as Greece where fear of litigation resulted in the sovereign paying up).

And in the Venezuelan case, because it has basically a single asset (oil generates 90% plus of its foreign currency earnings), with very extensive trade ties to the US, the sovereign is perhaps more vulnerable to high quality litigators than any other sovereign defaulter in history.

This is going to be fascinating to see play out

Very interesting piece. Indeed it is a facinating strategic subject of a terribly desperate humanitarian situation. I agree that the start of litigation from any bonholder-syndicated group should bring en masse claims from the rest. However, from a purely theoretical standpoint, Venezuela - perhaps as no sovereign in history - poses a very difficult game theory question, on the value-wipping effects of litigation in the long run vis-a-vis more "friendly" approaches leveraged on the increase of cash flows deriving from the country's titanic oil industry. Should the baton rest in the hand of litigants, I would become increasingly pessimistic on the prospects for both the country (including not only its current Gov't, but also its people) and the heterogeneous band of creditors in general.

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