Distressed Sovereign Debt Investing

[chesko182]

Does anyone have any experience trading names in this space in the past?

 

I'm from Venezuela and I'm sure a lot of you have read the headline news. Basically the government is on the verge of collapse, mainly due to little financing alternatives and having ran out of money, but they haven't defaulted just yet (bonds are Venezuela Republic and PDVSA, the state owned oil company)

 

I am quite familiar with the situation there and some of the scenarios which can play out in terms of a change of government. I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.

 

What are some of the things to look for here? 

 

Thanks

[Cigarbutt]

No experience in this space but have looked at this topic for a while.

 

-What key inputs do you use to estimate recovery rates in this specific case?

-Do you think that involvement of vulture hedge funds could actually increase risk for other investors?

 

-What's the future of Venezuela?

[chesko182]

One big issue here is that official economic data hasn't been published in a number of years, and even getting figures like total government debt is tough because the government has used alternative source of financing through China, Russia and others. So you have to make some assumptions and back of the envelope stuff when it comes to debt/GDP etc.

 

I'm assuming an IMF restructuring once a change of government takes place. The current government has no money left and people are on the streets every single day protesting because there is no food or medicine, next catalyst I think will be internal problems within the government and military that will cause them to break eventually, which is inevitable at this point.

 

I've started reading some pieces on the IMF process to get a better understanding.

 

The country has the biggest oil reserves in the world and if you bring back foreign investment with a more market friendly government, debt reduction should not be as hard as in Greece or Argentina for example which is very dependent on austerity. So from that simple standpoint, logic would tell me a 30-40% recovery rate is pretty conservative, hence why I think below 20c should make sense.

 

Have not given a lot of though to HFs, some of them have actually started buying I know for a fact. One bought an issue held by the Central Bank for ~23 cents and actually financed the government 300mm they needed to make an interest payment.

 

If anyone has seen any good pieces on this subject please share. It would also be helpful to see historical recovery rates and the specifics of each country at the time because I know these numbers vary by a lot.

 

Here are some links:

http://www.heritage.org/budget-and-spending/report/what-debt-crisis-default-primer-governments

http://www.financialpolicy.org/dscsovdebt.pdf

https://www.imf.org/external/np/pp/eng/2013/042613.pdf

Sovereign_Debt_Default_--_A_Primer_for_T.pdf

[Cigarbutt]

Thanks for the links chesko182.

Not in vogue anymore, Brady Bonds are still interesting to review because features of those bonds continue to appear in sovereign debt restructurings.

Venezuela has been involved in those bonds.

 

http://www.people.hbs.edu/besty/projfinportal/ssb%20brady%20primer.pdf

https://www.imf.org/external/pubs/ft/wp/wp9816.pdf

http://corporate.morningstar.com/ca/documents/MethodologyDocuments/IBBAssociates/StocksBradys.pdf

 

Venezuela has huge oil reserves but the break-even price is relatively high and oil infrastructure probably needs significant investment just to bring it back to normal levels. No?

 

I have followed Argentina over the years. Cycles are cycles and things can eventually get better. Currency controls are mostly a thing of the past for them. May take a while though.

 

https://www.bloomberg.com/news/articles/2017-01-19/macri-s-argentina-returns-to-bond-market-amid-hurdles-snapshot

 

 

 

As far as price controls, isn't this more of a symptom than a treatment?

 

I like investing at the bottom and can live with averaging down but is the bottom in sight?

 

[Green King]

Does anyone have any experience trading names in this space in the past?

 

I'm from Venezuela and I'm sure a lot of you have read the headline news. Basically the government is on the verge of collapse, mainly due to little financing alternatives and having ran out of money, but they haven't defaulted just yet (bonds are Venezuela Republic and PDVSA, the state owned oil company)

 

I am quite familiar with the situation there and some of the scenarios which can play out in terms of a change of government. I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.

 

What are some of the things to look for here? 

 

Thanks

 

Why don't you just buy some property on Margarita Island? Also care to give a local perspective on the safety of living there?

[JayGatsby]

I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.

How do you look at recovery rates for Venezuela (or sovereign debt in general)? I've always avoided sovereign debt because I've assumed the recovery rates if they defaulted would be close to 0, since they don't distribute assets.  I know Elliott and others have been effective at getting governments to repay by effectively holding them out of the bond market until a resolution is reached.

[Jurgis]

Don't you need to have like multi-million (billion?) accounts to go for distressed sovereign debt? I was just reading the Elon Musk book where he suggested some Canadian bank buy LatAm distressed at .25 on dollar (guaranteed by US, so .50 recovery was "certain"). But he was talking multimillions...

 

Anyway, I don't think I have insight into this apart that find sure opportunity like Musk did. Though this was in 1990's so possibly it was way easier to find sure things...  8)

[Pelagic]

Maduro's regime collapsing looks like just one of several scenarios to me. While I don't disagree that it appears to be on the verge of collapse, despotic and broke governments have held on for far longer than anyone would expect before and at this point it could be another couple years before a real collapse in Venezuela. Even in the event of a collapse, do we see a more normal government come into power or simply Maduro abdicating to another Chavezista in a more palatable form?

 

Looking at their oil reserves, they've sought alternative financing for their government by selling off portions of production to China, a loan by China paid back in oil. With roughly 2mmboe/d in production (declining due to lack of reinvestment) what's China's appetite for extending more similar loans. At a certain price prior to government collapse or default I think somebody would be willing to extend another similar loan, although Venezuela's ability to service it so far doesn't help their case.

 

http://www.cnbc.com/2017/02/10/venezuela-falls-behind-on-oil-for-loan-deals-with-china-russia.html

 

Rising oil prices kind of work against an investment in the sovereign debt. If you're hoping for a quick collapse, another leg down would speed that up, but if prices rise and the government's piggybank starts spitting out coins again then the current mess will likely stay around a while longer unfortunately.

 

[chesko182]

Why don't you just buy some property on Margarita Island? Also care to give a local perspective on the safety of living there?

Real estate is actually not cheap because everybody who is able to save some money will invest in hard assets given that we have hyperinflation (some estimates now put it above 1,000%), so there's a lot of natural demand for it. I haven't lived there in 8 years but know for a fact that safety is nonexistent; kidnappings, murders & getting robbed are every day occurrences. I had some experiences back in the day and have a lot of friends who've been through stuff too.

 

Venezuela has huge oil reserves but the break-even price is relatively high and oil infrastructure probably needs significant investment just to bring it back to normal levels. No?

 

As far as price controls, isn't this more of a symptom than a treatment?

 

I like investing at the bottom and can live with averaging down but is the bottom in sight?

 

You're correct on the high b/e price of oil I think it's in the low 40s and it's also the shitty kind of oil (heavy and sour? I'm not an oil expert though..) but either way Venezuela has the biggest oil reserves in the world and I think with a new government a lot of foreign money would come back and invest the CapEx needed as well as new projects.

Price controls started as a (retarded) treatment for inflation and is obviously now a symptom of the incompetence of the government and state of the economy.

Bottom is hard to call, but having seen some stats on distressed debt pre-default and post-default, history would suggest it is better to wait and invest after defaults happens as the average price drop I think is something to the tune of 25%, so the market doesn't always "know" that it's going to default". This is why I'm sitting still at the moment even though the lowest priced bonds are trading around 37 cents.

 

How do you look at recovery rates for Venezuela (or sovereign debt in general)? I've always avoided sovereign debt because I've assumed the recovery rates if they defaulted would be close to 0, since they don't distribute assets.  I know Elliott and others have been effective at getting governments to repay by effectively holding them out of the bond market until a resolution is reached.

This is what I'm working on now and trying to read up on it. One back of the envelope calculation is based on Debt Sustainability Assessment done by the IMF which basically looks at debt/GDP of the country as well as Interest payments as a % of GDP, and coming up with a conservative/realistic number to back solve what sort of haircut bondholders could negotiate with the country. In the case of Venezuela the oil reserves are a big part of the recovery value too because it removes the need for austerity measures, with proper investments the government can get a lot of $$$ from this. But either way, this is where I was  hoping someone here with experience in the space could give us some insights in terms of how to calculate this and what to look for, some of the assumptions one has to make here may end up putting this one in the too hard pile for me...It would also be interesting to look at a case study.

 

In terms of sovereign debt in general, you're right there are no claims on assets usually but what normally happens is that the defaulted bonds get exchanged for new bonds with a haircut on the original issue once an agreement is reached between the bondholders and the country. Historically recovery values have been between 40-70 cents for sovereign defaults, there are actually very few cases where investors lost 90% or more (I think one or two in Africa). Also the time it takes to actually reach a resolution is very important... Singer's Argentina investment was very highly covered by the media and although it was successful (I think he almost tripled his money) the fact that it took him 15 years brings the return to ~8%.

 

Don't you need to have like multi-million (billion?) accounts to go for distressed sovereign debt? I was just reading the Elon Musk book where he suggested some Canadian bank buy LatAm distressed at .25 on dollar (guaranteed by US, so .50 recovery was "certain"). But he was talking multimillions...

 

Anyway, I don't think I have insight into this apart that find sure opportunity like Musk did. Though this was in 1990's so possibly it was way easier to find sure things...  8)

Not really... many of these bonds have a minimum investment of $1K but obviously the typical investor in these is a hedge fund and my gut says not a lot of individual investors put money in these things. I haven't heard of that investment specifically but it sounds like some LatAm bonds issued in the late 80s/90s that where actually backed by US Treasury zero coupon bonds so that would have been a no brainer!

 

Maduro's regime collapsing looks like just one of several scenarios to me. While I don't disagree that it appears to be on the verge of collapse, despotic and broke governments have held on for far longer than anyone would expect before and at this point it could be another couple years before a real collapse in Venezuela. Even in the event of a collapse, do we see a more normal government come into power or simply Maduro abdicating to another Chavezista in a more palatable form?

 

Looking at their oil reserves, they've sought alternative financing for their government by selling off portions of production to China, a loan by China paid back in oil. With roughly 2mmboe/d in production (declining due to lack of reinvestment) what's China's appetite for extending more similar loans. At a certain price prior to government collapse or default I think somebody would be willing to extend another similar loan, although Venezuela's ability to service it so far doesn't help their case.

 

Rising oil prices kind of work against an investment in the sovereign debt. If you're hoping for a quick collapse, another leg down would speed that up, but if prices rise and the government's piggybank starts spitting out coins again then the current mess will likely stay around a while longer unfortunately.

 

Yes, but the reason why I think now there is a high probability a change in government in the next 12-18 months is actually related to the inevitable default of the bonds. They are essentially facing a liquidity crisis right now, they've cut imports by more than 50% (literally starving the country hence why these are being called Hunger Bonds by the press), and they've started to miss interest payments on bilateral and multilateral loans of as little as $30mm, and have taken desperate financing measures like raising $300mm from a hedge fund by selling debt at 20 cents on the dollar in order to be able to meet the last payment. I think there are still around 4 or 5 billion due this year that is going to be very hard to come up with (intl reserves are $10bn) and next year there's again billions of dollars due. At the same time the entire country is in the street protesting and latest polls show that current government approval is less than 20%. So once the default happens the government is basically toast because they won't even have money to pay themselves and all of them will instantly flee the country before they're put in jail for corruption and drug trafficking charges. And there is no way the current party wins another election after this mess..

 

 

[Pelagic]

Thoughts on the situation in Venezuela? It looks like Maduro is going to rewrite the constitution and entrench himself as "president for life" what happens next? PDVSA and Venezuela as a whole will probably face US sanctions this week as well. I feel that regardless of what Maduro is able to do this week to eliminate the legislative branch, rewrite the constitution, and solidify his power, the financial mess will catch up sooner rather than later and force him out of power, although I don't see the transition as being a peaceful one.

 

It's heart wrenching to watch a country spiral into totalitarianism and I can only hope this regime is short-lived as the Venezuelan people have suffered enough already. 

 

[Cigarbutt]

Sad turn of events.

Institutions matter.

Sometimes political/social climate deterioration is sudden but often the downturn is preceded by an autocratic drift.

I am re-reading Animal Farm by Orwell.

We take a lot for granted but things can get messy very rapidly once the drift is underway.

 

 

[MrB]

In my limited experience, this is what I call a "can't pay, won't pay" situation, so you're left with the discounted future cash flows as the intrinsic value of the bonds (surprised?). Certainly there will be new bonds, which will be issued in a scenario where the debt load has been reduced and the new debt load will be as large as the market will bear (the creditors will see to that). In effect the equilibrium is the largest SUSTAINABLE debt load and sustainability is determined by the tax base (your cash flows). 

 

SO,

Firstly what you have to figure out is what is normalized GDP (e.g. -25% for Greece recently).

Secondly, you have to figure out what a normalized tax base for the country is.

Thirdly from the tax base you can figure out how much you can allocate to debt service, which are your interest payments (more or less)

Fourthly capitalize your interest payments at a normalized interest rate for the country (it will be a low rate, because the debt has been reduced)

Lastly, divide your "new" debt/"old" debt and you should get a sense of the cents of the dollar your existing debt is worth. (e.g. for Greece we estimated it to be around 35 cents, margin of safety started below 30 and you could buy down to 17)

 

World Bank & IMF have useful data

 

It's a journey!!

 

 

 

 

[chesko182]

The news from yesterday increases the tensions in the country as it is now "officially" a dictatorship. Votes according to the government were more than 8 million and estimates of the actual votes range between 2-3 million (talk about inflating a number...) Protests and violence are likely to escalate.

 

~$4 billion of interest+principal payments are due this year, and they have less than 10 billion in reserves, a lot of which is in gold which is already collaterized for other loans. Hard to see China lending more money, but there is speculation that Russia might step in (they were the only country that called the elections legitimate).

 

My base case is for a default in the next 6 months at which case I will be looking at the bonds to potentially buy them at 15 cents of less (lowest dollar price now trading around 33c). Assuming some form of IMF bailout to the tune of $40 billion and running some realistic debt-GDP numbers with a haircut to the bonds recovery values can range from 20-50c in the form of a restructured bond exchange. The key here is also that a default would be a catalyst for a regime change given it would debilitate their powers and cut a lot of their financing options. Further US sanctions in the form of oil imports etc. would certainly accelerate this, but we'll have to see what Trump has in mind. President Maduro was just added to the OFAC list today.

[adventurer]

Instead of buying now or even when the current government is in charge, I would rather go for it once the government is gone and the bonds default. Since there are many HFs engaged as well as Goldman Sachs having their hand in there, I am sure the US will not be keen to make any further trades with the new government as long as their "old" debt is not paid. In that respect I have to admit that I do not understand GS to the fullest. The highest chance for profit basically occurs once the bonds default, which tells me they either believe in the govenment or they intend to buy more once the bonds defaulted to influence the new government.

 

Does anyone know where to find the bond terms?

 

I like MrB`s approach because I did not think of that so far, thank you for that.