Under President Hugo Chávez, Venezuela’s international reputation has fared poorly. Newspapers around the globe are filled with reports on street protests, political conflict and Chávez’s increasing authoritarianism. While the media have spotlighted the government’s flaws, financial markets have taken a great interest in the oil-rich nation. Venezuela’s government mandated Barclays Capital and Merrill Lynch to make the most of the positive sentiment in the markets to engineer a highly regarded $1.5 billion sovereign liability transaction.
“Regarding liability management in Latin America last year, Venezuela stands out. The sequencing and choice of instruments was skillfully done, as was the execution,” says Mohamed El-Erian, managing director at Pimco, the world’s largest emerging market bond fund.
Financial markets have been treating Venezuela well since oil prices rebounded spectacularly last year and Chávez’s hold over the country was confirmed when a recall referendum failed. The country saw successive upgrades in its rating during the year. Standard & Poor’s raised Venezuela, which has $22 billion in foreign debt, to B in 2004 from CCC in 2003.
Christian Stracke, emerging markets analyst at independent research firm CreditSights, notes: “Venezuela clearly has long-term problems – political, fiscal, economic – that it must face in order to graduate to a BB credit rating. For now, however, we continue to see good value in Venezuelan external-debt spreads relative to the rest of the market, and we continue to recommend an overweight in Venezuela.”
The government mandated Merrill Lynch and Barclays Capital to launch an ambitious liability management initiative in September. Tobías Nóbrega, finance minister at the time, and Alejandro Dopazo, head of public credit, agreed with the banks’ plan to structure a deal that would exchange maturing Brady bonds for new global bonds and simultaneously raise additional financing for the government.
Dopazo, who has since resigned, said on the eve of the transaction: “If we sold a foreign bond now, it would be at one of the lowest yields ever, so we want to take advantage of that.”
Carlos Mauleón of Barclays says the transaction was designed to “reduce short-dated debt service associated with DCB and Flirb [Brady] amortizations, reduce refinancing risk, extend average life and duration of external liabilities and create a new 10-year benchmark, maintaining the flexibility to raise new cash.” Venezuela offered to exchange all its DCB and Flirb Brady bonds for a 10-year global dollar bond. It received $2.2 billion in non-competitive offers and $500 million in competitive offers, but only accepted non-competitive bids at the clearing spread of 520 basis points. As a result, the global priced at a 520 basis points spread over 10-year US Treasuries to yield 9.27%, giving a coupon of 8.50% using a price of 95.056.
Venezuela achieved a 55% participation rate in the exchange offer, which is high for exchanges of this kind, as investors tendered Bradys with a face value of more than $2.7 billion. The exchange was split almost equally between the cash and exchange portions. The government retired $1.3 billion-worth of DCBs and $901 million in Flirbs in exchange for $705 million in new global bonds. It raised a further $795 million in cash, for a total of $1.5 billion for the whole transaction.
The deal attracted about $4 billion from 200 accounts for the cash tranche. When taken together with the exchange tranche, orders totaled nearly $5 billion – an over-subscription of more than three times.
Combining the cash and exchange portions in a single transaction created a dynamic between investors that worked in the sovereign’s favor. Brady bondholders were reassured that the new bond would be liquid. Strong demand from cash investors bidding for the bond indicated to holders of the Bradys that the new bond had value.
The bookrunners said the investor base in the deal was geographically diversified, with US accounts taking 64%, Europeans taking 27% and Venezuelans 3%. Other Latin American and Asian investors took the remaining 6%. Asset managers anchored the deal, with 42% of the order book, but hedge funds were also active, adding another 35%.
Max Volkov, director in international emerging markets at Merrill Lynch, says: “Hedge funds are now a big part of the emerging markets, so building an order book [requires] striking a balance between hedge funds and the long-term buyer base.” He says the strength of demand for the deal “opened everyone’s eyes to the amount of liquidity there is in the market for the country.”
Venezuela’s transaction was among the few exchanges last year. In January 2004, Citigroup structured a Panama deal, in which it exchanged $406 million in Brady bonds for $326 million in global bonds through a reopening of globals due 2023 to generate a $57 million nominal debt reduction and $2.5 million in net present value savings.
Goldman Sachs and CSFB launched a $2.8 billion transaction for Mexico, exchanging relatively expensive bonds due 2019, 2022 and 2026 for 10- and 30-year notes plus cash determined at a modified Dutch auction. In Mexico, local investment banking boutique Protego led the restructuring of $2.5 billion in bank debt for the state of Mexico. The deal substituted old facilities for new loans. A special purpose vehicle is the borrower, which will receive directly all the state’s non-targeted transfers from the federal government.
The Venezuela deal was important for Barclays. This was a follow-on mandate for the bank after it brought a liability management deal to the market for Venezuela in June. Barclays executed a tender offer for $1 billion in bonds due 2004, which achieved a 93% success rate.
While bankers, the government and investors are clearly pleased with the success of these transactions, the outlook for Venezuela’s economy remains as closely tied to volatile oil prices as ever. The government decided to spend its windfall ahead of the recall vote – expenditures rose 80% in the first five months of 2004. Others are concerned that Chávez is systematically reducing the transparency of public accounts, making it harder to monitor the true state of the public finances.
PDVSA, the state-owned oil producer, paid down $2.51 billion in asset-backed bonds in an aggressive form of liability management in August 2004, making the most of surging world oil prices in a deal led by JP Morgan and Deutsche Bank. The financial disclosure that regulators in the US required PDVSA Finance to provide gave the outside world an invaluable window on the inner workings of Venezuela’s most important company and the Finance Ministry as well. By buying in its bonds, PDVSA both saved itself some money and closed that window. LF