The Devil's Excrement

I have received many emails and there have been many comments on the previous post about the upcoming sale of the Venezuela 2022 bond, that suggest people are or get confused about it. Since people have until tomorrow to purchase it, I thought I would give a 101 introduction to why this is a good deal for those that need foreign currency.

The first reason is simple: We have exchange controls, there are only three ways to obtain foreign currency in exchange for Bolivars: Cadivi (Limited to $2,500 per year), SITME (Limited to individuals to $5,000 per year) and bonds denominated in dollar and sold by the Government (Minimum $3,000, maximum unknown at this time)

Even if the amount is limited, it is an additional path to obtain  foreign currency.

So, the Government is selling a 2022 bond (ends that year, this one is quirky, one third will end in 2020, one third in 2021 and the final one third in 2022). The bond will have a coupon of 12.75%, that is if you have US$ 100,000 of the bond you will receive (12.75%/2) or $6,375 twice a year, the first payment in February 2011 and every six months after that.

The Government will sell you these bonds at Bs. 4.3 per dollar. That is if you order $3,000, you pay 4.3 x 3000=12,900 Bolivars.

Here comes the part most people get confused about. Because Venezuelan bonds yield more than 12.75%, people will be able to sell this bond at a discount in international markets. That is, next week after you know how much you got, you can ask your bank to sell it in exchange for $ or transfer it to your investment account, where you will keep it until you want to sell it abroad. (No Bs. from now on, it’s all US dollars until 2022)

How do you know at what discount or at what price the bond will trade at?

Well, you have to see where comparable Venezuelan bonds yield today. Here are all of Venezuela’s bonds and what they were yielding today:

The red diamonds are PDVSA bonds, the blue triangles are Venezuela bonds.

As you can see, most Venezuelan bonds around 2020, like the 2023 were trading today at around 15% yield to maturity. This means that if you wait until 2023, collect all the coupons and at the end collect 100% of the face value, your effective annual yield would be 15%.

So, using an Excel formula for the yield (called YIELD) you can play and get at what price you would have to buy it to get 15% like the 2023 with the new bond. The answer is 87%.

This means that if you bought $3,000 for Bs. 12,900, when you sell the bond abroad, you will only get 87% of the dollars or $2,610. This means that each dollar cost you (12,900/2,610) or Bs. 4.94 (ignoring commissions)

The problem is that the Government is selling US$ 3 billion of this new bond, that is more than 30 days of trading for Venezuelan bonds and you can be sure most Venezuelans want the dollars, not the bonds. Thus they will turn around and sell them. That is a lot of bonds for the international markets. It will take time for the market to absorb them all. Therefore, the first few weeks the yield of the 2022 bond will be higher than it should be because of the excess supply.

How much higher?

Well, I drew a green arrow to show the possible range in the graph above, based on the numbers and past experience. In the last twelve months the worst yield of the 2023 was 16%. Thus if the supply is too much, it may be that the whole curve shifts up, that is, the comparable bonds yield up to 16%. Then the 2022 may be at most a point higher at 17%.

At what price would it have to trade to yield 17%? Using the same yield excel function, I get 78%. At 78%, you get 2,340 dollars for your Bs. 12,900 or Bs. 5.51. Given that the last time swaps were legal they were trading above 8, this is a very good deal.

The Government could do one more funny thing and increase the size of the bond from $3 billion to $4 billion (or 4.5 for that matter), that could lower it to 76-77% only briefly.

In fact, in the informal market today it was trading at around 81%

The high coupon makes this bond more attractive than the “comparables”. At 12.75% and 85% in 6.8 years, if Venezuela keeps paying, you would have recovered your investment and still have the bond, other bonds have much lower coupons, it would take much longer for this to happen. Additionally, the bond matures in three parts in 2020,2021 and 2022.

Thus, if you need foreign currency, the case is pretty clear and good luck!

This entry was posted on August 12, 2010 at 8:28 pm and is filed under Venezuela.