December 5, 2014 / 4:57 PM / 5 years ago

ANALYSIS-Venezuela default risks spike

* Default probability at record highs on oil price drop

* Sovereign bonds seen easier to restructure

* Distressed debt funds mull options

By Paul Kilby and Davide Scigliuzzo

NEW YORK, Dec 5 (IFR) - The dramatic drop in oil prices has Venezuela struggling to cover financing gaps. Default is looming for the oil-rich country unless the government changes it ways, said analysts.

Piece-meal attempts at addressing fiscal shortfalls may allow the country to muddle through in the short term, but concerns remain that the administration of President Nicolas Maduro will delay unpopular, albeit essential, policy changes ahead of national assembly elections late next year.

The market is already pricing in higher default probabilities going into 2017, when the country faces a spike in debt maturities. This is reflected in both state-owned oil company PDVSA and Venezuela’s inverted curves, where yields stand in the low 30s in 2016 and 2017, only to drop to the 20s and the teens in year 10 and beyond.

“If present policies are held unchanged, the market sees the height of default risk in two years time,” said Michael Roche, emerging markets fixed-income analyst at the Seaport Group.

Venezuela’s Expected Default Frequency - Moody’s market-based measure of credit risk - hit news highs last week of 11.61%, putting it well ahead of other distressed sovereigns such as Puerto Rico (7.1%), and Ukraine (4.6%). It was also above the 7.75% seen for Argentina just before it defaulted this summer.

DIFFERENT TERMS

Signs that markets are preparing for a restructuring scenario are also becoming more abundant.

Just last week, a panel organised by Cleary Gottlieb - the same law firm that advises Argentina in its legal battle against holdout investors - centred on such topics, including whether Venezuela might find it easier to default on sovereign obligations rather than on bonds issued by PDVSA.

While all bonds issued by PDVSA require unanimity to modify the terms of interest and principal payments, the bulk of the debt issued by the sovereign contains collective action clauses allowing a 75% majority to agree to a restructuring that is binding on all holders of a particular series.

The distinction, however, might not matter much in the event of a disorderly default.

“We think PDVSA and the sovereign are one and the same,” said Kevin Daly, a portfolio manager at Aberdeen Asset Management. “If the government were to default only on its sovereign bonds, PDVSA bonds would collapse as well.”

US distressed funds, meanwhile, have started to take a closer look at Venezuela, in a similar way they took a shine to Argentina before it defaulted earlier this year.

DUE DILIGENCE

While the investment case might not be as compelling as Argentina’s, several took part in a trip to Caracas organised by JP Morgan in recent weeks for special situation investors interested in learning more about the sovereign.

“US distressed investors are information-gathering and doing their due diligence,” said Roche. “If anything, they are looking at PDVSA - the entity that has property that can be attached.”

In the meantime the market remains relatively confident that the government can find short-term financing solutions without rocking the political boat.

Venezuela reportedly raising US$1.75bn through the sale of some US$4bn in repackaged Petrocaribe loans to Goldman Sachs is just one example of this. Goldman Sachs declined to comment on reports about the transaction.

At current oil price levels, the country faced a shortfall of about US$18bn for imports and debt service, which could be covered in part by one-off solutions, said Jorge Piedrahita, CEO at broker Torino Capital. These include Petrocaribe securitisations, recent agreements with China over loan terms, the reduction of imports and the sale of PDVSA’s US operations CITGO.

“I don’t think they are at the point where the discussion is: ‘Do I pay the debt or feed the people’?” he said. “I think they can do both. They are probably more than a year away from that discussion.”

Patrick Esteruelas, a sovereign analyst at emerging markets asset manager Emso, took a similar view. “The risk of Venezuela defaulting in 2015 remains manageable and very low. It is certainly below the 45% default probability implied by one-year credit default swaps. I would say it is less than half of that.”

Reporting by Paul Kilby and Davide Scigliuzzo; Editing by Matthew Davies

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