Turmoil-striken Venezuela is running out of options to continue servicing bonds, according to Rob Drijkoningen, co-head of the Emerging Markets Debt (EMD) team at Neuberger Berman.
Drijkoningen said that the troubled South American country, while still included in the JPMorgan EMBI GD Index, is slowly getting worse.
As a result in Neuberger Berman’s country credit score for Venezuela, driven by both the macro and the ESG components, is now the lowest in company’s EMD bond universe of 84 EM countries.
“[It has] a 1.7% weight at present, through dollar-denominated government bonds and quasi-sovereign bonds from the state oil company PDVSA, [but] the country is not included in the EM corporate and EMD local indices,” said Drijkoningen.
“We have been maintaining an underweight view across our hard currency portfolios – as well as our blend portfolios – for more than a year now based on the deteriorating fundamental outlook. We also considered valuations to be at the high end of the range, especially after the rally last year and in light of the lack of ability to pay.
‘Running out of options’
“We believe the country is running out of options to continue servicing bonds.Oil output keeps shrinking due to lack of maintenance, decrepit infrastructure and arrears to oil service providers.
As Venezuela does not really produce much except oil, the country has been forced to collapse imports and eat into FX reserves – which have fallen to a 15-year low of US$10bn – to service debt.
Drijkoningen, pictured left, points out that there is a US$5bn bond coupon and principal due by the end of 2017 and US$13bn to the end of 2018.
“The regime has maintained its willingness to service this debt, but defaulted on pretty much everything else,” he said.
‘Some exposure warranted’
Neuberger Berman maintains an underweight bias to the country, but Drijkoningen believes that maintaining some exposure is warranted.
“There is still meaningful recovery value and a decent chance the opposition will take over within a reasonable timeframe, improving the chances for meaningful reforms,” he said. “In terms of exposure, we favour lower priced bonds from PDVSA, as this debt may fare better than other index bonds in a restructuring scenario.”
Brad Tank, CIO of fixed income at Neuberger Berman, added that the regime of President Nicolás Maduro seeks to consolidate its power as anti-government protests sweep the country, leaving scores of casualties.
“The government has done everything it can, including eating deep into its dwindling foreign-exchange reserves, forcing a collapse of imports, and resorting to off-balance sheet deals to raise cash by pledging future oil production and related assets on the cheap – all in a desperate scramble for hard currency to meet its debt obligations.
“But its determination to cling to power is not only exponentially worsening the conditions for recovery under a new regime, it is also threatening a vicious circle,” he said.
Foreign condemnation including talk of US sanctions that would include a ban on oil imports, alongside civil strife that threatens to disrupt exports – either of which would deal a huge blow to the country’s ability to meet the rest of its debt payments in 2017 – are a concern to Tank.
As a result the market in Venezuelan debt appears to have concluded that default is “all but inevitable”. Bonds trade at 35-45 cents on the dollar, with prices dipping further around rumours of US sanctions.
“Price volatility is now associated less with the probability of default than with estimates of the timing of a bankruptcy, subsequent recovery values and the political circumstances surrounding all of this,” said Tank.
“This crisis has unfolded all too predictably. Because default will not be a shock, contagion will likely remain contained.”
Positive sentiment for EM
Nonetheless, Tank adds, the long “winning streak” for EM since early 2016 confirms that broader sentiment is positive. Importantly, this, he predicts is rooted in recovering fundamentals: better growth rates around the world, a progressive and pro-growth mix of policies in most countries, benign inflation, reasonable levels of government debt and more solid current account dynamics.
“Venezuela’s circumstances do not change those wider facts on the ground,” he added.