Venezuela: Summary Bond Terms Venezuela Bonds 12.75%, 2022 9.25%, 2027 9.25%, 2028 7%, 2038 Issuer Bolivarian Republic of Venezuela Currency USD Issue Date August 23, 2010 September 18, 1997 May 7, 2008 November 15, 2007 Tenor at Issue 12 Years 30 Years 20 Years 31 Years Time Remaining Till 10 Years 15 Years 16 Years 26 Years Maturity Duration 5.59 7.82 7.93 10.27 Maturity Date August 23, 2022 September 15, 2027 May 7, 2028 March 31, 2038 Maturity Type Sinkable Bullet Bullet Bullet Coupon 12.75% p.a semi-annual (February& August) 9.25% p.a. semi-annual (March& September) 9.25% p.a semi-annual (May& November) 7% p.a semi-annual (March& September) Day Count Basis 30/360 30/360 30/360 30/360 Bond Rating B2 (Moodys; Dec 2012), B+ B2 (Moodys; Dec 2012), B+ B2 (Moodys; Dec 2012), B+ B2 (Moodys; Dec 2012) (S&P; Dec 2012), B+ (Fitch; Dec (S&P; Dec 2012), B+ (Fitch; (S&P; Dec 2012), B+ (Fitch; Dec 2012) Dec 2012) 2012) Issuer Rating B2 (Moodys; Dec 2012), B+ Neg B2 (Moodys; Dec 2012), B+ B2 (Moodys; Dec 2012), B+ Neg B2 (Moodys; Dec 2012), B+ (Fitch; Dec 2012) Neg (Fitch; Dec 2012) (Fitch; Dec 2012) Neg (Fitch; Dec 2012) Use of Proceeds General Corporate Purpose Repay / Refinance Debt Repay / Refinance Debt Repay / Refinance Debt Governing Law New York New York New York N/A Recommendation Buy Buy Buy Buy Page 1 of 11
Venezuela Bonds - Analysis Country Overview The Bolivarian Republic of Venezuela is characterized by its overdependence on the petroleum industry (accounts for approximately 95% of export earnings; 2.5 million barrels per day and roughly 30% of GDP) and high sensitivity to exogenous shocks. Along with vast petroleum resources, the country also owns natural supplies of iron ore, hydroelectric power and diamonds. However, the country s economic and political fortunes are closely intertwined with the fate of its president, Hugo Chávez, who enjoys 54% of the popular vote and recently won re-election to begin his third term, extending his rule of 13 years for another 6 years. Currently, Venezuela faces a series of challenges which come in the form of a weakening of democratic institutions through the break down in human rights and basic freedoms, divergence of political interests and drugrelated violence. This means that the current administration is pursuing strategies contradictory to any democratic movement. Instead of equality and social justice, the administration stifles the human rights of citizens and engages in blatant political discrimination with the utmost disregard for the rule of law. In conjunction with this, President Chávez has sought to further increase government intervention in the economy through the continued nationalization of firms in select industries as he pursues a form of 21 st century socialism. Chávez is known to popularly utilise the country s oil wealth to roll out numerous social programmes catered towards the less fortunate while simultaneously exercising vast political control over most economic sectors and their operations. It is with this in mind that one must be cognizant of the instability and uncertainty within Venezuela and the wider region that will occur if he is incapable of holding his position as President and leader of the United Socialist Party of Venezuela. President Chávez is now 58 and has a history of fighting cancer. Although he had announced in July 2012 that he was free of all cancer cells, he was re-admitted to hospital in mid-december with a recurring type of pelvic cancer. This is his fourth surgery Page 2 of 11
since June 2011. At this time it is unclear whether he will be able to retain his office, which has given rise to uncertainty as to the political fate of the country. Immediately before leaving for Cuba, Chávez announced his successor Nicolas Maduro to carry on the work of his socialist party. Maduro is currently the Vice President as well as the Minister of Foreign Affairs and has been previously widely ridiculed for his former occupation as a bus driver. Overshadowing this is the praise he has received for his easy-going and affable nature while being deemed as a faithful ambassador of Chávez s views. Nicolas Maduro is highly respected among President Chávez s inner circle and is described as the most capable administrator and politician to carry on his work. In the event that Chávez is unable to return to Venezuela in time for the scheduled January 10, 2013 inauguration, elections may have to be held within 30 days unless the constitution is amended to state otherwise. The bond market has reacted positively to this unfortunate news, signalling that investors place a premium on a change in leadership for the country. Since the global economic contraction in 2009, Venezuela has managed to recover and was projected to have recorded growth of 4.7% by year end 2012. However, there is still a general gloomy outlook on Venezuela s economy, going forward. This is partly due to the presence of an uncertain global macroeconomic environment along with the country s high dependence on oil prices, which are seen by some economists to be overly inflated relative to the balance of world demand and supply, and petroleum exports. Despite these negative forecasts, the Venezuelan government s willingness to pay its debt in the near term is promising. The Chávez administration has never threatened to default on its foreign currency obligations although no legislation prevents the administration from refusing to pay the country s debt. While the percentage of Venezuela's debt denominated in foreign currency has fallen, it remains above 50% and will increase if the country devalues its currency which is currently fixed at 4.30 bolivares for 1.00 USD. Devaluation is expected to take place in early 2013 but will most likely be delayed due to the uncertainty surrounding the future of the Chávez administration. The devaluation of the currency may assist in boosting oil revenues in local currency as well Page 3 of 11
as closing the fiscal deficit. Currently, Venezuela does not face an external liquidity constraint given large and recurring current account surpluses and significant external financial assets. However, this could easily become unsustainable if the government takes on excessive debt coupled with an unexpected and sharp decline in oil prices. Venezuela: Economic Indicators There was an economic contraction in 2009-20102010 (as indicated by negative real GDP growth rates), which coincided with the global economic contraction, which caused a decline in oil prices and consequently, oil revenue. Record government spending in 2011 and 2012 are noted to have facilitated positive GDP growth. Over the review period, unemployment rates have been fairly stable between 7.9% and 8.6%. As illustrated by the projected decline, it has been noted that the Venezuelan economy is seeking to utilize its human resources more effectively with the 2012 implementation of social initiatives aimed at helping match individuals with employment opportunities and helping young people obtain their first job. Page 4 of 11
Venezuela: Economic Indicators Venezuela has recorded consistently high inflation rates which may be due to high state spending, excess liquidity in the money supply and fiscal mismanagement by government authorities. These high levels of inflation erode purchasing power and contribute to a lower standard of living which may further translate into a lack of overall international competitiveness over the medium term. The Venezuelan government has been consistently recording a public deficit which may be attributed to a lack of diversification and increased social spending on housing, agriculture and job creation programmes. In conjunction with this, the continued concessions offered to select Asian, Latin American and Caribbean countries on Venezuelan oil has also reduced potential additional revenue streams. Public Debt includes bonds, treasury bills and securities issued by the government or funds borrowed from supranational institutions. Over the review period, Venezuela s public debt has been increasing and is projected to have reached over 50% of GDP by the 2012 year end. This is consistent with the government s successive budget deficits. Page 5 of 11
Venezuela: Economic Indicators Venezuelan foreign exchange and gold reserves have been rapidly declining and are projected to have fallen well below the optimal level of US$26,800M (20 weeks of goods and services imports) by the end of 2012. On numerous occasions, President Chávez has transferred monies from the reserves to finance opaque initiatives such as the Fund for National Development. As the foreign reserves continue to decline, this puts devolutionary and inflationary pressure on the Bolivar. *Estimated Figures/Forecasts There was a significant recorded decline in the Central Bank benchmark interest rate between 2010 and 2012. This reduction in interest rates may have been motivated by an attempt to increase investment and consumption within the economy. However, as a consequence, this contributed to the rise in the inflation rate and, in the near term, may cause a weakening of the national currency, which, as noted above, is desired by the administration. Sources: International Monetary Fund (IMF) World Economic Outlook April 2012, Central Intelligence Agency (CIA) World Factbook 2012. Page 6 of 11
Venezuela Bonds Historical Data* Venezuelan bond prices have been charting an upward trajectory and, in December 2012, rallied to record highs, due to the great deal of speculation regarding the health of President Chávez and the foundation of his aspiring 21 st century socialist administration. The benchmark 2027 dollar bond, traded at its highest on December 10, 2012 to bid $103.125, with a yield of 8.863%. This is characteristic of all the illustrated Venezuelan sovereign bonds which traded at their highest around the same date. Chávez s ability to begin his third term as the Venezuelan president has come directly into question after he announced his successor, Nicolas Maduro, in the event that he is unable to remain in office. This announcement was made before he left for Cuba to undergo another surgery related to his battle with pelvic cancer. As a result of this operation there is a possibility that he may not be well enough to return to Venezuela for the January 10, 2013 inauguration. The more unfavourable the outcome of President Chávez s health becomes, the more the market responds positively to Venezuelan sovereign debt. Page 7 of 11
Venezuela Bonds Historical Data* As bond prices recently rallied, these record low yields may be indicative of the reaction by the market to the possibility that, Hugo Chávez may not be the leader of this oil rich country in the near future. In the event that Hugo Chávez is unable to be sworn in, there will be further speculation as elections will have to be held within 30 days after which, the market will anticipate what policies the new administration pursues. Page 8 of 11
Venezuela Bonds Historical Data* As at December 2012, the cost to insure against a potential default or restructuring of Venezuelan debt had declined significantly as the spread on Venezuelan five-year credit default swaps have narrowed since and investors remain attracted to the fairly high yields on Venezuelan sovereign bonds. *Historical Data Retrieved from Bloomberg as at December 31, 2012 Page 9 of 11
Venezuela Bonds: Duration Analysis Duration is a tool used to measure the approximate percentage rate of change of bond prices with respect to yield. This type of analysis follows the concept that interest rates and bond prices are inversely related. Duration analysis is useful to investors in the sense that it is a measure of risk which demonstrates the sensitivity of bond prices to a change in interest rates. Based on the duration calculations, for every 100 basis-point (1%) decrease in interest rates for the 2022, 2027, 2028 and 2038 bonds it is expected that bond prices will increase by 5.59%, 7.82%, 7.93% and 10.27% respectively. In this context, it is highly likely that the Venezuelan central bank will be further motivated to adjust interest rates downwards in order to encourage continuous investment and consumption within the economy. Considering the fixed-rate nature of these Venezuelan sovereign bonds, if there is a reduction in interest rates, investors will see bond price changes reflective of the increasing volatility associated with a longer time until maturity. Outlook & Recommendation In the near term, the outlook on Venezuela is very uncertain as the market responds to Chávez s health woes. Generally, in 2012 bond markets outperformed many forecasts and outlooks due mainly to accommodative policy measures. For the conservative/typical investor, it appears that they may have missed the boat with the recent rallying of Venezuelan sovereign debt especially as there is a lessened growth in the developedmarket due to anticipated monetary policy accommodations and more liquidity provisions. After this series of rallying, by December 17, 2012, the cost of underwriting government debt in the event of a default went back up to reverse a portion of recent profits. Despite the obvious political risk, based on the 2012 overall performance of emerging market debt (13.61% in returns on a market value-weighted basis) it would appear that there is still Page 10 of 11
potential for exceptional returns (in the form of attractive yields along with capital accumulation) within the market for bond-holders and potential investors. As it relates to the aforementioned Venezuelan sovereign bonds, the ability of the country to generate revenues and service their debt remains robust and, as such, for the long-term we recommend these bonds as a BUY. However, it is clear that a diversified and balanced portfolio is what will bring favourable returns to avid investors in this uncertain global macroeconomic climate. Disclaimer: This Research Paper is for information purposes only. The information stated herein may reflect the opinion and views of VM Wealth Management in relation to market conditions and does not constitute any representation or warranties in relation to investment returns and the credibility of the sources of information relied upon in the preparation of this report, without further research and verification. Before making any investment decision, please consult a VM Wealth Management Advisor. Page 11 of 11