Author Topic: Distressed Sovereign Debt Investing  (Read 3465 times)

chesko182

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Distressed Sovereign Debt Investing
« on: June 10, 2017, 10:37:57 AM »
Does anyone have any experience trading names in this space in the past?

I'm from Venezuela and I'm sure a lot of you have read the headline news. Basically the government is on the verge of collapse, mainly due to little financing alternatives and having ran out of money, but they haven't defaulted just yet (bonds are Venezuela Republic and PDVSA, the state owned oil company)

I am quite familiar with the situation there and some of the scenarios which can play out in terms of a change of government. I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.

What are some of the things to look for here? 

Thanks


Cigarbutt

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Re: Distressed Sovereign Debt Investing
« Reply #1 on: June 11, 2017, 05:46:39 AM »
No experience in this space but have looked at this topic for a while.

-What key inputs do you use to estimate recovery rates in this specific case?
-Do you think that involvement of vulture hedge funds could actually increase risk for other investors?

-What's the future of Venezuela?

chesko182

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Re: Distressed Sovereign Debt Investing
« Reply #2 on: June 11, 2017, 11:25:50 AM »
One big issue here is that official economic data hasn't been published in a number of years, and even getting figures like total government debt is tough because the government has used alternative source of financing through China, Russia and others. So you have to make some assumptions and back of the envelope stuff when it comes to debt/GDP etc.

I'm assuming an IMF restructuring once a change of government takes place. The current government has no money left and people are on the streets every single day protesting because there is no food or medicine, next catalyst I think will be internal problems within the government and military that will cause them to break eventually, which is inevitable at this point.

I've started reading some pieces on the IMF process to get a better understanding.

The country has the biggest oil reserves in the world and if you bring back foreign investment with a more market friendly government, debt reduction should not be as hard as in Greece or Argentina for example which is very dependent on austerity. So from that simple standpoint, logic would tell me a 30-40% recovery rate is pretty conservative, hence why I think below 20c should make sense.

Have not given a lot of though to HFs, some of them have actually started buying I know for a fact. One bought an issue held by the Central Bank for ~23 cents and actually financed the government 300mm they needed to make an interest payment.

If anyone has seen any good pieces on this subject please share. It would also be helpful to see historical recovery rates and the specifics of each country at the time because I know these numbers vary by a lot.

Here are some links:
http://www.heritage.org/budget-and-spending/report/what-debt-crisis-default-primer-governments
http://www.financialpolicy.org/dscsovdebt.pdf
https://www.imf.org/external/np/pp/eng/2013/042613.pdf

Cigarbutt

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Re: Distressed Sovereign Debt Investing
« Reply #3 on: June 11, 2017, 05:10:00 PM »
Thanks for the links chesko182.
Not in vogue anymore, Brady Bonds are still interesting to review because features of those bonds continue to appear in sovereign debt restructurings.
Venezuela has been involved in those bonds.

http://www.people.hbs.edu/besty/projfinportal/ssb%20brady%20primer.pdf
https://www.imf.org/external/pubs/ft/wp/wp9816.pdf
http://corporate.morningstar.com/ca/documents/MethodologyDocuments/IBBAssociates/StocksBradys.pdf

Venezuela has huge oil reserves but the break-even price is relatively high and oil infrastructure probably needs significant investment just to bring it back to normal levels. No?

I have followed Argentina over the years. Cycles are cycles and things can eventually get better. Currency controls are mostly a thing of the past for them. May take a while though.

https://www.bloomberg.com/news/articles/2017-01-19/macri-s-argentina-returns-to-bond-market-amid-hurdles-snapshot



As far as price controls, isn't this more of a symptom than a treatment?

I like investing at the bottom and can live with averaging down but is the bottom in sight?

Green King

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Re: Distressed Sovereign Debt Investing
« Reply #4 on: June 11, 2017, 06:34:20 PM »
Does anyone have any experience trading names in this space in the past?

I'm from Venezuela and I'm sure a lot of you have read the headline news. Basically the government is on the verge of collapse, mainly due to little financing alternatives and having ran out of money, but they haven't defaulted just yet (bonds are Venezuela Republic and PDVSA, the state owned oil company)

I am quite familiar with the situation there and some of the scenarios which can play out in terms of a change of government. I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.

What are some of the things to look for here? 

Thanks

Why don't you just buy some property on Margarita Island? Also care to give a local perspective on the safety of living there?
GK

JayGatsby

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Re: Distressed Sovereign Debt Investing
« Reply #5 on: June 11, 2017, 07:26:44 PM »
I've also started to think a little bit of how to calculate recovery rates of the bonds once they default and sell off from current levels (which I expect them to in the next 12 months). The lowest priced bonds are trading just below 40 cents now and my hunch is anything in below 20 cents area should be a good recovery bet, and I do think a default would cause a major selloff, there are a actually lot of retail holders in these bonds.
How do you look at recovery rates for Venezuela (or sovereign debt in general)? I've always avoided sovereign debt because I've assumed the recovery rates if they defaulted would be close to 0, since they don't distribute assets.  I know Elliott and others have been effective at getting governments to repay by effectively holding them out of the bond market until a resolution is reached.

Jurgis

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Re: Distressed Sovereign Debt Investing
« Reply #6 on: June 12, 2017, 09:50:38 AM »
Don't you need to have like multi-million (billion?) accounts to go for distressed sovereign debt? I was just reading the Elon Musk book where he suggested some Canadian bank buy LatAm distressed at .25 on dollar (guaranteed by US, so .50 recovery was "certain"). But he was talking multimillions...

Anyway, I don't think I have insight into this apart that find sure opportunity like Musk did. Though this was in 1990's so possibly it was way easier to find sure things...  8)

Pelagic

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Re: Distressed Sovereign Debt Investing
« Reply #7 on: June 12, 2017, 11:56:33 AM »
Maduro's regime collapsing looks like just one of several scenarios to me. While I don't disagree that it appears to be on the verge of collapse, despotic and broke governments have held on for far longer than anyone would expect before and at this point it could be another couple years before a real collapse in Venezuela. Even in the event of a collapse, do we see a more normal government come into power or simply Maduro abdicating to another Chavezista in a more palatable form?

Looking at their oil reserves, they've sought alternative financing for their government by selling off portions of production to China, a loan by China paid back in oil. With roughly 2mmboe/d in production (declining due to lack of reinvestment) what's China's appetite for extending more similar loans. At a certain price prior to government collapse or default I think somebody would be willing to extend another similar loan, although Venezuela's ability to service it so far doesn't help their case.

http://www.cnbc.com/2017/02/10/venezuela-falls-behind-on-oil-for-loan-deals-with-china-russia.html

Rising oil prices kind of work against an investment in the sovereign debt. If you're hoping for a quick collapse, another leg down would speed that up, but if prices rise and the government's piggybank starts spitting out coins again then the current mess will likely stay around a while longer unfortunately.

chesko182

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Re: Distressed Sovereign Debt Investing
« Reply #8 on: June 12, 2017, 04:57:47 PM »
Why don't you just buy some property on Margarita Island? Also care to give a local perspective on the safety of living there?
Real estate is actually not cheap because everybody who is able to save some money will invest in hard assets given that we have hyperinflation (some estimates now put it above 1,000%), so there's a lot of natural demand for it. I haven't lived there in 8 years but know for a fact that safety is nonexistent; kidnappings, murders & getting robbed are every day occurrences. I had some experiences back in the day and have a lot of friends who've been through stuff too.

Venezuela has huge oil reserves but the break-even price is relatively high and oil infrastructure probably needs significant investment just to bring it back to normal levels. No?

As far as price controls, isn't this more of a symptom than a treatment?

I like investing at the bottom and can live with averaging down but is the bottom in sight?

You're correct on the high b/e price of oil I think it's in the low 40s and it's also the shitty kind of oil (heavy and sour? I'm not an oil expert though..) but either way Venezuela has the biggest oil reserves in the world and I think with a new government a lot of foreign money would come back and invest the CapEx needed as well as new projects.
Price controls started as a (retarded) treatment for inflation and is obviously now a symptom of the incompetence of the government and state of the economy.
Bottom is hard to call, but having seen some stats on distressed debt pre-default and post-default, history would suggest it is better to wait and invest after defaults happens as the average price drop I think is something to the tune of 25%, so the market doesn't always "know" that it's going to default". This is why I'm sitting still at the moment even though the lowest priced bonds are trading around 37 cents.

How do you look at recovery rates for Venezuela (or sovereign debt in general)? I've always avoided sovereign debt because I've assumed the recovery rates if they defaulted would be close to 0, since they don't distribute assets.  I know Elliott and others have been effective at getting governments to repay by effectively holding them out of the bond market until a resolution is reached.
This is what I'm working on now and trying to read up on it. One back of the envelope calculation is based on Debt Sustainability Assessment done by the IMF which basically looks at debt/GDP of the country as well as Interest payments as a % of GDP, and coming up with a conservative/realistic number to back solve what sort of haircut bondholders could negotiate with the country. In the case of Venezuela the oil reserves are a big part of the recovery value too because it removes the need for austerity measures, with proper investments the government can get a lot of $$$ from this. But either way, this is where I was  hoping someone here with experience in the space could give us some insights in terms of how to calculate this and what to look for, some of the assumptions one has to make here may end up putting this one in the too hard pile for me...It would also be interesting to look at a case study.

 In terms of sovereign debt in general, you're right there are no claims on assets usually but what normally happens is that the defaulted bonds get exchanged for new bonds with a haircut on the original issue once an agreement is reached between the bondholders and the country. Historically recovery values have been between 40-70 cents for sovereign defaults, there are actually very few cases where investors lost 90% or more (I think one or two in Africa). Also the time it takes to actually reach a resolution is very important... Singer's Argentina investment was very highly covered by the media and although it was successful (I think he almost tripled his money) the fact that it took him 15 years brings the return to ~8%.

Don't you need to have like multi-million (billion?) accounts to go for distressed sovereign debt? I was just reading the Elon Musk book where he suggested some Canadian bank buy LatAm distressed at .25 on dollar (guaranteed by US, so .50 recovery was "certain"). But he was talking multimillions...

Anyway, I don't think I have insight into this apart that find sure opportunity like Musk did. Though this was in 1990's so possibly it was way easier to find sure things...  8)
Not really... many of these bonds have a minimum investment of $1K but obviously the typical investor in these is a hedge fund and my gut says not a lot of individual investors put money in these things. I haven't heard of that investment specifically but it sounds like some LatAm bonds issued in the late 80s/90s that where actually backed by US Treasury zero coupon bonds so that would have been a no brainer!

Maduro's regime collapsing looks like just one of several scenarios to me. While I don't disagree that it appears to be on the verge of collapse, despotic and broke governments have held on for far longer than anyone would expect before and at this point it could be another couple years before a real collapse in Venezuela. Even in the event of a collapse, do we see a more normal government come into power or simply Maduro abdicating to another Chavezista in a more palatable form?

Looking at their oil reserves, they've sought alternative financing for their government by selling off portions of production to China, a loan by China paid back in oil. With roughly 2mmboe/d in production (declining due to lack of reinvestment) what's China's appetite for extending more similar loans. At a certain price prior to government collapse or default I think somebody would be willing to extend another similar loan, although Venezuela's ability to service it so far doesn't help their case.

Rising oil prices kind of work against an investment in the sovereign debt. If you're hoping for a quick collapse, another leg down would speed that up, but if prices rise and the government's piggybank starts spitting out coins again then the current mess will likely stay around a while longer unfortunately.

Yes, but the reason why I think now there is a high probability a change in government in the next 12-18 months is actually related to the inevitable default of the bonds. They are essentially facing a liquidity crisis right now, they've cut imports by more than 50% (literally starving the country hence why these are being called Hunger Bonds by the press), and they've started to miss interest payments on bilateral and multilateral loans of as little as $30mm, and have taken desperate financing measures like raising $300mm from a hedge fund by selling debt at 20 cents on the dollar in order to be able to meet the last payment. I think there are still around 4 or 5 billion due this year that is going to be very hard to come up with (intl reserves are $10bn) and next year there's again billions of dollars due. At the same time the entire country is in the street protesting and latest polls show that current government approval is less than 20%. So once the default happens the government is basically toast because they won't even have money to pay themselves and all of them will instantly flee the country before they're put in jail for corruption and drug trafficking charges. And there is no way the current party wins another election after this mess..


Pelagic

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Re: Distressed Sovereign Debt Investing
« Reply #9 on: July 30, 2017, 04:39:34 PM »
Thoughts on the situation in Venezuela? It looks like Maduro is going to rewrite the constitution and entrench himself as "president for life" what happens next? PDVSA and Venezuela as a whole will probably face US sanctions this week as well. I feel that regardless of what Maduro is able to do this week to eliminate the legislative branch, rewrite the constitution, and solidify his power, the financial mess will catch up sooner rather than later and force him out of power, although I don't see the transition as being a peaceful one.

It's heart wrenching to watch a country spiral into totalitarianism and I can only hope this regime is short-lived as the Venezuelan people have suffered enough already.