Duggar, elena

Drexel University Conference “Sovereign Debt Restructurings: The Case of Venezuela”, 23 Feb 2018

Venezuela’s Debt Default Elena Duggar, Associate Managing Director, Credit Strategy and Standards

FEBRUARY, 2018

Agenda 1. Moody’s sovereign ratings 2. Venezuela’s default timeline 3. Venezuela’s restructuring is more complex than past sovereign defaults

Venezuela’s Debt Default, Feb. 2018

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Moody's lowered Venezuela’s government bond rating to Caa3 in 2015 » In January 2015, we downgraded Venezuela's sovereign bond rating to Caa3 from Caa1, anticipating the possibility of a credit event with investor losses of about 35% » In March 2016, we changed the outlook on the Caa3 rating to negative from stable to reflect the possibility of larger losses B1

Venezuela Moody’s LT Issuer Rating (Foreign)

Ratings

Foreign Currency

Local Currency

Gov. Bond Rating

Caa3/NEG

Caa3/NEG

Country Ceiling

Caa3

Caa2

Bank Deposit Ceiling

Ca

Caa2

B2 B3 Caa1

Caa2 Caa3 Ca Source: Moody’s Investors Service

Venezuela’s Debt Default, Feb. 2018

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Moody’s sovereign bond ratings incorporate four key factors Factor 1: Economic Strength • Growth dynamics • Growth • Volatility • Competitiveness • Scale of the economy • Nominal GDP • National income • PPP GDP per capita

Factor 2: Institutional Strength • Institutional framework and effectiveness • Government effectiveness • Rule of law • Control of corruption • Policy credibility and effectiveness • Inflation level and volatility • Quality of fiscal policy implementation • Track record of default

Factor 3: Fiscal Strength

Factor 4: Susceptibility to Event Risk

• Debt burden • Debt to GDP • Debt to revenue

• Political Risk • Domestic political risk • Geopolitical risk

• Debt affordability • Interest payments to revenue • Interest payments to GDP

• Government liquidity risk • Market funding stress

• Ability to deploy resources to face current and expected liabilities • Debt trend • Share of foreign currency debt • Contingent liabilities • SWF

• Banking sector risk • Strength of banking system • Size of banking system • External vulnerability risk • (CA + FDI) / GDP • EVI; NIIP/GDP

Source: Moody’s Sovereign Bond Ratings Methodology, December 2016

Venezuela’s Debt Default, Feb. 2018

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In default, Moody’s positions ratings to reflect expected recoveries Moody’s ratings refer to the expected loss on the securities (PD x LGD)

Approximate expected recoveries associated with ratings for defaulted securities

Source: Moody’s Rating Symbols & Definitions, July 2017

Venezuela’s Debt Default, Feb. 2018

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Venezuela’s default was triggered by missed interest payments in Nov. 2017 2 Nov. 2017

PDVSA failed to make the principal payment on a bond without a grace period Venezuelan President Maduro announced an intention to restructure Venezuela's debts. No details were announced then or at a subsequent meeting of creditors in Caracas on 13 Nov. 2017

12 Nov. 2017 20 Nov. 2017

Sovereign bonds due in 2019 and 2024 went into default on 12 Nov. 2017, and bonds due in 2025 and 2026 went into default on 20 Nov. 2017

3 Dec. 2017

President Maduro announced that Venezuela would create a cryptocurrency backed by oil, gas, gold and diamond reserves

8 Jan. 2018

EMTA issued a new Market Practice recommendation for the Republic of Venezuela's bonds effective 9 Jan. 2018, recommending flat trading

2018

Presidential elections are due in 2018 and a change in government could affect all aspects of the current position Venezuela’s Debt Default, Feb. 2018

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Venezuela’s restructuring is more complex than other sovereign defaults Restructuring negotiations will likely be complex, due to: » Venezuela’s external debt maturity profile » The interdependence between government and PDVSA finances » The extent of the economic and humanitarian crisis in Venezuela » Elevated sociopolitical tensions and a highly contentious political system » Lack of transparency on economic data » US sanctions applied to Venezuela and its government – All US persons/companies are prohibited from engaging in transactions that involve new debt with medium-term or long-term maturity for the sovereign or PDVSA – Further, Venezuela's restructuring effort is currently being led by Vice-President Tareck El Aissami, who is a Specially Designated National under US sanctions

Venezuela’s Debt Default, Feb. 2018

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Venezuela's restructuring could be the fourth largest in history » The government has around $36.7 billion in outstanding international bond debt. PDSVA has some $28.5 billion outstanding in bond debt as of end-2016 » If a future restructuring involves both entities, the size of the combined default could be as large as $65.2 billion Venezuela's restructuring could be the fourth largest in nominal terms (Total defaulted bond debt, $ billion) 300 250 200 150 100 50 0 Note: Bracket refers to the date of first default. For Venezuela, the combined amount of sovereign and PDVSA bonds outstanding are shown here, and they are the amounts on which the sovereign may ultimately start a debt restructuring.

Source: Moody’s Investors Service

Venezuela’s Debt Default, Feb. 2018

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Venezuela’s maturity profile would likely require a large restructuring » $5.4 billion and $5.6 billion upcoming bond payments in 2018 and 2019 for the sovereign and $3.1 billion and $3.9 billion for PDVSA Schedule of bond obligations as of November 2017 (Principal and interest payments, selected entities, USD millions) EDC Interest

EDC Principal

PDVSA Interest

PDVSA Principal

Sovereign Interest

Sovereign Principal

$14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 Note: EDC stands for Electricidad de Caracas.

Source: Moody’s Investors Service

Venezuela’s Debt Default, Feb. 2018

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Critical interdependence between PDVSA and government finances » PDVSA is a key source of government revenue and foreign exchange » There are no cross-default clauses between sovereign and PDVSA bonds The sovereign bonds could be easier to restructure than PDVSA bonds Comparison of bond features

Sovereign Bonds

PDVSA Bonds

Grace Period

30 day grace period on principal and interest

30 day grace period on interest only

Collective Action Clauses

Yes. The clauses activate at 75% of principal for most bonds and 85% of principal for two bonds.

No.

Acceleration Clauses

Yes. The clauses activate at 25% of principal holders' request.

Yes. The clauses activate at 25% of principal holders' request.

Source: Moody’s Investors Service

Venezuela’s Debt Default, Feb. 2018

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Venezuela is facing a deeper economic crisis than previous defaulters Real GDP Growth (index, t-5=100) Default Greece - 2012

140 130 120 110 100 90 80 70 60 50

Real Gross Domestic Product (% change)

Venezuela - 2017 Argentina - 2014

Argentina - 2001 Ukraine - 2015

Default Greece - 2012

15.0

Venezuela - 2017 Argentina - 2014

Argentina - 2001 Ukraine - 2015

10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0

t-5

t-4

t-3

t-2

t-1

t

t+1

t+2

t+3

t+4

Current Account Balance (% of GDP) Default Greece - 2012

10.0

t-5

t+5

t-4

t-3

t-2

t-1

t

t+1

t+2

t+3

t+4

t+5

Venezuela: Inflation and inflation volatility

Venezuela - 2017 Argentina - 2014

Argentina - 2001 Ukraine - 2015

5,000.0

Inflation volatility (RHS)

Inflation (CPI, % change Dec/Dec) 2,000.0

4,000.0

1,600.0

0.0

3,000.0

1,200.0

-5.0

2,000.0

800.0

-10.0

1,000.0

400.0

5.0

-15.0

0.0

0.0

-20.0 t-5

t-4

t-3

t-2

t-1

t

t+1

t+2

t+3

t+4

t+5

Note: t refers to the time of default; Inflation volatility is defined as standard deviations of rolling five-year windows of year-on-year CPI inflation.

Source: Moody’s Investors Service, Haver Analytics

Venezuela’s Debt Default, Feb. 2018

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Losses in past sovereign defaults offer limited visibility for Venezuela There is usually a high level of uncertainty around expected losses Âť The average historical sovereign loss rate was 46% over 1998-2016. The value-weighted loss rate was 70% because of the large Argentinean (73%), Russian (82%), and Greek (76%) defaults that garnered high loss rates Loss rates varied widely in the largest sovereign defaults (Loss rate, % of par) 90 80 70 60 50 40 30 20 10 0

Note: Loss rate is defined as 100 minus the average trading price (in % of PAR), 30-day post default or around closing date of distressed exchange.

Source: Moody’s Investors Service

Venezuela’s Debt Default, Feb. 2018

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The magnitude of losses in Venezuela's case is not yet clear » A relatively quick resolution could lead to lower losses if the Venezuelan authorities were to adopt a similar stance in restructuring the outstanding instruments as they did in 2016 » However, it remains unclear whether the authorities will seek liquidity relief in the form of payment extensions, or whether they will seek haircuts on principal amounts » Declining oil production constrains Venezuela’s ability to service external debt » Moody’s negative outlook for Venezuela reflects our view that there is a substantial likelihood of larger bondholder losses

Venezuela’s Debt Default, Feb. 2018

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Market access often remains impaired for many years after default » On average, sovereign governments remained out of international capital markets for 5.6 years after default and 4.4 years after final default resolution

Market exclusion is highly correlated with the haircuts imposed on investors (Sovereign bond defaults, 1997-2013)

» Length of market exclusion was highly correlated with the loss imposed on investors during the debt restructuring » Default resolution was relatively quick, taking slightly over one year on average, meaning length of market exclusion generally not driven by inability to resolve default but by length of time it took for country to rebuild ability and reputation to service debt

Source: Moody’s Investors Service, Sovereign Defaults Series: Market Re-Access and Credit Standing After Sovereign Default, Oct. 2013

Venezuela’s Debt Default, Feb. 2018

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Recent developments December 2017: Venezuela attempts to circumvent sanctions by creating a cryptocurrency » On 3 December, President Maduro announced that Venezuela would create a new cryptocurrency (or petrocurrency) backed by oil, gas, gold and diamond reserves. Each Petro will represent one barrel of oil as priced by OPEC, and will be supported by certified crude barrels from the Orinoco Oil Belt » It is unlikely that the government will be able to successfully institute the so-called Petro amid worsening political turmoil and the severe economic recession » Even if the government were able to set up a virtual currency, we do not believe that market participants would feel sufficiently confident that the government would transparently and faithfully manage the proposed currency (e.g., inflation was over 1000% in 2017) » Rather than a cryptocurrency, the Petro appears like an asset backed by commodities, to be traded electronically –

In Jan. OFAC stated: “A currency with these characteristics would appear to be an extension of credit to the Venezuelan government. Executive Order 13808 prohibits U.S. persons from extending or otherwise dealing in new debt with a maturity of greater than 30 days of the Government of Venezuela. U.S. persons that deal in the prospective Venezuelan digital currency may be exposed to U.S. sanctions risk.”

Venezuela’s Debt Default, Feb. 2018

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Appendix: Moody’s sovereign ratings accurately rank-order default risk Five-year issuer-weighted cumulative default rates, 1983-2016 Sovereign Issuers 40% 35% 30% 25% 20% 15% 10% 5% 0%

Aaa

Aa

A

Baa

Ba

B

Caa-C

Source: Moody’s Investors Service, Sovereign Default and Recovery Rates, 1983-2016, Jun. 2017

Venezuela’s Debt Default, Feb. 2018

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Moody’s related research Venezuela Research »

Issuer Comment: Government of Venezuela: Venezuela’s new exchange rate policy will not address macroeconomic imbalances or improve debt-service capacity , February 2018

»

Outlook: Moody's: Stable outlook for Latin America and Caribbean sovereigns as stronger growth balances rising debt and policy uncertainty, January 2018

»

Issuer In-Depth: Government of Venezuela – Caa3 Negative: Annual credit analysis, December 2017

»

Issuer Comment: Government of Venezuela: Venezuela’s attempt to circumvent sanctions by creating a cryptocurrency is unlikely to succeed, December 2017

»

Issuer In-Depth: Government of Venezuela: Restructuring ranks among the largest sovereign defaults ever and is more compl icated , November 2017

Sovereign Defaults Research »

Sector In-Depth: Myths and Facts about Sovereign Debt Restructurings (Presentation), January 2016

»

Special Comment: Sovereign Defaults Series - The Aftermath of Sovereign Defaults, October 2013

»

Topic Page: Sovereign Default Research

Methodology »

Research Guide: Moody's Rating Symbols & Definitions, July 2017 Venezuela’s Debt Default, Feb. 2018

»

Rating Methodology: Sovereign Bond Ratings, December 2016

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Elena Duggar Associate Managing Director Credit Strategy & Research elena.duggar@moodys.com +1.212.553.1911

Jaime Reusche VP – Sr. Credit Officer Sovereign Risk jaime.reusche@moodys.com +1.212.553.0358

Claire Li Associate Analyst Credit Strategy & Research claire.li@moodys.com +1.212.553.3780

Anna Snyder Associate Analyst Sovereign Risk anna.snyder@moodys.com +1.212.553.4037

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Venezuela’s Debt Default, Feb. 2018

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