The Brady Bond swap made simple

An intense debate has been unleashed about the government’s recently executed bond swap operation. As far as the financial implications of this swap are concerned, we note that many renown financial analysts are producing studies thereof, some showing positive results while others are negative. There is great confusion all around.

A few weeks ago, before the storm, I expressed certain reserves about the operation. Above all that results of the swap definitely were not as positive as those the authorities were promoting to validate the deal. I will try to present a simple analysis which I hope will shed light on the operation and allow readers to come to their own qualified conclusions.

In order to limit the analysis to strictly financial matters, it is necessary to clarify and to eliminate the noise created by some initial aspects that may cloud the issues. The first refers to the question of legality of the operation and the second to whether corruption was present.

As far as the legal issue is concerned, I should, not being a lawyer, refrain from taking positions. However, since one of the key inputs to a legal study would be whether or not the country has taken on new debt, I find it difficult to understand how Venezuela all of a sudden ends up with an additional US$ 1.317 billion in its kitty without net indebtedness. The only possible alternatives are either that the Nation has won a gigantic Lotto or, God forbid, has been involved in some type of misappropriation in the international markets. Anyhow, it is apparent that it is frequently more important to comply with one’s duty formally than realistically. In this sense, the bond swap could be totally “legal”.

With respect to the issue of corruption, only solid police investigation could reach a serious conclusion. Obviously, any such investigation should take into consideration not only the swap itself, but also any operation that took place prior to its execution and through which people in the know could have taken undue advantage. Since I am neither an investigator nor a policeman, it is impossible to issue a factual opinion. It is also irrelevant, since corruption may be present both in excellent financial operations as well as in the bad ones.

Having eliminated the aspects of legality and corruption we can proceed to the financial issues. This analysis is, in truth, extremely simple. By the way, in our analysis we have avoided all discussion as to whether the effects of the swap should be measured from the perspective of the Ministry of Finance or that of the Central Bank. For the common citizen, both form part of the same Venezuela.

Before the swap operation, Venezuela had an obligation on paper of US$ 4.441 billion. Interest incurred annually up to the year 2020 was to have been in the order of US$ 300 million. The debt was guaranteed by collateral that produced its own return which in turn, by the year 2020, should have been sufficient to amortize the principal of the debt.

After the swap operation, which in essence canceled the beforementioned debt, the collateral originally held was returned to Venezuela. This collateral, in the form of Zero Cupon US Treasury Bonds with a current value of approximately US$ 1.371 billion, has already or will obviously be sold in the open markets. In turn, Venezuela issued new debt instruments for US$ 4 billion maturing in the year 2027 and which create annual interest payments of US$ 370 million.

As a result then, the real difference between the “before” and “after”, and therefore the only valid basis for financial analysis, is the fact that Venezuela received US$ 1.317 billion in fresh funds. The cost of these funds will be US$ 70 million in additional interest (the difference between annual interest of US$ 300 million on the original debt and US$ 370 million on the new debt) that must be paid during 23 years until the year 2020, US$ 370 million in total interest to be paid during the seven years between the years 2021 and 2027, and finally, the capital of US$ 4 billion maturing in the year 2027. If all of this were rolled into a calculation as if the fresh funds were a new loan, the equivalent interest rate would be 8.8%.

In order to reach a final conclusion as to the validity of the swap, we must analyze whether the fresh funds are to be used to produce sufficient returns and/or social benefits over the 30 year period to merit the service of additional debt at 8.8% interest or if, on the contrary, and as has been tradition, the new debt simply adds to the country’s troubles.

Obviously, all this requires personal appreciation. In its analysis, the Government has used the basic premise that its management of the funds will produce a return of 10% per annum. The result, therefore, is positive. For those who believe that the government does not have a plan of action that will guarantee sufficient returns, the result is negative. Financial analysis shows that both could be right. It all depends which lens you look at it through, or in financial jargon, which discount rate is being used.