BANKING ON VENEZUELA / THE WALL STREET JOURNAL ( RECOMMENDED READING )

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DECEMBER 7, 2009, 4:03 P.M. ET.

Banking on Venezuela

By JOHN LYONS

With its economy shrinking and inflation soaring, Venezuela began nationalizing banks last week, stoking fears that a full-blown banking crisis may be next. Sound like a buy?

Strangely, the answer may be yes, at least in the short term. Last week's sharp selloff in Venezuela's dollar-denominated bonds, a response to President Hugo Chavez's takeover of a handful of banks and warning that others were "on the radar," seems to have gone too far. Indeed, Monday the benchmark bond recovered a little after falling 9.5% last week.

First, fears of mass nationalizations may be overblown. President Chavez accused bank owners of making big loans to themselves and their associates, prompting investors to worry about the potential for a repeat of a 1994 episode which led to a broader banking crisis.

This time around, the vast majority of Venezuelan deposits are held by five big banks, regarded as well-run and unlikely to be affected in the shake-up. Analysts say Mr. Chavez is targeting up to a dozen small banks that together account for around 20% of the assets in the banking system.

Second, even if banking troubles worsen, they won't necessarily undermine the ability of the government or the state-oil company, PDVSA, to repay their loans. In fact, President Chavez has recently been loosening some terms for the international oil majors operating in the country in an apparent sign of the government's need to keep attracting foreign capital.

Alejandro Grisanti, an analyst who follows Venezuela at Barclays Capital, recommends bonds that he estimates are already trading around default recovery levels. His favorite is PDVSA's 5 3/8% bond due 2027, which closed Friday at 41.77 cents on the dollar, yielding 14.73%. That's in the ball park of the recovery rate of around 35 cents on the dollar in Ecuador's recent debt workout. But unlike Ecuador, PDVSA has valuable assets within reach of international creditors, such as the U.S. oil company Citgo and several refineries. Mr. Grisanti also notes that Venezuela's 7% bond due 2038 is trading for 49 cents on the dollar and yielding 14.56%.

To be sure, bank interventions can be unpredictable in Latin America, and particularly in Venezuela, where confidence in Mr. Chavez's ability to manage the complex financial industry is low. If investors panic and withdraw deposits across the board, even strong banks could be damaged. What's more, Venezuela's long-term prospects aren't good. The country's deep economic contraction mixed with 30% inflation is redefining the term "stagflation".

Oil production, which accounts for almost all of the country's exports, is dropping amid investment declines. But the need for foreign investment to keep the oil industry on its feet, perversely might provide some reassurance for international investors. After all, President Chavez cannot afford to see the flow of dollars from overseas dry up completely.

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