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UPDATE 2-PDVSA 2017s fall on disappointing debt swap terms

(ADDS downgrade, UPDATES levels)

By Paul Kilby

NEW YORK, Sept 19 (IFR) - The 2017s issued by Venezuelan oil company PDVSA were closing Monday off intra-day lows, even as investors shunned the terms of a debt exchange targeting US$7.1bn of those securities.

The 5.25% 2017s were ending the day at around 73.00 after hitting 71.75 earlier, while the 8.5% 2017s were back up to 77.30 after slumping to a 76.50 bid in the morning.

The 5.25% 2017s closed on Friday at 75.125, while the 8.5% 2017s ended last week at 79.40.

That followed S&P's announcement that it had downgraded PDVSA to CC from CCC, after calling the transaction a distressed exchange.

The rating agency warned it would lower the rating on the 2017s to D on completion of the operation, which it said would delay payments on the existing notes.

"We view the offer as distressed rather than purely opportunistic, given the current challenging operating conditions and the significant upcoming debt maturities that PDVSA faces," the ratings agency said.

PDVSA President Eulogio Del Pino said earlier this month that the new bond had been given a positive evaluation by three rating agencies.

If successful, the long-awaited liability management operation would give the beleaguered oil exporter some relief from a wall of maturities falling due over the coming months.

Yet while a good chunk of the 2017s are thought to be held by compliant government entities, PDVSA will likely need to bring in a critical mass of foreigners to get past the 50% participation rate set by the company.

"The swap looks like it would be more appealing to locals than foreign investors, given the 1:1 ratio in addition to the uncertainty over the value claims on Citgo," said Sean Newman, senior portfolio manager at Invesco.

PDVSA announced Friday that for each US$1,000 in principal of existing 2017s, bondholders would receive an equal amount of new 8.5% amortizing 2020s, backed by a first-priority interest on 50.1% of capital in Citgo Holdings.

After the early bird deadline of September 29, however, holders will receive US$950 of new notes for every US$1,000 of old securities exchanged.

"The market was expecting a ratio of 1 to 2 or 1 to 3," said a fixed-income analyst. "The rating agency would have left ratings alone on an exchange ratio of this type."

But the initial par-for-par offer disappointed many market participants, who said a higher ratio would be required to make the transaction NPV-positive for holders.

"It is difficult to get past the fact they are asking for 1 to 1," said Siobhan Morden, head of Latin American strategy at Nomura.

"They are starting with an NPV negative (transaction) and are looking to the Citgo stock to compensate. That is a difficult starting point."

How accounts value the Citgo pledge will likely make all the difference when holders are deciding whether to participate or not.

That could prove difficult, given that Citgo operating shares have already been pledged on an earlier bond offering form the US based borrower.

While Invesco's Newman puts a rough value of the Citgo claim at 50 to 55 cents on the dollar, holding the stock comes with legal risks should PDVSA default.

"You enter a real legal jungle on who gets priority claims on Citgo relative to holders of its debt," he said.

"And you face possible lawsuits from existing PDVSA holders who may think they have similar claims on the assets."

Credit Suisse is acting as financial advisor on the exchange offer. (Reporting by Paul Kilby; Editing by Marc Carnegie)

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