REFILE-UPDATE 2-Ukraine bonds fall as restructuring mooted; investors weigh options

Thu Mar 6, 2014 4:52am EST

By Carolyn Cohn and Sujata Rao

LONDON, March 5 (Reuters) - Ukraine's short-dated dollar bonds plunged by as much as 6 cents on Wednesday after the country's finance minister said it may start talks with creditors on restructuring debt, though Western aid pledges helped prices to recover.

Ukrainian bond prices have been under pressure for weeks despite prospects of a multi-billion dollar International Monetary Fund bailout, as the state of the country's economy and the sheer weight of debt repayments made a restructuring likely.

Credit default swaps markets in fact have been pricing a 50 percent probability of a Ukrainian default or restructuring within the next five years, according to data from Markit.

Nevertheless, bond prices fell across the curve after Finance Minister Oleksander Shlapak's comments. Shlapak also said Ukraine faced about $10 billion in repayments on its foreign currency debt this year, a higher figure than most analysts had expected.

Ukraine's June 2014 $1 billion bond plunged more than 5 cents on the dollar to 90 cents. State energy firm Naftogaz's government-guaranteed $1.6 billion issue due Sept 2014 also fell 5.5 cents versus Tuesday's close to 85.7, according to Tradeweb.

Longer-dated dollar bonds also fell between 1 and 3 cents.

All the bonds later recouped most of their losses, however.

"To be very honest, this does not come as a surprise to anyone looking at Ukraine's financial situation. Second, these loan packages are usually accompanied by some form of debt restructuring," said Zsolt Papp, who helps manage an emerging debt portfolio at Swiss private bank UBP.

Investors were forced to take bond writedowns of around 70 percent in Greece, for instance, after a 2012 IMF-led bailout.

An IMF mission is visiting Ukraine this week but other donors have already come up with pledges of support, with the European Union promising 11 billion euros ($15.11 billion), including loans from development banks EBRD and EIB.

The EBRD said it was offering loans worth 5 billion euros ($6.87 billion) over the next six years.

Ukraine has said it needs $35 billion.

Analysts said the pledges were supporting debt prices, along with hopes that any restructuring will take the form of extending bond maturities rather than imposing "haircuts", or reductions on the bonds' repayment value.

"11 billion euros is very big, it's big enough for Ukraine not to need to reprofile (extend debt maturities)," said Gabriel Sterne, an economist at Exotix in London.

Sterne said Ukraine's problem was liquidity, not solvency, meaning changing short-dated bond tenors would be more useful than outright restructuring.

While a lot of debt is due for repayment in 2014 and 2015, Ukraine's sovereign debt equates to less than 50 percent of annual economic output. In Greece, it was more than 100 percent.

Immediate 2014 payment demands were in any case manageable, if the EU package comes through quickly, said Kilian Reber, analyst at UBS Wealth Management.

"Ukraine has repayments on foreign currency debt of... about $500 million each quarter, they should be able to do that," he said.

INVESTORS

Ukrainian bonds figure large in the portfolios of many prominent investors, including star Templeton fund manager Michael Hasenstab, who made a name for himself with similarly audacious bets in Ireland and Hungary.

Templeton is estimated to hold more than a third of Ukraine's sovereign dollar bonds, but data from end-2013 indicate this does not include the securities maturing in 2014.

The way Ukrainian dollar bonds have traded in recent weeks seems to imply investors have come to terms with the likelihood of restructuring but some analysts such as Regis Chatellier at Societe Generale reckon bondholders should prepare for worse.

"The reality is that even with IMF support, restructuring is probably necessary and in fact, given the extreme situation from the economic and geo-political point of view, Ukraine's debt burden is not sustainable," Chatellier said.

He noted that aside from debt payments, Ukraine needs to finance a gaping current account deficit and could also see a disgruntled Kremlin hiking gas supply prices.

The currency's 10 percent-plus fall this year versus the dollar will also make it costlier to service debt.

"Reprofiling may not be enough," he said.

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