* IMF deal unlikely before May 25 elections
* Ukraine in "pre-default state" -acting president
* Bond curve indicates possibility of debt restructuring
By Sujata Rao
LONDON, Feb 24 While bond markets have reacted
jubilantly to the possibility of Western aid for Ukraine,
big-name investors are worried about how fast Kiev can secure a
rescue and whether an IMF bailout may reschedule its debts.
The faith of funds such as Templeton, Fidelity, Amundi, ING
and Stone Harbor Investment Partners in Ukraine's ability to
repay its debts seemed to have been vindicated late last year
when Russia offered Kiev a $15 billion rescue.
That deal is doubt following the weekend overthrow of
Moscow-backed president Viktor Yanukovich, and Ukraine's new
authorities have turned to the West, appealing for urgent
financial help to avoid a default.
Hopes for a deal with the International Monetary Fund
boosted Ukrainian dollar bonds by 5-9 cents across all
maturities on Monday, reducing the country's bond yield premiums
to U.S. Treasuries by a half percentage point on average,
according to JP Morgan's EMBI Global index.
This offered some relief to bondholders whose punt on one of
the highest-risk emerging markets has fared poorly this year.
Ukraine, along with Venezuela, is this year's worst bond
performer, recording losses of 13 percent by end of last week on
the JPMorgan index.
Bondholders' worries are by no means over. "Ukraine is still
a risky call. It is not out of woods as there is a lot of
short-term debt coming due," said Sergei Strigo, head of
emerging debt at Amundi, which has a total of $1 trillion under
management. "If you look at the bond curve you can see it still
indicates potential for (debt) restructuring."
Normally, it is costlier to buy longer-term debt insurance
and yields on longer-dated debt are higher than on bonds
maturing in the near future. In Ukraine, the reverse is true and
this is making investors nervous
Acting President Oleksander Turchinov said on Sunday that
"the Ukrainian economy is heading into the abyss and is in a
The probability of default is as high as 52 percent in the
next five years, data provider Markit estimated, basing its
calculations on prices for credit default swaps.
Amundi owns Ukrainian debt but cut exposure after the
Russian bailout deal, which Moscow subsequently suspended,
especially to bonds maturing in 2014. Its holding no longer
exceeds Ukraine's 3 percent weight in the index.
Strigo said investors were heartened by the end to the
violence that led to Yanukovich's fall and the interim
government's plans for swift elections and to seek international
"The chances of quick reform and macro-adjustment as per IMF
requirements have improved," he said, noting the hryvnia's
effective devaluation that was a major IMF requirement.
"But the big questions are: will there be enough money? And
second, will that money come in time? The bond curve is still
indicating potential for restructuring."
The IMF agreed a $15.5 billion loan for Ukraine in 2010, but
suspended the deal last year after Kiev failed to implement the
required reforms, which included removing gas price subsidies
and freely floating the currency.
BIG CASH NEEDS
Ukraine has said it needs around $35 billion in foreign
assistance over the next two years and it asked to receive the
first part of the aid in the next one to two weeks.
The government must repay $6.5 billion to creditors in 2014,
and needs a further $6.5 billion to fund its balance of payments
gap while it is also $1 billion in arrears to Russia for gas
supplies, according to estimates from Commerzbank.
This would more than wipe out central bank reserves, which
Goldman Sachs reckons are down to $12-$14 billion.
Bondholders believe that an IMF package would benefit
Ukraine by forcing the much-needed reforms, but a deal may take
time to piece together and could prove unpalatable to the
country's new rulers who face elections at the end of May.
"As investors we need to see there is a source of funds to
repay debt. There was a sure source of funds which was Russia
and that's not there any more," said Angus Halkett, a portfolio
manager at Stone Harbor, which owns Ukrainian debt.
"You have an increase in the level of uncertainty and an
increase in bond prices at the same time, which is ambitious."
U.S. Treasury Secretary Jack Lew and IMF Managing Director
Christine Lagarde agree that Ukraine needs both bilateral and
multilateral support for any reforms, a U.S. Treasury official
said in Washington. However, the official made clear that "a
fully established government" had to request help.
This cannot be installed until after the elections are held
on May 25.
SELLING INTO THE RALLY?
So will investors make use of the rally to sell? On the plus
side, Ukraine's high yields make it too costly for funds to
exclude the debt from their portfolios: its 2017 bond for
instance has a 9.25 percent coupon.
Secondly, most allocations are small, except for Templeton,
which on Dec. 31, 2013 held over $6 billion worth of Ukraine
sovereign dollar debt, a third of outstanding volumes.
Templeton's bet is led by its star investor Michael
Hasenstab who has made a name - and money - with contrarian
investments in Hungary and Ireland when they were struggling.
Templeton declined to comment specifically on Ukraine,
saying only it had the capacity to buy and hold investments that
are out of favour. But clearly, the reckoning is that rewards
from Ukraine will eventually emulate those in Ireland.
"Hopefully, Ireland's story will be repeated in many parts
of the world that are struggling today," Hasenstab wrote in an
BAIL-OUTS AND BAIL INS
Even if default is averted, there is a chance an IMF deal
will involve a "bail-in" for creditors, forcing them to share
the burden by having part of their debt written off.
Aid programmes should be revamped to prevent public money
being used to pay private sector creditors who take the cash out
of the country, a 2013 IMF paper suggested.
Analysts such as Gabriel Sterne at Exotix note that during
the IMF bailout of Cyprus last year, debt maturities were
extended by three years, a principle that could be applied in
Ukraine which has a lot of short-dated debt coming due.
But unlike Cyprus or other euro zone states, Ukraine's debt
is relatively low at around 40 percent of annual economic
output. That makes a big bond write-down unlikely.
"Ukraine doesn't have a solvency problem, it doesn't have
much debt. But it lacks hard currency and has a large (funding)
deficit," Halkett of Stone Harbor said. "So yes, some sort of
terming out of the maturity structure of Ukrainian debt would be
extremely helpful for them."