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Ukraine bondholders confident as default threat looms
February 13, 2014 / 7:37 PM / 4 years ago

Ukraine bondholders confident as default threat looms

* Ukrainian bonds fall amid heightened risk of default

* Bondholders still confident Russia will help

* Falling hryvnia to put pressure on corporates

By Davide Scigliuzzo

LONDON, Feb 13 (IFR) - Ukraine’s sovereign bonds have remained relatively resilient to default fears emanating from rising political tensions, but a collapse in the value of the local currency could hurt the corporate and banking sector.

The political standoff between President Yanukovich and the opposition adds to an already precarious economic picture.

A current account deficit of almost 9%, dwindling foreign exchange reserves - at USD17.8bn in January, the reserves are not enough to cover three months of imports - and the risk of a sharp devaluation of the hryvnia have shortened the odds of a Ukraine default.

Its sovereign bonds have fallen in recent days, approaching the record lows reached in early December, when the country backed off from a trade agreement with the European Union and opted to forge stronger ties with Moscow.

Ukraine’s sovereign curve is sharply inverted, with the yield on its 2014 notes above 20%, but overall its bonds still trade at relatively high cash price levels, with investors reluctant to price in substantial haircuts.

“Bonds maturing this year are still trading in the 90s. I don’t get that,” said Eric Fine, portfolio manager at Van Eck Global. “I think the chances of a default by Ukraine are higher than Venezuela, and the market is pricing in the opposite.”

Ukraine’s bonds are mostly held by a few large institutional investors led by Franklin Templeton, whose nominal holdings are worth over USD6.7bn, according to Thomson Reuters data.

Investors with exposure to the country are also confident that in spite of the geopolitical brinkmanship, Russia will once again come to Ukraine’s rescue to service external debt costs estimated by the country at just under USD10bn this year.

“What only a few months ago seemed a tail risk is now becoming a reality in Ukraine,” said Tatiana Orlova, senior economist for Russia and the CIS at RBS.

An escalation of protests in January forced the resignation of prime minister Mykola Azarov, but negotiations between Yanukovich’s ruling party and the opposition on constitutional reforms and the creation of a new cabinet have so far made little progress.

Russia pledged USD15bn in aid in December, but has suspended disbursements, after a first USD3bn payment, in the wake of prime minister Mykola Azarov’s resignation.

“Foreign investors seem to be voting with their feet,” said Timothy Ash, head of emerging markets research ex-Africa at Standard Bank. “Without external support it appears only a matter of time now before the hryvnia suffers a seismic move, and this will raise serious concern over the durability of the banking sector, debt sustainability, et al.”

Angus Halkett, a portfolio manager at Stone Harbor believes the funds from Russia will ultimately come through.

“It is just a question of how bad the situation has to get for that to happen.”

Ukraine’s relatively low debt level, estimated to have reached just over 40% of GDP in 2013 is also a source of comfort. “It is more of a cash flow issue than anything else,” said Halkett. “The  response in the event of a default will likely include a restructuring of maturities rather than a sizable haircut.”

CORPORATE HEADACHES

Pressure on corporates is building too.

Currency controls introduced in February to stem a plunge in the hryvnia do not affect Ukrainian corporates’ servicing of international debt. But if the hryvnia continues to fall, the credit standing of companies with sizable foreign liabilities and local currency revenues will come under further pressure.

According to analysts at Sberbank Investment Research, the vast majority of Ukrainian banks, most agricultural companies, as well as Naftogaz and steelmaker DTEK are among the most exposed.

The yield on Naftogaz’s September 2014s soared to over 40% on Thursday, with the bonds trading at a cash price of 83.833, according to Tradeweb data, while DTEK’s April 2018s dropped to a new low of 83.00 to yield 13.36%. The hryvnia has lost around 7% against the dollar so far this year.

Rating agencies have taken note. “Due to the imposition of limited capital controls and the recent depreciation of the hryvnia, we see the immediate threat to companies’ foreign currency borrowings as higher than that to their local currency debt,” Fitch said on Wednesday, when it downgraded a host of Ukrainian corporates to CCC on the back of a similar action taken on the sovereign.

Rival agencies Moody’s and Standard & Poor’s took similar steps in January, downgrading Ukraine to Caa2 and CCC+ respectively. (Reporting by Davide Scigliuzzo; Editing by Sudip Roy)

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