August 27, 2015

Ukraine and the creditor group have reached an agreement on debt restructuring, Ukraines PM Yatseniuk has announced today. Following failure of Ukrainian authorities to introduce debt payment moratorium, Ukraine agreed to a very sweet deal (in our view), compensating haircut with huge coupon, small maturity extension and value recovery instruments. Today prices of Ukraine bonds are surging across the board.

The deal consists of:

     20% write-down of the debt principal (USD 3.8bn, including bonds of the City of Kiev and government guaranteed debt);

Extension of maturities by 4 years (i.e. to 2019-2027 respectively);

Coupon rate set at 7.75% for all Eurobond issues subject to restructuring (this compares to 7.2% average weighted rate according to MinFin);

Issue of Value Recovery Instruments (GDP warrants) - see attached file for a detailed description.

Ukraine now has to convene a noteholder meeting under each of the bond issues, at which an adequate volume of votes in favor of the restructuring has to be obtained. Still, as nearly half of Ukraines foreign debt subject to restructuring is held by the creditor group, getting a legal approval of the restructuring terms should not be a problem, in our view.

While the distribution of holdings across the debt issues subject to restructuring is unknown, we believe lenders apart from the creditor group will follow the example, driven by animal spirits.

Legal formalities on the USD 500mn issue due Sep 23, 2015 are unlikely to be implemented in time. Still, we do not see it as a big issue, should Ukraine be fast enough to obtain a waiver from its debt holders, according to which they would refrain from their right to proceed with an event of default option.

USD 3bn note by Russia remains a separate issue as Moscow is highly unlikely to agree for any sort of restructuring (including extension) of this debt. According to todays statement by Russian MinFin Siluanov, Russia will not take part in the restructuring.

While the government may still try to negotiate some kind of solution with the Russian government, we feel nearly 100% sure Ukraine will have to affect this payment in time (Dec 2015), having to recognize this debt as official.

Taking this into account, we believe the final 20% haircut will amount to USD 3.2bn.

Impact on Ukraines FX market will likely be limited. While Ukraines sovereign FX needs are now generally covered with prospective bailout flows, we do not expect the authorities to use these additional resources to be used to shore up the UAH via open market operations. Instead, the NBU will continue accumulating reserves via FX purchases, in line with the IMF program objectives and as long as the USD/UAH stays within the boundaries acceptable to the central bank (which currently seems to be UAH21 to UAH23 per USD). 

To this end, we retain a bearish view on the UAH and continue to expect it to close the year at around 25 per USD, weighed by increased imports (including gas) in autumn, as well as somewhat looser administrative restrictions following the Oct elections. One should also take into account potential reshuffling of the government this autumn. 

FX and capital restrictions will likely be extended (in general) until further signs of stabilization of Ukraines financial system. The reader should recall that the central banks capital and FX restrictions (Regulation #354) expire next week (Sep 3). We however anticipate them to be extended for another couple of months (although certain symbolic softening is still very likely, in our view).

While a successful completion of the debt operation in line with its objectives is one of the preconditions for the central banks plan of a gradual removal of the present restrictions (please see also our Capital Markets Weekly dated Aug 10, 2015), we believe other preconditions to be more important from the perspective of future market liberalization. As a reminder, these include:

Full implementation of bank recapitalization based on the results of the 2014 diagnostic studies;

 A target level of the NBUs net international reserves (= adequate purchases of FX by the NBU, left unspecified) as specified in the plan for the 1st stage of the liberalization;

Full transition of Naftogaz to the interbank market for its FX purchases (= no further reliance on NBU reserves, which is still not there, as we see it).

For more information: alert270815.pdf