Ukraine Cassandras Are Disregarded as Bonds Top 90 Cents

Photographer: Vincent Mundy/Bloomberg

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Photographer: Vincent Mundy/Bloomberg

A pedestrian walks past burnt out trucks abandoned on the roadside as she heads towards the Ukrainian parliament building in Kiev.

Russia sees a high probability that neighboring Ukraine will default. Standard & Poor’s says that outcome is likely. Even Ukraine’s acting president calls the country’s plight a “pre-default situation.”

Bondholders don’t share the same concern.

The nation’s $1 billion of 7.95 percent notes due in June are trading at 93.9 cents on the dollar and its bonds maturing in 2023 fetch 86.2 cents. By comparison, Argentina’s benchmark bonds hovered at 25 cents before the country’s record $95 billion default in 2001. Ecuador’s notes traded at 32 cents a week before it halted payments in 2008.

While mounting capital flight has drained Ukraine’s foreign reserves to an eight-year low of about $15 billion, investors are betting the country will be able to tap the foreign aid it needs. The U.S. said today it’s formulating a $1 billion loan guarantee while the European Union and International Monetary Fund have signaled they’re ready to provide assistance. Russia threatened to pull a $15 billion loan accord after its ally, Viktor Yanukovych, was ousted as president last week following three months of protests.

“If they were really on the brink of default, you’d see a much bigger discount in those bonds,” Dan Heckman, a senior fixed-income strategist at U.S. Bank Wealth Management, which oversees $115 billion, said in a telephone interview from Kansas City, Missouri. “There have been pretty strong statements made by both the European Union and the U.S. The risk near term is mitigated by their public offers for support.”

Since reaching a record high of 11.37 percent on Feb. 19, yields on Ukraine’s 2023 bonds have fallen 1.56 percentage points to 9.81 percent today.

East-West

Ukraine, a key east-west energy route between Russia and Europe, spiraled into crisis in November when protesters took to the streets to oppose Yanukovych’s rejection of a deal to deepen ties with the European Union. Violence crested last week when at least 82 protesters and police officers died in fighting before a peace deal and the leader’s flight from Kiev.

Russian Deputy Finance Minister Sergei Storchak said yesterday that Ukraine faces a “high” chance of defaulting on its sovereign debt. The situation in the country must stabilize before Russia will provide further aid from the $15 billion bailout agreed on last year, Russian Finance Minister Anton Siluanov said Feb. 21 in an interview in Hong Kong.

Ukraine risks default without “significantly” favorable changes in its political crisis, according to S&P, which cut the nation’s credit rating to CCC with a negative outlook on Feb. 21, leaving it four steps above default.

‘Out of Control’

Arseniy Yatsenyuk, a former central bank chief and the leader of Yulia Tymoshenko’s opposition party in Ukraine’s parliament, was named the country’s new prime minister today, while Oleksandr Shlapak was named finance minister. Interim President Oleksandr Turchynov said he expects parliament to approve the appointments tomorrow.

EU and U.S. officials have signaled they’re willing to help Ukraine’s new government.

“I would also support the idea of a donors conference” for Ukraine with the goal being “to put together a substantial aid package,” European Union Economic and Monetary Affairs Commissioner Olli Rehn said yesterday in Strasbourg, France.

U.S. Secretary of State John Kerry, speaking to reporters today at a roundtable in Washington, said the U.S. is formulating a $1 billion loan guarantee for Ukraine and that the Obama administration is also considering additional direct assistance.

Financing Needs

“We are here ready to help just as soon as there is someone at the end of the telephone,” U.K. Chancellor of the Exchequer George Osborne said in an interview Feb. 23 in Sydney. “We should be there with a checkbook to help the people of Ukraine rebuild their country.”

Ukraine owes about $500 million in monthly foreign debt payments this year, according to S&P. Obligations spike in June when $1 billion of bonds mature.

Ukraine’s interim leadership estimates its financing needs at $35 billion over the next two years.

“To support better this economy, we need to engage in a dialog in which the Ukrainian authorities, once designated, will seek out the help and support of the IMF,” Managing Director Christine Lagarde told Stanford University students yesterday in California.

‘Extremely Uncertain’

Ukraine’s bonds due in June sunk to as low as 92.8 cents on the dollar last week as deadly clashes engulfed Kiev and concern the country would plunge into civil war escalated.

The extra yield investors demanded to own the nation’s dollar debt instead of U.S. Treasuries surged to an average 12.14 percentage points on Feb. 19, the most since 2009, according to JPMorgan Chase & Co. data.

Ukraine’s reserves have fallen to about $15 billion, Stepan Kubiv, who was appointed governor of the central bank Feb. 24, said yesterday. The country is considering measures to stem withdrawals after as much as 7 percent of deposits were taken from banks last week.

“The political situation is still extremely uncertain,” Trevor Cullinan, an analyst at S&P in Dubai, said in a telephone interview yesterday. “The secessionist risk has seemingly increased over the past week. It’s still unclear whether or how strongly Russia will react to this potential move to a more Western direction.”

Investors including Franklin Resources Inc., which owns about a third of Ukraine’s international dollar bonds, face volatility in asset prices in the near term, according to Fran Rodilosso, who helps oversee about $1.5 billion in debt exchange-traded funds as a money manager at Van Eck Associates Corp.

‘Messier’ Process

“The process could be messier than anticipated, and there’s a chance the market is being too optimistic with how much Ukraine actually needs,” Rodilosso said in a telephone interview from Miami. “We may see a good bit of volatility going forward.”

While a new government needs to be in place before Ukraine can receive aid, an EU proposal should come by the start of next week, Elmar Brok, the head of the European Parliament’s foreign-affairs committee, said yesterday in Strasbourg.

“As the Europeans and the Americans have emboldened protesters to pursue their efforts to ultimately get rid of Yanukovych, it is likely they will step up to the plate and fill the void that is left by Russian support,” Robbert Van Batenburg, the director of market strategy at broker Newedge Group SA, said by phone from New York. “I don’t think anyone believes they’ll force them to just figure it out themselves.”

To contact the reporter on this story: Boris Korby in New York at bkorby1@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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