Ukraine Bonds Below 40 Cents Show Investors Brace for Writedown

Ukraine’s plummeting bond prices are signaling that creditors including Franklin Templeton face steep writedowns in the nation’s foreign debt restructuring.

The country’s $2.6 billion of notes due July 2017 fell to a record 39.3 cents on the dollar on Thursday, according to data compiled by Bloomberg. Current prices are consistent with about a 20 percent cut in the principal and a 50 percent reduction in coupon payments, according to Vadim Khramov, a Bank of America Corp. strategist in London.

Finance Minister Natalie Jaresko asked for more foreign aid this week to help the economy recover from the annexation of its Crimea region by Russia a year ago and a separatist insurgency in its eastern industrial base. Russia said it wants $3 billion of Ukraine’s notes it owns to be repaid in full, while Templeton won’t accept a writedown, said a person familiar with the situation who asked not to be identified.

“There is mounting concern that the restructuring could involve a substantial haircut,” Regis Chatellier, a director of credit strategy at Societe Generale SA, which has an underweight recommendation on Ukraine, said by phone from London Wednesday. “That Moscow and Templeton would refuse a haircut had to be expected. If they don’t budge this could trigger a default.”

IMF Loan

Ukraine is looking to shave about $15 billion from its debt-servicing costs over four years as part of an International Monetary Fund loan approved last week. The government will probably initially seek to reduce the face value of its international bonds by 35 percent and trim coupon payments, an offer that is “unlikely to be easily accepted” by creditors, Khramov said in a research note on Thursday.

“Even if the final level of the haircut is lower than initially proposed, bond prices would likely suffer further,” Khramov said. “We continue to recommend reducing risk.”

Ukraine’s dollar bonds have handed investors a 30 percent loss this year, the most among 84 emerging and developed nations tracked by Bloomberg indexes. The country’s biggest foreign bondholders are Russia and Templeton, which has hired Blackstone Group LP to advise on the restructuring talks, according to a person with knowledge of the matter, who asked not to be named because the details are private.

‘Most’ Creditors

The government’s delegation met with representatives of Templeton on March 18, another person said. Templeton’s press office didn’t return requests for comment.

“Most of our creditors understand that this type of deal is the only thing that will bring us back to some form of debt sustainability and we’re all in this together,” Jaresko said in an interview with CNBC television on Friday.

Speaking to the the Council on Foreign Relations in New York, she said the restructuring will require a combination of extended maturities, reduced coupons and a writedown of principals.

The 2017 notes traded at 40 cents as of 6:06 p.m. in Kiev, down from trading above par last July.

SocGen’s Chatellier said the bonds could decline to between 35 cents and 37 cents as a 30 percent principal reduction on Ukraine’s $18 billion in outstanding foreign-currency bonds “can’t be ruled out.”

‘Official’ Creditor

Morgan Stanley economists Alina Slyusarchuk and Robert Tancsa in London are less downbeat, saying bond prices already account for the prospect of a principal writedown and risks to the IMF program. The bank moved Ukraine to marketweight from underweight in a report on Thursday.

“Market pricing now reflects many restructuring scenarios and the risk/reward is more balanced,” they said in the report.

Ukraine, the U.S. and the European Union blame Russia for supplying the rebels with arms, troops and money in a conflict that has killed more than 6,000 people, an allegation the Kremlin rejects. The conflict may cause the economy to shrink as much as 11.9 percent this year and inflation may accelerate to 42.8 percent, the government in Kiev said earlier this month.

Russia isn’t part of the restructuring talks because it is an “official” rather than private creditor to its neighbor, Deputy Finance Minister Sergey Storchak said on Tuesday. The country bought Ukrainian securities in December 2013, two months before an uprising in Kiev toppled President Viktor Yanukovych, an ally of Vladimir Putin.

‘Key Risk’

Ukraine is not holding separate discussions with Russia on its bond holdings and it can’t afford to redeem “right now” the $3 billion note maturing in December because of insufficient foreign-currency reserves, Jaresko told CNBC. “Paying out right now is not a discussion we’re having,” she said. “We’re having a discussion on debt restructuring and meeting the IMF targets.”

The 5 percent bond owned by Russia “remains the key risk to successful debt restructuring,” Bank of America’s Khramov said. If Ukraine repays in full, it “would impose a higher burden on other debtholders and complicate negotiations.”

The hryvnia’s 55 percent slump in the past 12 months, the steepest among currencies tracked by Bloomberg, has boosted the cost of servicing foreign debt. The exchange rate is up 17 percent in March versus the dollar as the central bank tightened capital controls and the IMF sent $5 billion to help avoid a default and boost Ukraine’s record-low foreign reserves.

“The support from the IMF is clearly positive, and there is less tension on the ground,” Chatellier said. “But the economic situation in Ukraine has got worse and there is no political solution to the conflict in sight.”

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