World's Riskiest Credit Market Was the Best Place to Sit Out Selloff

Updated on
  • Ukraine bonds return 25% in month on deal with creditors
  • Sovereign debt outperforms even amid selloff in risky assets

The country deemed most likely to default worldwide was also the best place to park your money in the August market meltdown.

Ukraine’s dollar-denominated bonds returned 25 percent in August after a debt-restructuring deal with private creditors that gave better-than-expected terms to investors. The accord was a necessary step to meet conditions for a $40 billion International Monetary Fund-led aid package to help pull the war-torn country out of recession.

“I didn’t think appetite for a relatively small issuer with a track record of economic mismanagement would generate that kind of buying interest,” said Per Hammarlund, the chief emerging-markets strategist at SEB in Stockholm. “The performance reflects the volatility of default-prone credits -- high risk should give high returns when things go right.”

Ukraine outperformed amid a rout in riskier assets after China’s unexpected devaluation of the yuan sparked concern the world’s second-biggest economy was slowing more than forecast. While stocks fell the most in three years and bonds slid from Brazil to South Africa, the east European country -- with its 32 percent probability of default-- beat the odds with a deal that included extending maturities by only four years and kept interest payments close to current levels.

Analysts who were underweight Ukrainian bonds were caught by surprise after the deal spurred a rally that sent $2.6 billion of notes due July 2017 up 15 cents on the dollar to more than 70 cents. The bonds were little changed at 73.16 cents on the dollar on Tuesday. Deutsche Bank AG and Morgan Stanley have since raised their recommendations on the debt to neutral and brokerages including Bank of America Corp. said current prices were warranted.

“The restructuring deal appears more favorable to the creditors than I expected,” Winnie Kong, a strategist at Deutsche Bank in London, said by e-mail. “Very few of us expected such a favorable combination of only a four-year maturity extension and almost no change of coupon.”

In addition to a maturity extension, the accord reached between Ukraine and creditors led by Franklin Templeton cuts the principal on $18 billion of bonds by 20 percent and sets interest payments at 7.75 percent. It also offers warrants linked to economic growth, with payments starting in 2021 should expansion surpass 3 percent. The creditor group owns about half of the country’s debt. Other bondholders will be asked to consider the deal later this month.