Tue 08/15/2023 10:59 AM
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Ukraine’s sovereign eurobonds have stabilized in price following a 10-point climb in the past month, marking the highest price for Ukraine's $19.7 billion of hard currency notes since June 2022.

Ukraine’s $912 million 7.75% 2024 bonds have risen to 34/35, nearly doubling in price since mid-May when they were at 18 cents. At the longer end of Ukraine’s maturity profile, the $1.75 billion 6.876% 2031 note hit a high of 29/30 on Aug. 14, up from 15 cents in mid-May. Today, the 2031s are at 27.75/28.5, according to Solve Advisors. The 2031 bonds were in the mid-80s before Russia launched its full-scale invasion 18 months ago.

The bonds rose amid an overall rise in emerging market credits supported by inflows into the EM credit space, sources said. Appetite for Ukraine’s local government notes is steady and, today, the Ministry sold 6.4 billion hryvnia ($173 million) of domestic bonds, in line with the three prior auctions that raised UAH 7.2 billion on Aug. 8, UAH 3 billion on Aug. 1 and UAH 14.7 billion on July 25. Ukraine’s local notes are seen by many observers as restructuring-proof, because they are the Ministry’s last remaining means of market access and most of the holders are Ukrainian banks, the largest being state-owned, and the National Bank of Ukraine.

Meanwhile, Ukraine’s Ministry of Finance is preparing the framework for a eurobond restructuring that will be significantly harder than the two-year debt service freeze that lapses in August 2024. The standstill left the principal intact and interest is still accruing on the debt.

Ukraine, led by Finance Minister Sergii Marchenko and Commissioner of Public Debt Management Yuriy Butsa, is set to ask investors to write down a substantial amount of principal and some expect an NPV reduction of up to 50%, sources said. White & Case and Rothschild are working with Ukraine’s Ministry of Finance. Weil Gotshal advised a number of bondholders and warrant holders in 2022.

Certain international noteholders, including BlueBay and Amia Capital, have urged the Ukrainian government and all involved stakeholders to adopt an innovative approach to the upcoming restructuring of Ukraine’s debt. New instruments could contain the features of a Brady bond-like structure to leverage unused special drawing rights, collateralize Ukraine’s new debt with seized Russian assets, or combine the expected principal haircut with the issuance of future financing rights, or FFRs, eligible for use in post-restructuring sovereign issuance.

The Ministry said on March 24 that it will assess “a number of alternative scenarios” for implementing the necessary debt treatment in order to maximize the efficiency and success of the process, being mindful of the objective to restore Ukraine’s market access as early as practicable.

Kyiv’s ambition for the debt restructuring is to restore debt sustainability, reduce its financing gap through its four-year IMF program and land a deal that will “create the necessary conditions” for commercial sector participation in Ukraine’s post-war reconstruction.

Ukraine’s many international donors and a range of multilateral partners have pledged to continue plugging Kyiv’s roughly 30% budget deficit. In March, the so-called Group of Creditors of Ukraine further agreed to extend the standstill on their official bilateral loans from Aug. 1, 2022 to the end of the IMF program in 2027. The six governments (Canada, France, Germany, Japan, the U.K., and the U.S.) gave assurances that they would take part in Ukraine’s upcoming debt treatment, provided that private external creditors deliver a debt treatment “at least as favorable”.

The IMF thinks Ukraine’s oft-repeated vision of returning to the international capital markets will take a number of years to materialize. According to the Washington-based fund’s baseline scenario, Ukraine will not raise a single dollar of debt in the eurobond market in the next four years, it said in July.

Under its downside scenario, which assumes a more protracted and intense war destroying consumption and investment, the IMF has forecast Ukraine to raise its first eurobond in 2029, but the Fund underlines that both scenarios, and especially the downside, are riddled with exceptionally high uncertainty due to the developments on the battlefield.

The IMF estimates Ukraine will have a $42.2 billion financing gap in 2023, $38.5 billion in 2024 and $23.6 billion in 2025 in the baseline case. The downside projections show a $46.7 billion shortfall this year, $45 billion in 2024 and $28.5 billion in 2025.

Under both scenarios, the IMF is budgeting for Ukraine to obtain “debt operations” relief of $4.6 billion in 2024, $3.2 billion in 2025 and $3.6 billion in 2026. However, if the downside scenario should materialize, Ukraine would need to cut deeper in its debt stack to reduce the funding gap. The Fund believes Ukraine’s real GDP growth will be between 1% and 3% in 2023 and step up to 3.2% in 2024 before doubling to 6.5% in 2025.

The IMF has stated that for Ukraine’s debt to remain sustainable in the years after the IMF program, Kyiv must lower its public debt-to-GDP ratio to between 60% and 65% by 2033 and keep gross financing needs capped at 9% of GDP. In 2021 Ukraine’s $98 billion state and state-guaranteed debt represented 48.9% of GDP, and the ratio rose sharply in 2022 to 78% thanks to a 29.1% contraction in GDP.

Investors have told Reorg that Ukraine must restore interest payments on its eurobonds after a potential hard restructuring. However, resuming coupon payments, which would easily exceed $1 billion annually, may be politically difficult for Kyiv’s partners because the payments are funded, to a substantial degree, by European and American taxpayers and both the U.S. and U.K. will hold elections in 2024. By the summer of 2024, Ukraine will also owe investors roughly $3 billion in unpaid interest that has accrued on the eurobonds under the two-year standstill.

The existing deal with bondholders was implemented in August of last year when Ukraine secured the required 66.6% support in each bond, combined with a simple majority across all notes. The minimum participation to form a quorum was also 66.6%. Ukraine had reserved the right to make certain “redesignations” in the consent solicitation and the proposal also featured a cross-condition which meant the proposal would only pass if holders of Ukraine’s GDP warrants accepted their deal.

The GDP warrants that, similarly to the eurobonds, are governed by English law and have a higher consent threshold of 75%. This has made some analysts and investors believe Ukraine will face tougher opposition in negotiating a hard restructuring on these instruments. On top of that, several market participants argue that the warrants should not be restructured on the basis that they are not debt liabilities, but only contingent liabilities. As a consequence, the warrants have traded at a premium to the sovereign notes. The warrants, now quoted at 47/48 cents, pay out if real GDP growth exceeds 3%, subject to being the hryvnia-equivalent of at least $125.4 billion.

In 2022, Ukraine amended the reference amount linked to reference year 2023, so that the payout is capped at 0.5% of GDP at current prices. Ukraine also secured the right to redeem the warrants in whole or in part at par between Aug. 1 2024 and Aug. 1, 2027.

While the Finance Ministry readies its eurobond transaction, Ukraine’s armed forces are pushing ahead with their counteroffensive, but haven’t delivered any major breakthrough yet. In recent weeks, Ukraine has hit a number of targets in the South of the country and at sea, suggesting to some military analysts that Kyiv is attempting to reach the Sea of Azov and thereby cut off Russia’s land corridor to Crimea. This would push the Russians to use the Sea of Azov for supplies, making the invader more vulnerable to drone and long-range missile strikes. Meanwhile, Ukrainian pilots are due to start training this month in NATO countries to fly American-made F-16 fighter jets.

Since Russia’s withdrawal from the Black Sea Initiative, Moscow has relentlessly bombed Ukrainian port cities and infrastructure, including the major port of Odesa and assets on the Ukrainian side of the Danube, only a few hundred meters away from NATO territory in Romania.

Diplomatic efforts to restore peace in Ukraine are also underway and today, Andriy Yermak, President Zelensky’s chief of staff, said the Jeddah talks in early August on a peaceful solution were successful. “We are already making arrangements for the next round of the event,” Yermak said on X (formerly known as Twitter).

During the meetings with advisors from 41 other nations in Jeddah, Ukraine presented a “Peace Formula” involving, among many things, a complete restoration of its territorial integrity and the establishment of a special court to prosecute Russian war crimes.

Kyiv commented on Aug. 8 that “The overwhelming majority of partners clearly emphasized the need to withdraw Russian troops from the territory of Ukraine and the impossibility of freezing the war in any form, as this would only give time to prepare for new attacks on Ukrainian territory.” Russia, which did not take part in the talks, called the initiative a failure.

An overview of Ukraine’s sovereign eurobonds with their new extended maturity date is shown below. The GDP warrants are shown at the bottom:
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