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Almost Normal

Ukraine has crossed through the default hurdle, having successfully restructured the majority of its debt pile with 75% of creditors agreeing the new terms. Finance Minister Natalie Jaresko said new bonds and GDP-linked securities would be issued in mid-November, stressing that bondholders abstaining from the ongoing exchange would not be eligible to receive new GDP-linked securities under the creditor deal.

This is a big step in Ukrainian plans to move the country from the kleptocracy envisioned by Putin and his personal tape-worm Viktor Yanukovych and toward a more dynamic growing economy. The second step, privatization, is still being sketched out.

Restructuring in place, we can now talk meaningfully about yield curves again. Below are the curves when Russia invaded the country (2/12/2015), when default was unavoidable and no plan was in place (8/28/2015), and after the market has priced the terms of the restructure, from a duration and principal loss perspective.

The curve is still inverted, indicating a USD liquidity issues connected to deep and prolonged recession and too high a sensitivity on US rates. This sensitivity is stressing the entire EM complex: we haven’t seen this degree of vulnerability since the Asian crisis in 1997.

Dispite the continuing difficulties, corporate bond yields are tightening as well. The Ukrainian government restructuring terms are pretty creditor-friendly, and they serve as the benchmark for needed corporate restructuring. As such, restructuring deals are coming in and being agreed-upon. And anticipated deals are being priced into current bonds.

Things feel almost normal. The public utility Naftogaz is able to tap credit markets, securing $500 million of bridge financing from domestic commercial banks, and expects to raise $400 million from the EBRD and the World Bank (under EIB and EU guarantees) in the coming months in order to finance further purchases from Russia. Under this deal, Ukraine resumed gas purchases from Gazprom on Oct. 12, transferring a $234m prepayment to buy 1 bill cubic meters of natural gas (at a price point of $227/tcm for 4Q15).

One outstanding issue: Ukraine owes $3 billion to Russia and they have expressed no interest in participating in the restructuring agreement. Russian Finance Minister Anton Siluanov on Oct. 13 reiterated that Russia treats the Eurobond as official rather than commercial debt and continues to insist that this debt be repaid when it matures on Dec. 20 this year. Of course they do, and fat chance of that happening.

Ukrainian officials will treat the Eurobond held by Russia as commercial debt and as such have repeatedly invited Russia to participate in the debt exchange proposed to other sovereign bondholders. Ukraine repaying $3 billion upon maturity is not feasible difficult to commit to both economically and politically, as they have a primary objective of keeping a $40bn western support package fully financed.

The IMF has revised its lending-into-arrears policy so it can continue to finance countries that defaulted on selected official debt. This is a green light for Ukraine to default on the Russian-held bond on December 20 and continue to receive IMF funding.

The restructure isn’t such a bad deal for Russia. They would agree to extend the bond’s maturity by eight years on average (from 2015 to 2019-2027) and apply a 20% nominal haircut which would be partly offset by a 2.75pp coupon step-up (from 5.0% p.a. to 7.75%) and GDP-linked securities.

But when you are dealing with a greedy little crook that can’t help but overreach, reasonable isn’t a part of the vocabulary. Since it is clear that bondholders abstaining from the ongoing exchange would not be eligible to receive GDP-linked securities, it looks like Ukraine will outright default on this bond. Thus telling Putin to stuff it in his stocking on December 20.

Merry Christmas, Putina. Couldn’t happen to a nicer vampire.

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