Ukraine Bondholders’ Tough Talk Signals Debt Deal Won’t Be Easy

International Monetary Fund Logo Over Ukraine Flag

(Bloomberg – – Lyubov Pronina, Krystof Chamonikolas – March 17, 2015)

The jockeying has begun in Ukraine’s debt restructuring talks.

The government’s notes slid below 42 cents on the dollar on Tuesday as Russia said it wouldn’t budge on being paid back a $3 billion loan in full on time and the Financial Times reported Franklin Templeton won’t accept a cut to its $7 billion bondholdings, citing people it didn’t identify. The nation’s debt, which handed investors a loss of 25 percent this year, may fall below 40 cents, according to Arca SGR SpA.

The stakes are high for Ukraine. One of the conditions it agreed to when receiving a $17.5 billion loan package last week from the International Monetary Fund was that it would work out a restructuring with bondholders. Finance Minister Natalie Jaresko set a June target for getting a deal done and said it may include a principal reduction to help the nation save much-needed hard currency after a year of fighting between government forces and pro-Russian rebels crippled the economy.

“There is lot of pressure on Ukraine’s bonds simply because of the uncertainty on the outcome of the restructuring,” Giuliano Palumbo, a money manager who helps oversee $3 billion in emerging-market debt for Arca SGR in Milan, including Ukrainian bonds, said by e-mail on Monday. “Franklin Templeton and others may in the end have to take some sort of hit as the country is broke.”

Russia’s Stance

Franklin Templeton has hired Blackstone to advise on the talks, according to a person with knowledge of the matter, who asked not to be named because the details are private. The New York-based consultancy will sit across from Lazard Ltd., chosen by Ukraine last month for the negotiations along with White & Case LLP.

Templeton hired Weil, Gotshal & Manges LLP to help with talks, according to a spokesman for the legal adviser. A spokesperson for Franklin Templeton declined to comment when contacted by Bloomberg News on Monday.

Russia holds $3 billion of Ukrainian Eurobonds due this December, making it the nation’s largest foreign bondholder after Franklin Templeton. The country isn’t taking part in Ukraine debt talks because it’s not a private creditor, Deputy Finance Minister Sergey Storchak told reporters on Tuesday.

Limiting Losses

Relations between the neighboring countries have soured since President Vladimir Putin bought the debt in December 2013, two months before pro-Russian President Viktor Yanukovych was toppled in a bloody uprising in Kiev. The ouster paved the way for the annexation of Crimea and led to a year of fighting between Ukrainian government troops and separatists in the country’s east.

“We are not now presenting calls for early repayment of the loan, even though there are grounds for that,” Interfax cited Russian Finance Minister Anton Siluanov as saying on Monday. “We await $3 billion in December of this year, as was promised.”

Ukraine’s ability to service liabilities, including $5.4 billion due this year, has been curtailed as the insurgency drove international reserves to $5.62 billion in February and pushed the country deeper into recession.

Having negotiating power concentrated with a few large investors may help limit losses for bondholders, according to Lutz Roehmeyer, a money manager at Landesbank Berlin Investment GmbH.

“If big holders oppose nominal cuts, then Ukraine should be as creative as possible to design a restructuring that avoids a haircut,” Roehmeyer, who oversees $1.1 billion of emerging-market assets, including Ukraine’s bonds, said by phone on Monday. “If you lower coupons and push out maturities by more than five years, you can achieve the same improvement in debt sustainability.”

‘Hard Ball’

Ukraine’s bonds have posted the worst losses among 58 nations tracked by the Bloomberg U.S. Dollar Emerging-Market Sovereign Bond Index this year.

The government’s $2.6 billion of bonds due in July 2017 slumped for a fourth day on Tuesday to within less than a cent of an all-time low of 41.35 cents on the dollar reached three weeks ago. The notes may drop toward this trough, according to Richard Segal, the head of emerging-market credit strategy at Jefferies Group LLC in London.

Ukraine will hold its next review with the IMF in June after securing the first $5 billion from the package. The Washington-based fund and the government envision aid reaching $40 billion with contributions from the U.S. and European Union and a prospective $15 billion in savings to be negotiated with bondholders.

“The bonds continue to fall as the markets may perceive that negotiations will be tougher and the June deadline might not be met,” Segal said by e-mail on Monday. Reports suggesting big bondholders have hired their adviser “imply the negotiations could be more hard ball from both sides,” he said.

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