US to Guarantee Ukraine Sovereign Bond

Emerging Markets, EBRD editions, May 15 2014

Ukraine is marketing a US$ 1billion deal that will be backed by the US government, giving it access to funding at far cheaper rates than it could ever normally expect to raise unsupported.

Local media cited data from the Ukraine government saying that it would issue five-year bonds with a maximum yield of 2.9% – far less than Ukraine pays for debt now, yet much more than the just under 1.6% that US five-year Treasuries pay. This would appear to make it enormously attractive to investors who will receive more yield for US government risk.

JP Morgan and Morgan Stanley are understood to be the lead managers on the issue for the Caa3/CCC/CCC-rated sovereign.

Access to funding is vital for Ukraine, which has external financing needs (corporate and sovereign) of $58 billion, according to Capital Economics. A more than $30 billion package of ISI assistance anchored by $17 billion from the IMF was put in place last month, in large part to deal with the short-term rollover of debt Ukraine was facing; analysts say this aid should be enough to cover Ukraine’s financing needs from 2014 to 2016. Bloomberg data suggests that Ukraine needs almost $8 billion this year to meet debt repayments, including interest.

Access to cost-effective funding at a time of political crisis is essential for Ukraine, in order to prevent its relatively modest 40% debt to GDP ratio from moving unsustainably higher. An illustration of the change in funding costs for the sovereign in its own name can be seen in the US$1.25 billion 10-year Eurobonds raised by Ukraine last year. They carried a 7.5% coupon but today yield 10.22%.

There are a number of precedents for the US move. It has previously provided guarantees for bonds issued by Jordan and Tunisia.

The US provided a US$1 billion loan agreement for Ukraine last month, implemented by the US Agency for International Development, allowing Ukraine to borrow money which the US would honour should Ukraine prove unable to pay it back. At the time USAID assistant administrator Mark Feierstein said the guarantee “assures investors of full repayment of principal and interest” and “will help the government of Ukraine access capital at reasonable rates and manage the transition to a prosperous democracy.”

It was not immediately clear if the bond is backed by this previously-announced agreement, or if it is an additional guarantee. Vadim Khramov, analyst at Bank of America Merrill Lynch, said the bond was “basically a form of a loan to Ukraine that would have a US interest rate on it and likely be AAA-rated. The US already approved this guarantee and it is included in the IMF programme, as a part of external financing.”

Confirmation of the bond issue comes a day after Khramov said that Ukrainian debt would have to be restructured, probably involving losses to investors, if further regions of Ukraine sought and gained independence. The findings, discussed in yesterday’s Emerging Markets, were that if Kharkov and Southeastern regions of Ukraine were to become independent and cease sending money to the central government, then the IMF’s aid package would be insufficient and would be abandoned, although this was not the bank’s base case.

Crucially, the bond sale should be completed, and the money in government coffers, before the presidential election on May 25, which should help present some sense of stability and sustainability before Ukrainians go to the polls. The EU raised Eu100 million in the bond markets for a loan to Ukraine yesterday, saying a further Eu500 million was to follow subject to “required legal procedures in Ukraine.”