Ukraine: Mass Corporate Debt Restructuring Looks Likely
April 14, 2015
by Banu Elizondo and Jason Trujillo
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Ukraine’s biggest economic problem is its deep recession. We expect gross domestic product to contract by about 7% this year, as the conflict with Russia has devastated Ukraine’s vital industrial corridor in the east, interest rates and inflation are soaring, and its currency teeters on collapse. With sovereign restructuring now a certainty, in our view, it’s likely that more companies will seek debt restructuring.
IMF bailout buys time
The severity of the economic slowdown makes the current debt burden unsustainable, in our view. We expect the Ministry of Finance to reach out to debt holders to restructure the country’s debt. The government took a big step by approving the reform bills suggested by the International Monetary Fund (IMF) in early March. The National Bank of Ukraine also raised interest rates to 30%,1 successfully stopping the free fall of the Ukrainian currency. The currency’s stability is critical to ensuring that the new budget and the IMF program are sustainable.
While the IMF plans to provide several billion dollars in funding over the next four years, there is also $15.3 billion of sovereign debt restructuring implied in this package. In addition to financing, the IMF deal provides impetus for the current administration to push for long-due structural reforms.
Cease-fire offers a short-term victory
In February, Ukrainian and Russian leaders agreed to a cease-fire. While NATO has recently said that the agreement is “largely holding” for now, the underlying factors fueling the conflict remain in place. In our opinion, both sides will likely interpret the cease-fire agreement differently, and it’s likely only a matter of time before conditions of the agreement are violated.
Furthermore, parts of the cease-fire deal cause us to question the viability of long-term success. Of particular concern is the condition that the Ukrainian parliament must approve the parts of the plan pertaining to amnesty for separatists, financial re-integration of conflict areas, local elections and special status for the military conflict areas — a tough sell for politicians in Ukraine, in our view.
Nevertheless, we believe the agreement is a short-term win for many parties because:
- Europe avoids imposing additional sanctions on Russia, a significant trading partner, while it tries to rejuvenate its economy.
- Russia, in turn, benefits by avoiding not only another round of sanctions from the West, but also the potential arming of Ukraine by the US.
- The IMF program in Ukraine, in the works for months, was announced only minutes after the cease-fire agreement. And the break is much welcome by the Ukrainian military as it allows time to regroup in the event of further military escalation.
Corporate debt restructuring likely
With the Ukraine economy under significant pressure, the operating environment has become very challenging for even the strongest companies. A major impediment is that foreign suppliers of key input materials, such as fertilizer, are demanding upfront payments before sending goods, a departure from the previous average of 60-day payment terms. While understandable, this change comes at the worst possible time because companies are forced to tie up a large amount of cash just as incremental financing is becoming virtually nonexistent. Coupled with the sharp drop in local demand, this has put significant pressure on corporate liquidity.
Given this severe liquidity crunch across the business sector, it’s not surprising that we’ve begun to see companies attempt to restructure their debt. With sovereign restructuring now a certainty, in our view, it’s likely that more companies will seek debt restructuring because international banks will be increasingly reluctant to lend in Ukraine. That, coupled with a very weak economic outlook, is driving companies to preserve liquidity. We believe that asking lenders to extend maturities instead of paying down debt when it comes due will likely be viewed as an effective way to preserve liquidity.
Not every corporate entity will need to restructure — many perhaps, but not all. The very top tier of Ukrainian corporates appears to have so far retained access to international capital markets. This is a small club, however.
Business confidence remains weak
The outlook for Ukraine’s business environment has worsened substantially, in our opinion. Six months ago, many business leaders were expecting, or at least hoping, the country would emerge from recent turmoil and start to show improvement. Instead, despite some hopeful developments in eastern Ukraine, we believe the economy is now basically in free fall. The key assumption previously was that western countries would provide adequate economic support to Ukraine, thereby lessening Russia’s influence. That has thus far not been the case.
1 Source: National Bank of Ukraine, March 3, 2015
Banu Asik Elizondo
Senior Portfolio Manager
Banu Asik Elizondo, senior portfolio manager on the Emerging Market Debt team, focuses on both sovereign analysis and portfolio management.
Prior to joining Invesco in November 2013, Ms. Elizondo worked at ING US (now VOYA Financial) as the lead portfolio manager for the emerging markets hard currency sovereign portfolios. She was previously the senior credit analyst covering infrastructure investments for the high-yield team. In addition, Ms. Elizondo served as a sell-side analyst at Wachovia Securities (now Wells Fargo Securities), covering the telecommunications, cable and media sectors for high yield and investment grade. She has more than 10 years of experience in high-income products.
Ms. Elizondo holds a BS in economics from Duke University and is fluent in Turkish, French and English and proficient in Italian.
Jason Trujillo is a Senior Analyst with Invesco Fixed Income. He is responsible for the analysis and investment recommendations for emerging markets corporate bonds.
Mr. Trujillo joined Invesco in 2013. Previously, he was with Lord Abbett as an associate portfolio manager for their Taxable Fixed Income Group. Mr. Trujillo also worked as a senior investment analyst at Duggan Asset Management and was a vice president for the fixed income division of Nomura Securities International.
Mr. Trujillo earned a BS degree in business management from North Carolina State University. He also earned an MBA from The Fuqua School of Business at Duke University.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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