Ukraine: Opportunities in the External Debt Market
I am positive that there will be a resolution to the political stalemate in Ukraine. Having returned from a recent trip to Kiev, I generally found that there was little anxiety among the population about the present political situation. And there is the possibility that the two opposing sides, the President and the Parliament, are looking to reach a compromise. They are being pushed in that direction not only by the weariness of the people on the streets, but also by businesses that back the respective sides and which are growing increasingly impatient about the possible negative impact on the Ukrainian economy arising from political uncertainty. A walk to Independence Square in Kiev revealed that sporadic groups of young people on the square (very remotely resembling anything politically motivated) are greatly outnumbered by bustling crowds in the huge modern shopping centre occupying two floors underneath the square. During my trip, I did not come across anyone who was seriously contemplating the possibility of a non-peaceful outcome to the political stalemate.
Not surprisingly, international markets have so far showed remarkable resilience in the face of the political developments in Ukraine, very much to the irritation of many local players who were hoping to make a quick profit on an expected drop in asset prices. The most likely resolution of the political stalemate would be a behind the scenes agreement between the President and the ruling coalition, leading to an election approved by the Constitutional Court. This scenario will allow all the parties involved, including the Constitutional Court, to save face. The President’s request for an election will be granted. The Party of Regions, as a result of the election, will remain in power (probably after agreeing to stop enticing deputies from other factions to cross the floor). And the Constitutional Court judges, no doubt, will be relieved of the burden of making a tough choice between the two sides. The date of the election, at the time of writing, looks certain to be postponed from the end of May to late summer or early autumn.
Given the tightness of the sovereign credit (the spread gap between 10-year Ukrainian and Russian CDS is just 5 bps wider than it was prior to the President’s decree), there is little attraction in directional trades. Instead, investors could consider relative value trade opportunities in the Eurobond market. The local debt market in Ukraine remains in an initial stage of development.
The relative illiquidity of local bonds, the absence of the means to hedge the Hryvna exposure and a 1% tax on purchasing hard currency are just a few issues that Ukraine needs to resolve before foreign capital can start playing a bigger role in the local market. Ukraine has relatively few Eurobonds, and the bulk of them are issued by banks. Unlike bank bonds in Russia and Kazakhstan, Ukrainian bonds have less dispersion in terms of credit rating, which can be partly explained by the sovereign ceiling of B1/BB- by Moody’s and S&P. In this respect, it is interesting to note that the range of spreads of bonds with similar credit ratings is actually quite large. Figure 1 shows the asset swap spreads for Eurobonds with the credit rating of BB- by S&P or Fitch.
The Alfa Bank bond and the long UkrSibBank bond currently look attractive. Alfa Bank (Ukraine) is part of the Russian financial and industrial concern Alfa-Group. This Ukrainian bank cannot only rely on the support of its parent company in Russia, but is a rapidly growing and profitable entity in its own right. During 2006, Alfa Bank (Ukraine) tripled its assets compared to the 59% growth the Ukrainian banking sector experienced in general. The spread of the Alfa Bank bond over the Ukrainian sovereign curve increased by about 50bps during February. This is mainly a technical factor as the bank was increasing the size of its outstanding bond initially issued in December 2006 from US$160m to the current US$345m. Since then, the spread started to come down, but is still about 20bps off its lowest level achieved in early February.
UkrSibBank bonds also remain undervalued. UkrSibBank is the third-largest bank in Ukraine, with a controlling 51% stake held by BNP Paribas. The remaining 49% belongs to two Ukrainian businessmen, who also hold substantial stakes in the country’s metallurgical and chemical industries, the backbone of Ukrainian export. The UkrSibBank ’11 bond is actually rated higher than the sovereign by Moody’s, due to the specifics of the methodology used by this rating agency. Given the strong position of UkrSibBank in the Ukrainian market, (it has total assets of around US$4.4bn at 31 December 2006, equating to a 6.6% market share in Ukrainian bank assets) and the support of its main shareholders, the current spread of 130bps for the UkrSibBank ’11 over the sovereign is attractive (Figure 2).
For both trades I would recommend hedging the exposure to the Ukrainian banks by decreasing the sovereign bonds as we can expect further supply of sovereign Euro-bonds. According to the financial plans for 2007, Ukraine will borrow about US$1.2bn externally. This has not been done so far as the political turbulence has put these plans on hold. It is unlikely Ukraine will tap the international market before the elections, which means that the issuance is likely to come within a relatively short period of time in the second half of the year, potentially putting upward pressure on the sovereign spreads.
The bonds of Alfa Bank (Ukraine) and the long bond of UkrSibBank are undervalued relative to the sovereign curve. I expect the spread on the Alfa Bank 2009 bond to tighten by 40bps, and the spread on the UkrSibBank 2011 bond to tighten by 20bps in the next two to three months.