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Putin Is Becoming A "Vulture" Bond Investor

With Washington throwing its full faith and credit behind a new Ukrainian bond issue, it appears it’s time for Moscow to play spoiler to current debt restructuring talks between Kiev and its creditors. Russia is the country’s second-largest creditor after buying $3 billion in bonds back in the days of Viktor Yanukovych (who was once the victim of an attempted assassination by egg and who famously fled the country amid widespread protests last year) and now the Kremlin wants its money and isn’t likely to be amenable to any haircuts imposed on private creditors. Here’s more from Bloomberg:

Ukraine, after gaining a lifeline from the International Monetary Fund, included Russia’s bond among the 29 securities and enterprise loans it seeks to renegotiate with creditors before June. Finance Minister Natalie Jaresko has promised not to give any creditor special treatment. The revamp will include a reduction in the coupon, an extension in maturities as well as a cut in the face value, she said.

 

Russian Deputy Finance Minister Sergey Storchak said March 17 that the nation isn’t taking part in the debt negotiations because it’s an “official” creditor, not a private bondholder.

Should Russia decide to stick with a hardline stance on the negotiations (and it’s likely they will) it could not only embolden other prospective holdouts, but may indeed force Ukraine into a default: 

Holding out can lead to two outcomes: Russia gets paid back in full after the notes mature in December, or Ukraine defaults. The former option is politically unacceptable in Kiev, according to Tim Ash, chief emerging-market economist at Standard Bank Group Plc, while the latter would likely start litigation and delay the borrower’s return to foreign capital markets, which Jaresko expects in 2017.

 

“Russia will be holdouts, to try and force a messy restructuring,” Ash said by e-mail on March 19.

 

If Russia holds out and litigates, there is a “real threat” that Ukraine will deem the Eurobond an odious debt, Lutz Roehmeyer, a money manager at Landesbank Berlin Investment GmbH, said by e-mail on March 23. This refers to a legal theory that a nation shouldn’t be forced to repay international obligations if they don’t serve the best interests of the country and its citizens.

Clearly, this is an opportunity for Russia to turn the restructuring talks into political leverage as it wrangles with Washington and the West over the fate of Eastern Ukraine. This is set against a particularly contentious situation in Eastern Europe that’s recently been characterized by a show of NATO force along the Russian border and the usual sabre-rattling out of Moscow (with the latter getting much louder this morning). As a reminder, just yesterday Vladimir Putin’s Security Council condemned what it called an “anti-Russian” US security strategy that it says is aimed at Russian containment by way of military posturing and the use of puppet governments. As far as Putin’s stance on Ukraine’s debt is concerned, well, he can always go the “nuclear route”: 

The Russian bond has a covenant allowing the holder to call it if Ukraine’s public debt tops 60 percent of economic output, which the IMF said took place last year.

 

“It’s a kind of nuclear option, evaporating their leverage,” Rogge’s Ganske said. “If Russia accelerates, then Ukraine has to pay or default on it -- i.e. game over.”

 

More from Moody's on the restructuring: 

The key driver of Moody's decision to downgrade Ukraine's long-term government debt and issuer ratings to Ca is the government's plan to restructure the majority of its outstanding Eurobonds as well as other public sector external debt and the rating agency's expectation that private creditors will incur substantial economic losses as a result of the restructuring. The debt operation is intended to provide $15.3 billion of the four-year, $40 billion external financing package agreed with the IMF and other multilateral and bilateral creditors. The package was approved by the IMF Executive Board on March 11.

Although negotiations over the specific details of the restructuring are only now getting underway, Moody's believes that the likelihood of a distressed exchange, and hence a default on government debt taking place, is virtually 100%. The bonds' recovery value will be determined by the terms of the debt exchange and is currently being discussed with creditors. The terms could include a grace period on principal repayments during the term of the IMF program, a reduction in the existing bonds' current coupons, which now average 7.1%, and a haircut on the outstanding principal.