Ukraine plays hardball on Naftogaz bond

September 25, 2009

Ukraine is playing hardball over a maturing $500 million Eurobond from energy group Naftogaz, offering investors a new state-guaranteed bond rather than returning their cash when it is due next week.

This isn’t a case of “can’t pay”, but “won’t pay”. In fact, Ukraine has just been given $3.3 billion by the International Monetary Fund earmarked specifically for external debt payments.

Ukraine has chosen to ignore this and is instead forcing through a restructuring of the Naftogaz bonds. The IMF has sanctioned extending the maturity of the bonds as long as it was something bondholders wanted — though it is hard to see why they would.

Bondholders now face a stark choice. Their bonds were due to be repaid in full next week. Instead they are being offered a bond swap with an increased coupon — 9.5 percent compared with 8.125 percent on the old bond — and a government guarantee.

This won’t be enough to erase the discount at which the bonds currently trade: the new bonds are expected to trade at around 92 cents on the dollar, compared with around 89 cents today. Bondholders will have to wait another five years if they want their money back in full.

The swap will be binding if approved by 75 percent of bondholders voting at a meeting later in October. But those bondholders who do not sign up to the one-for-one exchange by an October 8 deadline will still have their bonds swapped, but at a 5 per cent discount.

Of course, bondholders could choose to reject the offer. But Naftogaz has the right to call a second vote at which it would require fewer votes. And even if they won, bondholders would then face the prospect of a court battle to recover their money.

In theory, bondholders should reject the Naftogaz offer. In practice, they are unlikely to do so. Only the IMF has the ability to twist Ukraine’s arm: the country is surviving thanks to its $16.4 billion bailout. Of all institutions, it should make sure that Ukraine is held accountable to its lenders.

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