Capital Markets: Surviving in Turmoil
2009 was a difficult year for Ukrainian capital markets. The Global Recession badly affected the real sector of the Ukrainian economy and practically froze activities on raising debt or equity capital. The doors of international debt and equity capital markets remained closed for Ukrainian borrowers throughout the year.
Raising debt on the domestic market proved to be no less difficult. According to the State Commission for Securities and Stock Market of Ukraine (SEC) in January-August the volume of bonds issues decreased by 2.7 times — to UAH 8.66 billion. The number of issues decreased from 572 to 185. According to experts, most of these issues were accomplished in connection with the restructuring of existing debt or were technical (designed for optimization of cash flows within business groups). During the first 9 months of 2009 there were approximately 40 technical defaults. As a result, corporate bonds, always one of the most conservative instruments, turned out to bear real risk.
Many debtors started, in order to avoid default and bankruptcy, exploring opportunities for restructuring of outstanding debts. One of the most significant challenges related to restructuring remains insufficient legal regulation of relevant procedures. Internationally common restructuring know-how and techniques for settling difficulties in relations between bond issuers and bondholders have not yet been properly implemented in Ukraine. Moreover, as a rule corporate bonds are not secured and in case of bankruptcy of the issuer the claims of bondholders are satisfied as fourth priority, leaving them with little chance of return of their investment. The technical default of hypermarket operator Karavan, pending in court for more than half a year, is a good example of insufficient security over rights of bondholders under Ukrainian law. Bondholders’ rights were also negatively impacted by NBU Resolution No.421 prohibiting from early repayment on banks’ debt securities except for redemptions at a price lower than 50% of the face value which does not lead to considerable worsening of the bank’s liquidity. The resolution was not registered by the Ministry of Justice, but appears to be applied by Ukrainian Banks in practice starting from 22 July 2009. The completed and pending restructuring transactions once again revealed that absence of specific regulation for debt-for-equity swaps creates significant difficulties on the path of efficient restructuring and needs to be addressed by legislators and regulators without delay.
Effective from 15 November 2009 (apparently subject to Ministry’s of Justice approval pending at the time of writing of this article) the National Bank of Ukraine (NBU) restored caps on interest rates under loans from foreign lenders to Ukrainian borrowers abolished about a year ago (except for loans with less than one-year maturity which continued to be subject to interest rate limitation of 11% p.a.). Under the NBU’s new resolution the re-established interest rate limits are: 9.8% p.a. for short-term (less than one year) loans, 10% p.a. for loans with a term of from one to three years, and 11% p.a. for loans with a term of over three years. Floating interest rates are now capped at LIBOR for three month USD deposits plus 750 basis points. The new regulation should not apply to existing loans unless they need to be amended. The NBU may refuse registration of loan amendments resulting in interest (defined as including all related costs, such as interest, fees, commissions and other payments to the lender) exceeding the regulatory cap. This rule, however, would not apply, if amendments relate to the change of a party’s name, address, banking details or assignment of debt to a foreign borrower.
Many experts and market players have already expressed their dissatisfaction with such changes of NBU regulatory policies, stating that the reintroduced caps will make international borrowings hardly possible for most Ukrainian banks and other corporate borrowers (many believe that loans at crisis may not be obtained even by the most reputable borrowers with an interest rate less than 12% p.a.). It is especially painful for those borrowers negotiating restructuring of their existing debt.
The NBU’s interference in this process through the establishing of non-market interest limitations raises the risk of failure of restructuring efforts by Ukrainian borrowers.
Capital/finance markets may be also affected by the On Amendments to Certain Ukrainian Laws for the Purpose of Overcoming Negative Consequences of the Financial Crisis Act of Ukraine adopted by Parliament at the end of October 2009 and awaiting execution by the President of Ukraine at the time of writing of this article. This Act provides for a ban on early prepayments of loans received from foreign lenders. It appears that such a limitation will most likely challenge the credibility of Ukrainian borrowers and will become another obstacle on the path of getting finance deals done.
Due to the problems with the state budget deficit and the urgent need to recapitalize suffering banks, the government stepped up its activity on the domestic debt capital market. By October the Ministry of Finance had borrowed almost UAH 45 billion on the domestic bond market with the National Bank of Ukraine purchasing bonds in the amount of around UAH 28 billion.
The restructuring of corporate Eurobonds produced a number of success stories. One of the most discussed in the media was Naftogaz. Upon its technical default on 30 September 2009, Naftogaz agreed with its bondholders to exchange USD 500 million in Eurobonds for new bonds guaranteed by the state and maturing in 2014. The new bonds would have a coupon rate of 9.5% p.a. compared with 8.125% p.a. on the previous issue. The SEC via a separate resolution, allowed Naftogaz to issue foreign debt securities governed by foreign law outside of Ukraine. Such a decision was part of the restructuring requirements for the Government to grant security for Naftogaz’s obligations to the bondholders. Prior to this only the Government was entitled to issue securities outside of Ukraine.
Other borrowers restructuring Eurobonds included XXI Century, Nadra Bank, First Ukrainian International Bank, Bank Finance and Credit and Alfa-Bank of Ukraine. The restructuring of developer XXI Century can be viewed as one of the most efficient transactions. XXI Century proposed a gradual schedule of bond payment with a final date on 24 November 2014. Over 90% of holders of XXI Century Eurobonds issued in May 2007 and worth a total of USD 175 million agreed to restructure the debt until 2014.
In September 2009 SEC consented to Naftogaz issuing debt securities abroad, explaining that placement of foreign debt securities by a Ukrainian issuer outside Ukraine does not require receipt of a special permit from the SEC, as specified in Article 37 of the On Securities and Stock Market Act of Ukraine (effective as of 3 May 2006). This consent further confused the answer to the question as to whether a direct issue of securities abroad is an option for a Ukrainian issuer. The On Securities and Stock Market Act removed the requirement of denomination of corporate bonds only in Ukrainian currency. However, the relevant provision remains in the Commercial Code, leaving it unclear whether a direct issue is possible. The long-standing LPN structure for Ukrainian Eurobonds was developed to by-pass relevant restrictions of Ukrainian securities laws. It has to be seen whether the SEC will now have a position consistent with applicable law and whether the regulation of new Eurobond issues will be clear to the market.
In general, tested under scrutiny by the world crisis, the Ukrainian economy managed to “hold the blow” and survived in the turmoil, while generating hopes for potential for not too distant stabilization and growth. The Ukrainian government keeps avoiding the worst consequences by manual navigation in stormy economic seas. Some willful decisions, such as relieving on numerous occasions Ukrainian state-owned borrowers from the burden of an otherwise mandatory tender procedure for selecting lenders and financial and legal consultants, proved to be an efficient mechanism for allowing quick capital injections or expedited restructurings.
With a trace of market improvements both worldwide and in Ukraine coming closer at the end of the year, some Ukrainian companies issued announcements of their substantial finance plans for the near future, while the share quotations of Ukrainian issuers on international stock exchanges rose after last year’s devastating drops. Based on these positive trends such issuers started to think about a successful secondary public offering (SPO) on even better terms. And companies that suspended or refused to carry out an IPO in 2008 started to consider project resumption. Construction company TMM has announced that it is preparing an SPO and its affiliate Sintal Agriculture raised USD 13 million in October 2009 as a result of a successful private placement. As reported, agricultural company Mria is also working on an SPO, while another agricultural business, Landkom International, is preparing a 45% (USD 16 million) charter capital increase. Two other companies competing on the agricultural market, Dakor Agro Holding and Agroton, are likely to conduct an IPO at the Warsaw Stock Exchange. All such plans of medium-sized issuers are short term. The slower pace was indicated by heavyweights like Smart-Holding and East One. As noted in the media, these holdings will wait until the time is right to borrow from western equity capital markets, which is unlikely to occur before 2011.