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Bond market signals Ukrainian confidence

Heightened activity on Ukraine’s bond market is a clear reflection of companies’ faith in the country’s economic future. Ben Aris reports.
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Ukraine’s new government has been in office for more than 100 days and domestic companies are starting to get a feel for where the country is heading. Increasingly confident that Ukraine is on track to repeat last year’s double-digit growth, managers are turning to the bond markets to raise money and go back to the business of growing.

“Ukraine still faces big political risks, but they are diminishing,” says Ed Parker, senior analyst at Fitch Ratings. “Ukraine has always had a great potential and now confidence is rising that it will be realised.”

The local bond market is tiny but still represents the only way of raising unsecured debt and is a simple way of tapping into a growing pool of liquidity in the otherwise fragmented banking sector.

The government estimates that a total of Hrv4.34bn ($800m) of corporate bonds were issued last year and expects a similar number to be issued this year. But this number is misleading because less than half of the bonds are tradable.

Data search

Information about Ukraine’s immature fixed income market is vague. Local investment bank Dragon Capital estimates that at least half of the bonds issued last year were little more than deals cut between a company and its favoured bank, in which the underwriter buys the whole issue and holds it to maturity.

Maturities are typically three years, but nearly all these bonds have a put option after 6-12 months, when the buyer has the option of selling them back to the issuer: in effect making the bonds a series of issues with one-year maturity.

Ukrainian blue chip companies are making the most active use of the bond market and yields have been falling. Blue chips command a spread of 300 basis points over the sovereign treasury bills, or yields of about 9%. Most of the bonds are small. The biggest are in the order of Hrv100m and a whole raft of small issues are between Hrv5m-Hrv10m, mostly issued by unrated companies that are willing to pay coupons of up to 18% a year.

Domestic market grows

However, the market is already growing. A few companies have begun to raise serious sums on the domestic capital market. Ukraine’s Boryspil international airport announced plans to issue what may be the biggest corporate bond this year of Hrv300m and at least three companies have plans to offer Hrv100m bonds this spring.

Although the total volume of bonds being issued may rise modestly, the biggest change is that more are expected to be listed on the local exchanges and so be tradable, underpinning a growing secondary market.

“The bond market will continue to develop from here,” says Igor Podolev, first deputy at Ukrainian Eximbank. “We are enjoying strong economic growth and a currency that has been stable for six years, bar some wobbles last autumn during the elections.”

T-Bills and Eurobonds

The government has a 1.6% of GDP budget deficit to plug this year, but has already said that it prefers to tap the domestic market rather than issue Eurobonds to fill the hole.

“The plan is for the government to borrow what it needs from the domestic market and it is off to a good start,” says Andrei Bespyator, a fixed income analyst at Dragon Capital in Kiev.

In the first three months of this year, yields on treasury bills fell rapidly: in January the government issued four and five-year bonds with yields of about 11% but by April investors were paying between 6.2% and 6.4% for the same paper.

There were Hrv5bn worth of treasury bills outstanding in February, but the state quickly took advantage of the falling rates to issue another Hrv1.3bn between March and April and is certain to come back for more as the year wears on.

With inflation running at 15% year-on-year in March, these bills are returning negative real returns but, as both bankers and bureaucrats are expecting inflation to fall to 10% by the year-end and the hryvnia to appreciate strongly (estimates vary between 2%-5% by the year-end), government bills should return good real returns over the course of their life.

The combination of high yields and strong currency appreciation has already tempted foreigners into the Ukrainian domestic capital market. Again, information is vague but the government estimates that last year foreigners held one-third of Ukrainian treasury bills and expects this to rise to between 55% and 60% by the end of this year.

International lure

Despite attractive borrowing conditions at home, some think the government may still be forced to tap international capital markets because it has made some bold assumptions in this year’s budget. For example, it assumes that tax reforms will deliver a hefty 25% increase in tax revenues.

“The biggest economic uncertainty is the budget position and a question mark remains over how big the deficit will be at the end of the year,” says Fitch’s Mr Parker. “I wouldn’t be surprised to see the Ukrainian government issuing Eurobonds later this year after all.”

Even if the government has to turn to the Eurobond market to make up a shortfall as Ukraine’s total external debt is a very modest 25% of GDP, it has plenty of manoeuvring room.

Big issues

While the government is trying to avoid the international capital markets, several leading Ukrainian companies are returning cap in hand. After more than a decade of neglect, Ukraine is in need of massive investment but resources remain limited.

Among the big issues last year was state-owned Ukreximbank’s placement of a $150m Eurobond with a fixed coupon rate of 7.75% a year that is due to mature in 2009. National gas company Naftogaz Ukrainy issued a five-year $500m Eurobond with a yield of 8.125%.

Mobile phone operator Kyivstar broke the ice this year with a seven-year $175m Eurobond issue in April at a modest 7.75% yield. The second largest mobile phone operator in the country, Kyivstar had initially planned to offer a $150m bond, but increased the amount due to the high demand, mostly from investors in the US, the UK and Germany.

Several top-10 banks are also planning to tap international capital markets. Ukrsotbank started a road show of its Eurobonds worth $100m-$150m in April. UkrSibbank has hired Deutsche Bank and UBS to manage a $100m-$200m Eurobond placement later this year, which will go on the road in May.

And Kiev city government will follow up its $200m Eurobond last July with another $250m Eurobond issue this year, which will be used to build a new bridge over the Dnepr plus other infrastructure projects.

The Ukrainian fixed-line telephone monopoly Ukrtelecom could be the biggest corporate Eurobond issuer this year. It plans to raise $350m for capital expenditure but says it has not committed itself to the idea of Eurobonds yet because it is watching the domestic market closely.

“Companies with plans to issue Eurobonds last year delayed because of the political turmoil, but they are coming back to market now where they are being well received,” says Dragon’s Mr Bespyator. “However, as the yields are falling here, several have said they are watching what happens on the domestic market, which is becoming increasingly attractive.”

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Read more about:  Central & Eastern Europe , Ukraine