Negotiating through dangerous territory in the restructuring of Ukrainian sovereign debt, PJT Partners' EMEA restructuring team opted to utilise a value recovery instrument in a novel way, to the satisfaction of parties on either side of the deal. 

Ukraine deals warrants VRI first for PJT Partners

Among the more successful debt restructuring advisory units in recent years has been the one fielded by Blackstone, the US-based private equity house. It remains a leader in its segment, except that it is now part of PJT Partners. In a calling-card transaction, PJT’s Europe, the Middle East and Africa restructuring team advised bond holders in Ukraine’s recent debt restructuring, deploying what could become a new fund raising instrument.

PJT Partners encompasses three former Blackstone advisory activities: specialising in restructuring, mergers and acquisitions (M&A) and fund raising. Constrained by conflicts of interest with the asset management business, they were spun out in October 2015 via a merger with PJT Partners, the vehicle of one-time Morgan Stanley M&A boss Paul Taubman. At the same time, the firm was listed on the New York Stock Exchange, with Blackstone shareholders getting one share in the new business for every 40 existing shares they owned. The company now has a market value of about $1bn, and its largest shareholder is Blackstone chairman and CEO Steve Schwarzman.

Turbulent times

The Europe, Middle East and Africa team has a great track record. Among other notable deals in the past couple of years, it advised senior creditors on IVG Immobilien’s €4.6bn restructuring – the largest under Germany’s current insolvency regime – and Dubai World on the optimisation of $14.6bn of debt. So it was not entirely surprising when, in February 2015, the team got a call from asset manager Franklin Templeton, which had gotten wind of impending trouble with its huge investment in Ukrainian sovereign bonds.

Ukraine’s political and economic problems were not exactly new, but they escalated into crisis a year earlier, when Russia annexed Crimea and civil war broke out in the east of the country. The conflict in the eastern region was rumbling on, in spite of the Minsk 2 peace agreement, which the country struck with Russia in February 2015, and the conflict was stunting growth even as it drained state finances. With important swathes of industry located in the contested region, gross domestic product (GDP) fell 7% in 2014. In the same year, the Ukrainian hryvnia halved in value against the US dollar and, as a result, the national debt-to-GDP ratio increased from 41% to 73%.

In 2014, the International Monetary Fund (IMF) had agreed a $17bn bail out for Ukraine. In February 2015, the country again entered into discussions with the IMF (among others) to address its liquidity problems, and its sovereign bonds were trading at about 40% of face value. In March 2015, the IMF agreed another $17.5bn bail out, demanding further economic reforms.

“The IMF had gone into Ukraine and said it needed to conserve financial liquidity, to deleverage and to convert debt – in other words, a haircut,” says PJT partner Martin Gudgeon, who is the head of EMEA restructuring. “And it wanted it done fairly quickly.”

More specifically, the IMF wanted Ukraine to save $15.3bn in public sector financing during the programme period, to bring the public debt-to-GDP ratio to less than 71% by 2020 and to keep budget financing needs at an average of no more than 10% in 2019 to 2025. As the easiest way to hit all three targets, the government announced it was looking at a 40% write-down.

Big stakes 

With bond holders reaching for professional advice, PJT was appointed to represent an ad hoc committee of sovereign and quasi-sovereign bond holders over the restructuring of $22.6bn of external liabilities. There were four bond holders on the committee itself – BTG Pactual, Franklin Templeton, TCW and T Rowe Price. Together, they owned some $9bn of the debt, with the lion’s share – approaching $7bn – held by Templeton.

“The fact that Templeton’s holding was so large made some conversations easy, and some conversations difficult,” says Mr Gudgeon.

The restructuring focused on 14 US dollar-denominated Eurobonds with maturities ranging from 2015 to 2024. “There was no point in restructuring domestic liabilities,” says PJT partner David Riddell. “If you forced a loss on those, you would have to recapitalise the Ukrainian banks that held them, so it would merely be circular.”

Russia, which would end up as the only hold-out, owned all of a single $3bn Eurobond but would not participate in any restructuring. That left everyone else facing an issue of cross-default in December 2015 when the Russian bond matured.

The Ukrainian government was keen to maintain access to international capital markets, a wish that served to temper its likely course of action. But it insisted that it needed a significant debt write-off to maintain debt sustainability. The bond holders disagreed, arguing that Ukraine faced a liquidity issue and not a solvency issue, and that a payment deferral would be best for the country and the capital markets.

Touch and go 

The most important person in these proceedings was the outsize bond holder, in the shape of Templeton's senior vice-president, portfolio manager and co-director of the international bond department, Michael Hasenstab. If he folded, everyone else would fold with him. Ukraine, advised by Lazard, clearly believed that the amount Templeton stood to lose in the event of default was a powerful negotiating lever.

But Mr Hasenstab would not parley. Having been advised that it was dangerous to negotiate where one party can make decisions but the other cannot, he stayed away from any face-to-face talks with Ukrainian officials. Reportedly, he was present on a couple of conference calls, but said nothing.

That left the financial advisers and lawyers to grind on with neither side prepared to budge. The government had important local elections coming up and needed to play to the gallery at home. “We were very firm that there should be no haircut and they were very firm that it would be 40%,” Mr Gudgeon recalls. “There was only going to be a deal if something different entered the stage.”

That something different was the ‘value recovery instrument’ (VRI). As one of the bonds approached its mid-September maturity date and the prospect of default, the pressure to reach agreement was mounting. In early August, Ukrainian finance minister Natalie Jaresko flew to the US to meet Mr Hasenstab. The fund manager also, reportedly, took a call from Ukraine’s prime minister as a deal began to edge closer.

What the committee now proposed to accept was a 20% haircut plus the VRI, which would allow creditors to participate in any Ukrainian recovery. In September 2015, agreement was finally reached on the restructuring of $18bn of sovereign debt – the quasi-sovereign debt was restructured separately. With the backing of the IMF, new 7.75% bonds were issued, worth $14.8bn and maturing in nine tranches between 2019 and 2027. The VRI will pay out after 2021, if real GDP growth exceeds 3%. Though payments are capped until 2025, thereafter the upside is unlimited. If Ukraine defaults during the IMF programme, the face value of the warrant effectively restores the principal claim for creditors, as if no haircut was applied. The new notes and VRIs have no cross-default in the case of default on bonds held by hold-outs – i.e. Russia.

“GDP warrants have been used before for sovereign restructuring, but only for a very small percentage of the debt,” says Mr Riddell.

The bonds rallied immediately on news of the proposal and have continued to trade higher. July 2017 bond prices, for example, have recovered more than 100% since March 2015.

Much-needed expertise  

Restructuring discussions continue with certain corporates that have Ukrainian links. Integrated steel manufacturer Metinvest, with facilities in eastern Ukraine, is seeking to restructure more than $3bn of debt, including $1.1bn of bonds.

“We were engaged in September 2015 by the international bond investors,” says PJT partner Tom Campbell. “We remain in discussion with other lenders and the company itself over a potential 'amend-and-extend' with no reduction of principal.”

The firm is also advising Ferrexpo, a Swiss-headquartered iron ore producer operating in Ukraine, on restructuring some $900m of debt.

So it appears that this will not be the end of the VRI, which may even have a future as a primary market instrument for governments needing new money. “We will use the VRI again,” says Mr Gudgeon, “and we would very positively like to create a new market for this instrument”.


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