TALE OF TWO DEFAULTS: THE UKRZALIZNYTSA DEBT

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 002171 SENSITIVE SIPDIS DEPT FOR EUR, EUR/UMB, EEB/OMA E.O. 12958: DECL: 12/17/2019 TAGS: EFIN EREL ETRD PGOV PINR UP XH SUBJECT: TALE OF TWO DEFAULTS: THE UKRZALIZNYTSA DEBT RESTRUCTURING REF: KYIV 2140 Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and (d) ¶1. (C) Summary. Following market angst over the possibility of a Ukrainian sovereign default, negotiations have resumed between creditors and Ukrzaliznytsa, the Ukrainian state-owned railway company, whose subsidiaries recently defaulted on a $110 million loan payment. An Ukrzaliznytsa advisor refuted Deputy Prime Minister Nemyria's claim that Ukraine needed to allocate budget monies for Ukrzaliznytsa's debt payment. He was confident that a compromise would be reached by the end of January 2010 to extend outstanding principal loan payments of $440 million into 2012. Once the debt is restructured, the railway company, which is expected to have good cash flow again in 2010, should be able to make future payments. End summary. HARDLINE REACTION -------------- ¶2. (C) The $550 million Barclays syndicated loan had been originally taken out in 2007 by Ukrzalyznytsa at LIBOR plus 2.5% for the completion of trestles and the procurement of rolling stock. The terms of the loan were modified in August to LIBOR plus 5.0%, when the company (via its six regional railway subsidiaries) made its first principal and interest transfer of $118 million. Although the company made an $8 million interest payment on November 11, it missed its second principal transfer of $110 million. Market analysts suggested that Ukrzaliznytsa had been temporarily hit by lower cargo volumes during the first nine months of 2009, with declines of 29.4% compared to the same period in 2008. ¶3. (C) Squire Capital partner Robert Grant (please protect throughout),serving as Ukrzaliznytsa's advisor on the debt restructuring talks, confirmed to Econoff that some of the 26 investors in the Barclays Capital's syndicated loan had taken an "adversarial" stance toward Ukrzaliznytsa after the six subsidiary railways defaulted on the $110 million principal payment. Led by BlueCrest Capital and Banco Finantia, hardliners within the creditors' steering committee had demanded immediate payment of $50 million from Ukrzaliznytsa. They had called on the Ukrainian Ministry of Finance to bail out the state-owned company and offer a sovereign guarantee as a condition for restructuring, according to Grant. The creditor group had also sought a higher interest rate in line with Ukraine's current sovereign yield curve, with an amortizing schedule concluding payments in 2011. "NO BLOOD FROM A STONE" -------------- ¶4. (C) Grant told us on December 17 that internal divisions within the creditor group had allowed Ukrzaliznytsa to conclude, however, that 8-10 investment banks wanted to finalize a restructuring agreement. A "middle bloc" of banks could be persuaded to accept a "take it or leave it" exchange offer that Squire Capital would launch on January 11 and close on January 27, especially because the bankers had come to realize they would get "no blood from a stone". Ukrzaliznytsa would sweeten its original offer from 8.75% to 9.25% with a 1.25% structuring fee and full principal payments spread out over 2010 ($90 million),2011 ($150 million),and 2012 ($200 million). There was also a possibility Ukrzaliznytsa would ante up an additional $20 million for 2010, making the 2012 principal payment $180 million. ¶5. (C) Grant underlined that Ukrzaliznytsa would make no principal payments until May 2010. He also denied that the Ukrainian government planned to come to the aid of Ukrzaliznytsa. Deputy Prime Minister Nemyria had told the Ambassador on December 15 that the GOU needed to make a "large payment to the Ukrainian railways on December 29" as a part of a deal to conclude Ukrzaliznytsa's "sensitive" debt restructuring (reftel). (Note: Nemyria had made this statement while pitching Ukraine's case for emergency IMF monies. End note.) ¶6. (C) Grant believed Ukrzaliznytsa could exploit a loophole in the syndicated loan's contractual sharing provision. While any payments to creditors would need to be split pro-rata, the sharing provision could be waived if two-thirds of the investors agreed. Grant thought that this would KYIV 00002171 002 OF 003 isolate the most hostile hedge funds and lead to a quick resolution. He had already reached out to senior ING executives in Amsterdam who had agreed to serve as a "stalking horse" among the creditors. EGG ON FACE FOR BARCLAYS'S RUDLOFF -------------- ¶7. (C) In the meantime, having already sold out its share in the syndicated loan, Barclays Capital resigned as the exchange agent. Furthermore, rumors swirled that some of the 26 investors had accused Barclay's chairman Hans-Joerg Rudloff of mismanagement and incompetence. ¶8. (C) Grant indicated that Rudloff had raged against Prime Minister Tymoshenko in a recent private phone call, expressing his disgust with the GOU for failing to meet terms of its loan agreement. Grant speculated that Barclays Capital was acting aggressively in an attempt to cover up for either misleading investors or not doing proper due diligence on the syndicated loan documents. ¶9. (C) Rudloff and other Barclays representatives had allegedly told investors that the Barclays syndicated loan contained cross-default covenants, which would have triggered an acceleration of a second Ukrzaliznytsa syndicated loan (from Deutsche Bank) that had been secured with a sovereign guarantee. Grant pointed out, however, that Barclays and all 26 investors had the opportunity to review loan documents when they were last amended in August. At the time, Ukrzaliznytsa lawyers had stripped an amendment in the loan document that had made Ukrzaliznytsa an obligor. With the syndicated loan taken only in the name of the six regional Ukrainian railroads, Ukrzaliznytsa was no longer on the hook in the event of default. None of the creditors had caught this amendment until the "crash". UNFOUNDED PANIC -------------- ¶10. (C) Panic ran through European markets on November 20, after fears of a purported Ukraine sovereign default generated automated "sell" instructions for bond traders. According to Kyiv-based Dragon Capital managing director Peter Bobrinsky, the default news was circulated by a disgruntled hedge fund investor in the Barclays' instrument. Allegedly, Moore Capital representatives had divulged that the Barclays debt contained cross-default covenants, which (if true) would have triggered accelerated payment of the sovereign-guaranteed $700 million syndicated instrument with Deutsche Bank. In the midst of a severe budget crisis and with its IMF loan program off track, Ukraine would have been hard pressed to meet such a large, unexpected sovereign obligation. ¶11. (C) Dragon Capital's Bobrinsky speculated that Deutsche Bank would have had no reason (legal or political) to seek payment acceleration. Not only was there no explicit cross-default covenant in the Barclays syndicated loan to the six Ukrainian regional railways, Deutsche Bank was not in a position to push for acceleration with Ukraine's authorities, who have not yet ruled on issuing Deutsche Bank a commercial operating license. Germany's leading financial institution only maintains a small representative office in Kyiv but has plans to open a subsidiary in the coming months. ¶12. (C) Separately, representatives from the Moody's rating agency concurred with Bobrinsky's assessment after meeting with Ukrainian Ministry of Finance officials. Moody's announced that the default on the $110 million payment to Barclays had "no impact" on the Deutsche Bank loan and could not lead to a accelerated sovereign-backed obligation. A POST-DUBAI WORLD -------------- ¶13. (C) Grant told us that, on the sidelines of the Ukrzaliznytsa talks in London last week, there were numerous conversations among investors about the Dubai debt scare and the general creditworthiness of quasi-sovereign borrowers worldwide. Whereas hybrid, quasi-sovereign firms once had looked like a good bet with their mix of public and private sector attributes, Ukrzaliznytsa investors had seemed to conclude that shaky state finances would continue to undermine confidence in state-owned strategic enterprises. KYIV 00002171 003 OF 003 Nonetheless, absent legal or political means to avoid a debt restructure, creditors would take the best deal they could get, thought Grant, especially because there would be a new Ukrainian president and a turnover in Ukrzaliznytsa management after the upcoming presidential election. COMMENT -------------- ¶14. (C) An Ukrzaliznytsa debt restructuring deal that repays principal in full at acceptable terms will slightly ease investor fears about other Ukrainian quasi-sovereign debt. Although we have not seen details of a recent audit conducted by Ernst and Young, Ukrzaliznytsa is a solid company with a good medium to long-term cash flow outlook. Barclays and its investors had been mistaken to misread loan documentation and conclude Ukrzaliznytsa could be forced to make $110 million quarterly principal payments under the threat of a cross default. In the end, it appears very likely that the Ukrainian state railway company will conclude a deal in January that should set the matter to rest. TEFFT