Identifier
Created
Classification
Origin
09KYIV2171
2009-12-18 16:18:00
CONFIDENTIAL
Embassy Kyiv
Cable title:  

TALE OF TWO DEFAULTS: THE UKRZALIZNYTSA DEBT

Tags:  EFIN EREL ETRD PGOV PINR UP XH 
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VZCZCXRO0640
RR RUEHDBU RUEHSL
DE RUEHKV #2171/01 3521618
ZNY CCCCC ZZH
R 181618Z DEC 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 9000
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
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)

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