Here’s the challenge. Find the thousands of individual investors who bought the Republic of Ukraine’s retail-targeted bonds, tell them Ukraine can’t keep up the payments and persuade at least 85% of them to accept a new, less onerous, bond instead. That was the task facing lead manager ING Barings – with syndicate members Credit Suisse First Boston, Commerzbank and Salomon Smith Barney – when the east European sovereign launched an exchange offer for all its outstanding international issues.
Ukraine began the new century in big trouble.
It had to pay $3.2 billion on its debts in 2000 and its foreign reserves stood at only $1 billion. But, unlike Pakistan which faced a similar problem last November, Ukraine couldn’t simply turn to a small number of institutional investors to agree a bond restructuring. Its paper was scattered far and wide.
“One of the main difficulties we faced was that there were Five different instruments covered by the offer,” explains Andrew Dell, head of debt syndicate at ING Barings. “Certain instruments were held mainly by professional investors. But others were held, literally, by the man in the street.”
And yet, against all expectations, the syndicate managed to track down this army of small investors and persuaded over 90% of them to accept the new deal by the March 15 deadline.
Selling a restructuring deal to retail investors in Germany and Switzerland is the messy reality of sovereign bond restructuring: the consequence of the IMF’s new-found zeal for burden sharing. This philosophy requires countries in trouble to restructure their bonds before they can expect any help from the multilateral agencies. In the past, the practical difficulties of such restructurings kept Eurobonds out of sovereign debt work-outs. With the exception of Pakistan, Ukraine has become the only distressed sovereign to complete a restructuring of international bonds. Ecuador, the First test-case for burden sharing, has still not made any offer to its bond holders.
“I would imagine the IMF is ecstatic about this deal,” says Connor O’Driscoll, manager of the Galileo fund. “Many investors found it very alarming last year that the IMF was basically recommending sovereigns to restructure unilaterally. Instead, Ukraine has offered investors a deal that is the best obtainable in the circumstances, and that is very positive.”
Under the terms of the exchange, Five outstanding bonds, notably a Dm1.4 billion bond and a e500 million issue, could be swapped for one of two new instruments, one in dollars, one in euros. With seven-year maturities and low coupons (by Ukraine’s standards) of 11% and 10%, the new bonds give the government a little more breathing space.
Ukraine has sweetened the pill for investors by offering no reduction in principal, amortization starting in 2001 and, unlike on Pakistan’s exchange offer, no interest-free grace period.
In late February, the syndicate embarked on what one observer described at the time as the “Herculean task” of getting 85% acceptances. Winning over institutional bondholders was relatively easy, if a little nerve-racking. “A lot of professional investors indicated that they were prepared to accept the deal but that they would put their ticket in at the last moment,” says Dell.
So everything depended on reaching the men and women in the streets of Baden-Baden and Luzern. That meant working through the different layers of intermediaries involved in selling the original bonds, often ending up with small savings banks. It was a little like Chinese whispers. “Each intermediary has the ability to modify the way information about the deal is presented,” says Symon Drake-Brockman, managing director at ING Barings. “It is difficult to lay it out in a form that will reach all investors in the same way.” To get information to investors directly, ING Barings set up a website about the offer which received an average of 450 hits a day.
Once news began to Wlter down that Ukraine intended to default, the lead manager was bombarded with anxious calls. There was great uncertainty about the deal’s terms. Many believed it would only go ahead if 100% of bond holders accepted. Perhaps the greatest confusion surrounded coupon payments due on the outstanding bonds. Would Ukraine pay the large interest payment due on the Deutschmark bond on February 26?
It would not (though investors would get the money later, if they signed up for the deal).
For some retail investors that posed serious practical problems. “I happened to pick up one telephone call from a guy asking whether coupons would be paid on the old bonds,” recalls Dell. “He was counting on the money to pay for his car insurance.”
By the second week of March, the banks were still a long way short of their 85% target.
Then, in the very last days and hours before the deadline, acceptances arrived in a rush.
The Final Figure for acceptances, 98.16%, was well in excess of expectations.
The deal had been well-structured. Drake-Brockman says: “We spent several weeks in Kiev working with the ministries and with the IMF to Find out what structure was most viable. It was a deal that genuinely balanced the investors’ interests with Ukraine’s needs.”
Nevertheless, Ukraine has a lousy track record of sticking to deals. This is its second debt restructuring since the collapse of the Soviet Union and it has repeatedly fallen out with the IMF. Will it keep its side of the bargain this time? “If the Ukrainian administration does what it says it is going to do there is now a good chance the bonds will be serviced and will repay on maturity,” says O’Driscoll. “But of course nobody is saying these should be investment-grade bonds.”
The creation of a single debt-management office within the Finance ministry last month has boosted the credibility of the deal. “Like other countries, we have learnt that having many different divisions involved in debt management doesn’t help efficiency,” says Vitaly Lisovenko, the department’s new head.
The biggest lesson is that even retail-targeted bonds can be restructured, if the terms are attractive. But sovereigns planning to renege on their obligations should remember this: bearer bonds are harder to default on than those in registered form. That’s not only because investors in registered bonds are easier to trace. Some $800 million-worth of Ukraine’s bearer bonds in small denominations – several truckloads – had to be taken to an undisclosed location following the completion of the offer to be physically destroyed.
