Things could be on the up for Ukraine. New deals in the steel, oil and agri-sectors and the government’s recent placement of its biggest eurobond yet could signify a light at the end of the tunnel, writes Laura Benitez.
The odds have been against Ukraine. Its wide exposure to the eurozone countries, impending parliamentary elections, and volatile relationship with the IMF have been putting the country’s financing capabilities under considerable pressure.
However, recent developments have shown that Ukraine has a lot to be hopeful about, and could even signal a growth in foreign investor appetite.
One sign of Ukraine’s return to form came with the government’s announcement on August 16 that it had accepted an offshore oil and gas exploration bid.
According to reports by the Financial Times, the consortium will be led by ExxonMobil and includes Royal Dutch Shell and the Anglo-Dutch group, which together will pay a minimum of US$300mn for a 50-year agreement with the Ukrainian government. The group is also expected to invest US$400mn for the initial phase of the exploration venture − to take place in the reserves of the Ukrainian deep marine shelf field Scythian under the Black Sea.
The development, which is scheduled to begin in around seven years, will give Ukraine the opportunity to break away from Russia’s hold over its energy imports, which have drained the country’s resources for the past decade.
Another boost to investor sentiment came in May this year with the news that the Ukrainian government successfully placed its first public foreign debt and largest-ever sovereign bond on the eurobond market.
The US$2bn five-year eurobond was priced at 9.25%, a rate that although high, seems favourable considering the country’s current risk climate. Olga Khoroshylova, banking and finance partner at CIS law firm Egorov Puginsky Afanasiev & Partners (EPAP), says that the bond, which the government has been attempting to place since the end of last year, was raised “at the best price it could get”.
Andre Küüsvek, director for the European Bank for Reconstruction and Development (EBRD), Ukraine adds: “The recent eurobond is very good news for Ukraine and confirms that there is always a market at a certain price. The fact that the government has issued this will obviously create a better benchmark for the private sector.”
A glimmer of hope
These recent developments could start to open doors for cash-starved corporates who are relying on the faith of European investors. Already this year, Ukraine’s steel and agribusiness sectors have been proving many wrong with companies such as Metinvest and Kernel Holding managing to raise and extend their annual pre-export finance (PXF) loans.
“Even during the most difficult of times when most analysts believed that the Ukrainian government could not issue anything externally, there have still been a few companies in the steel industry, for example, that have managed to raise funding.
I think that there is a small window open for steel companies to continue raising funding this year, and I expect more companies to be tapping the market again in the next six months. Following the success of the government’s eurobond, it’s looking more hopeful,” Küüsvek says.
Metinvest closed its most recent PXF facility at US$325mn in May this year. At the time the deal was expected to raise up to US$500mn, but closed only slightly oversubscribed due to nervy investor sentiment. The deal, which was not underwritten, paid a price of Libor plus 4.75% − higher than Metinvest’s previous five-year US$1bn PXF which closed at the end of 2011 at a price of 3% over Libor.
Although Metinvest is being forced to accept higher loan prices, the company is still managing to roll out its syndications; a testament to the company’s reputation as a reliable borrower. As further proof of this, Metinvest publically revealed that it had repaid its five-year US$1.5bn global refinancing facility in May this year – the largest loan ever offered to a private company in Ukraine.
In addition, a spokesperson at Metinvest confirms that the company is in the process of launching a new PXF loan into the syndication market, and sources close to the deal reveal that Deutsche Bank will once again be leading the transaction.
However, despite the company’s success in its ability to raise the required funding over the years, the Metinvest spokesperson explains that the company hopes to start diversifying its financing due to the inadequacy of bank loans.
“Although it is a relatively cheap source of capital, it is short term and also, usually being a secured debt instrument, it makes other debts expensive. Metinvest tries to diversify its sources of capital away from the bank debt by using various instruments such as bonds, export credit agency (ECA) financing, committed standby facilities and outsourcing.”
EPAP’s Khoroshylova agrees that steel companies will have to continue to seek alternative forms of funding in order to achieve longer tenors.
“Even four to five years ago, reliance on the capital markets was much more significant and the capital market deals were happening much more often, especially for unsecured lending. After the first wave of the crisis we saw some capital market loans in the metal and steel sectors, although it was mostly secured financing.
However the lending that is happening now is highly secured financing, or financed from international organisations that normally come with very stringent conditions, with various governance securities.”
One steel company that has not been successful this year is Ukraine’s Donetsksteel Iron and Steel works, which according to sources in the market has halted its PXF that was launched last November. The company mandated Deutsche Bank to co-ordinate the US$750mn five-year PXF facility.
Pavlo Perkonos, director of development for Kiev-based research company Delphica Project, says that banks could be stalling the syndication due to the company’s significant drop in production volumes in the first half of 2012, as well as the closing of some of the company’s plants in April this year.
In fact, recent figures for Ukraine’s steel production reveal that the sector may be about to experience a downward turn, which could further deteriorate corporate funding.
“The decrease in steel export tonnage due to the descent of import demand is the first risk for Ukrainian steel producers. The second one is a price fall. We expect a 5-7% decrease in prices for longs and a 14-15% drop for flat steel in 2012 compared to 2011. This will lead to the decline in export sales by approximately 7% to US$15bn.
Accordingly, the worsening of Ukraine’s steel producers’ profitability is expected in 2012. This is going to be a significant factor that will curb the prospects of Ukraine steel producers for international funding mobilisation,” Perkonos adds.
Another factor at play here is that 75% of Ukraine’s inland produced steel products are exported, with only one quarter being consumed on the domestic market, making the steel sector highly vulnerable to external shocks.
Nevertheless, Perkonos says that despite falling production levels, there could be a loophole for the metals and mining sector due to the majority of assets in the industry belonging to Russian as well as Ukrainian investors. Additionally, many Ukrainian steel producers have the option to obtain funds through their parent companies, such as Metinvest, Ferrexpo and ArcelorMittal, which makes these companies a lower risk investment and increases their chances of receiving international bank funding.
Küüsvek explains that although the EBRD could potentially finance more projects, the investments crucially depend on genuine investors, domestic or foreign, of which there is a shortage. However, he adds that just like the steel industry, there are also pockets of opportunity in the agribusiness sector that are drawing in investor funding.
“We are also finding it quite difficult at this point to syndicate transactions in the market as it’s a challenge to attract the commercial banks to participate. However there continues to be some names specifically in the agribusiness sector, particularly grain, which are expected to hit the market with large syndications soon,” Küüsvek adds.
One Ukrainian agribusiness that is finding success is leading sunflower oil producer Kernel Holding, which in July extended the US$222mn tranche of its US$500mn PXF from October last year. The deal, which was led by ING Bank, UniCredit Bank and Deutsche Bank, marked the largest agri-PXF in the CIS region to date.
However, despite the odd glimmer of hope offered by successful top-tier corporates, the country’s economy is in fact grinding to a halt; the overall diminishing appetite for Ukraine’s exports is bringing this year’s projected economic growth to just 3%.
Ukraine’s dependence on Europe as its main export market and its heavy external funding needs are the main determining factors for the country’s descending growth rate. Its local banks’ balance sheets are also weak, and although banks remain well-capitalised, European risk exposure and currency volatility are making it difficult for local banks to provide long-term loans.
Rudolf Putz, trade facilitation programme head at the EBRD, says that although most Ukrainian banks have sufficient liquidity to finance short-term trade transactions with tenors of up to three to six months, most foreign exporters, commercial banks and private insurance underwriters are still very cautious in taking risks on importers and banks in Ukraine. He adds that in most cases, larger foreign trade finance transactions with longer tenors require risk cover by export credit agencies or financing by the EBRD.
“There is currently very little investment in Ukraine, and people are not investing and buying much imported machinery and equipment because the local economy is still suffering, and many companies are still struggling to find buyers for their goods. So most of the trade finance business that we’re seeing is import of foodstuffs, commodities and import of spare parts and consumer goods and electronics,” Putz says.
Investor appetite in the Ukraine is at an all-time low, mainly due to the ongoing problems in the European Union, which accounts for 26% of Ukrainian exports.
Küüsvek says: “Out of all the CIS countries, Ukraine is by far the most connected to the eurozone in terms of investor and trade flows and indebtedness. If you add together these three components and take the percentage of the GDP – it accounts for 3% − it’s by far the most vulnerable country right now and most affected by its external influences.”
Meeting with resistance
Indeed, the country’s debt burdens are weighing heavily on an already fragile economy. The government owes US$3bn to the IMF and US$1.5bn to Russia’s VTB Capital Bank, after it paid the first half of its debt payment in June this year. Margarita Valentinovna Kuznetsova, head of documentary operations and trade finance at VTB, says that the government is expected to pay the balance of its debt to VTB in 2014.
Additionally, Ukrainian companies and banks have racked up a total of US$58bn in corporate and sovereign debt, which is due to be repaid this year, accounting for a third of the country’s GDP. These scheduled debt repayments would be achievable perhaps with IMF aid, but since funding was blocked at the beginning of 2011 the country has no choice but to go it alone.
The IMF has stated that it will only resume funding on the condition that Ukraine raises its domestic gas prices to curb its budget deficit – a factor that has proved to be a sticking point for the government, which clearly doesn’t want to take unpopular measures before the parliamentary elections in October this year.
“There is still a major stumbling block which relates to the domestic energy tariffs; it is one of the major budget problems that Ukraine has. Rightly so, the IMF is encouraging Ukraine to increase its domestic energy tariffs, gas prices have risen and Ukraine is paying prices of US$400 and above per 1,000m3 of gas to Gazprom of Russia, and only getting a fraction of that back sending it to domestic consumers,” the EBRD’s Küüsvek says.
Küüsvek adds that Ukraine’s national oil and gas company NaftoGaz is putting considerable financial pressure on the Ukrainian budget – which is expected at around 2% of GDP for 2012 – to ensure financial sustainability.
“It’s always easier to raise tariffs after the elections compared to before, so clearly once it’s over there will be more breathing space to make the necessary adjustments and reforms.”
It’s expected that the government will eventually yield to IMF demands once the parliamentary elections are behind them, which will unlock billion of dollars of additional aid and ease Ukraine’s troubled economy.
The last few months have undoubtedly proven that Ukraine is on the right track for economic recovery. However, for many corporates and local banks, access to funding and high interest rates will continue to pose challenges for the year ahead. And until the parliamentary elections are behind them at least, and IMF conditions are met, their future hangs in the balance. GTR