Ukraine - buy backs?
It’s interesting to hear Finance minister Marchenko talk about using the current war risks to buy back more government debt.
GDP warrants are the obvious choice therein and the MOF seems already to have undertaken two buy back operations on these instruments - one last Summer and one this February retiring around one fifth of the $3.4bn liability. Both seem to have been conducted in the 90s on price, given the timing of MOF press releases.
War aside the buy back makes sense as these instruments are a huge structural liability for Ukraine - it might only be $3.4bn nominal liability but the payout structure is just perverse in my view, with bondholders getting 40% of nominal USD growth above 4% real GDP growth and 15% for 3-4%, with no cap on payouts between 2025-2040, and only a 1% of GDP cap on payouts from 2019-24. I was never a fan of the warrant structure - at least for Ukraine (at the time of the 15’ restructuring I had suggested warrants as a solution to the powers that be, but never imagined no cap on payouts for the duration of the instruments), albeit it’s a boon for bond holders (hence some banks had 200+ valuations prior to the current upsurge in geopolitical risk). As an aside when the bonds were first issued I estimated valuations at 120-odd on growth prospects, but halved my valuations as I have always expected a major, defining war between Ukraine and Russia over the medium term. My medium term was 4-5 years, and I might have been out there by two years.
But… Ukraine is facing the real prospect of an all out war with Russia and the question has to be asked if at this current time bond buy backs are the best use of Ukrainian government and donor money? That’s not for me to answer but there is obviously a moral hazard question to be asked there - is tax payers money again being used to bail out bondholders?
Clearly there is logic in trying to underpin market sentiment by supporting bond prices thru buy backs - this can help anchor broader macro financial stability and help to keep the population calm in trying circumstances. If geopolitical risks endure there might be little floor to bond prices and as yields push higher this can add to broader public unease about risks - risking pressure on the UAH. Some support to bond prices thru buy backs can help anchor yields and help the NBU in supporting the UAH - kind of cheap NBU intervention, but by the MOF.
There is the problem of timing/pricing. It seems as though the MOF might have been buying warrants back earlier this year at much higher prices - warrants in the 90s. With warrants currently trading in the high 60s, obviously questions could be asked as why these purchases were not delayed. I guess the response there is hindsight is great, it’s always hard to catch a falling knife and imagine where prices would have been without the intervention. Yields would have been much higher. And while money could have been saved by delaying, at least the intervention would have served a purpose of supporting sentiment/confidence.
But from hereon I guess it’s tricky as if Putin escalates, bond prices will go lower providing better buy back opportunities further down the line. The MOF will have to mull over timing/pricing and what signalling effect this all has.
I guess critics might say that depending just how bad the escalation related to Russia gets, then there may be no point buying back bonds which might eventually end up in some restructuring scenario - true in an absolute worst case scenario of a brutal war, large territorial losses, GDP contraction, devaluation (repeat of 2014/15 and some more).
But tricky decisions for the MOF - I guess though buy backs back the Zelensky narrative that Russia won’t invade. Kind of putting his money where his mouth is. And if Putin does invade Ukraine may well get its cash buffers bolstered by Western donors or indeed a Belarus-style scenario where Putin writes the cheques.