Last week, the Ministry of Finance of Ukraine successfully placed $2bn of Eurobonds. As a result, the government should have enough FX funds to repay external debt through May 2019, as we expect the IMF Executive Board to approve the new stand-by agreement with Ukraine this December and IMF-conditioned tranche from the EU and borrowings under the World Bank guarantee will be received.
The yields of the new Eurobonds are slightly higher than the sovereign yield curve, which makes them attractive for investors. Due to political risks, Ukraine's sovereign curve justifiably should remain above those of peers with ratings B/B-, at least until 2020.
New bond placement was successful. Initial guidance was announced at 9.25% for five-year notes and 10% for the 10-years. At the end of the pricing procedures, two Eurobond issues were finally announced: $0.75bn at a 9% yield (coupon rate will be 8.994%) maturing in 2024, and $1.25bn at a 9.75% yield, maturing in 2028.
The issues were oversubscribed with a total of $4.9bn of demand despite high political risk given next year's elections, lack of a finalized deal with the IMF, and the currently unfavorable situation for emerging markets. Under such circumstances, we see the cost of new funding as close to fair. The most expensive issue during the last decade was in 2012, when five-year bonds were placed at 9.25% with a spread to the benchmark above 800bp.
External debt repayments are fully funded at least until May. The new Eurobond issue is enough to cover the government's external debt repayments until the end of February. Furthermore, we believe the staff-level agreement with the IMF is sufficient for Ukraine to be authorized to receive the tranche of EUR0.5bn from the EU and $0.4bn under the World Bank guarantee, which will allow the government to repay FX debt at least until May 2019.
But the government needs to plan the next new Eurobonds issue no later than 1Q19, in order to repay $1bn of US-backed bonds in May and in September-$1.1bn (including interest) for Eurobonds issued in 2015 under the debt restructuring. Overall, we anticipate $3bn of new Eurobonds will be needed next year.
Trading above yield curve makes new bonds attractive. At issuance, the new 2024s were priced at a 602bp spread to the benchmark or 25bp above the sovereign yield curve. This is the usual new-issue premium required by the market and added to the yield curve. In turn, the new 2028's spread was 616bp, about 40bp above the yield curve.
We assume that the spread between the new bond yields and the sovereign curve will eventually tighten to zero. Overall, the level of sovereign risk remains high due to political uncertainty given the upcoming elections, and the ongoing military conflict. So, new issues in 2019 are unlikely to be cheaper for the government.
The sovereign yield curve is justifiably above most peers that have a B/B- credit rating. But the curve can shift down at the end of 2019 or at the beginning of 2020 when political situation in Ukraine stabilizes after the presidential and parliamentary elections.
This comment was originally produced by Investment Capital Ukriane LLC (ICU), a leading investment bank and broker based in Kyiv, Ukraine, for clients. Taras Kotovych is the senior financial analyst covering sovereign debt at ICU.