When twisting bondholders' arms makes sense
When an issuer is in danger of collapse, investors often have the wrong incentives. That’s why Metinvest is right to threaten bondholders with a cram down, just as the sovereign is right to threaten a debt moratorium.
Steelmaker Metinvest took its gloves off on Friday and told investors that if the latest meeting in its consent solicitation odyssey fails, it will take a tougher approach. The firm, which has been trying to reprofile its three Eurobonds since early April, will go to a London court and attempt a scheme of arrangement. This would prevent any investor from enforcing the Eurobonds’ terms, including giving official notice that the May 2015 Eurobonds — which Metinvest has not repaid — are due.
To be fair to the holders of the $113.6m May 2015 Eurobonds, of which a small holdout group is the reason that two months of negotiations have not borne fruit, the firm could probably have repaid their principal. But then it couldn’t have done anything else. According to Metinvest, it had only $130m in unrestricted cash and cash equivalents as of mid-April.
If financial mismanagement was the reason Metinvest was hard up for cash, then the holdout group’s recalcitrance might be more understandable. But the fact is that Metinvest has much of its operations in Ukraine’s industrial heartlands, which are now the site of Europe’s worst armed conflict since the wars in the former Yugoslavia. The biggest criticism of Metinvest is that it should have started negotiating with bondholders and pre-export finance lenders — who it has also failed to repay — much earlier than it did. But the 61% year on year drop in first quarter earnings is the down to the war in Donbas, not stupid debt management strategy.
So a group of investors holding, by one analyst's estimate, just 3% of the company’s total debt are preventing it restructuring the other 97%. These investors, under the terms of the recent offer, would receive 25% of their principal in cash and the rest in two instalments, with the last in January 2016. They would be repaid in full.
It’s a shame that this isn’t good enough. But investors factor in repayment risk when they buy bonds. The risk of reprofiling is something they face. This fact obviously doesn’t obfuscate the risk that some bondholders will decide to push for more at the expense of a firm’s future and other investors’ prospects. But the extent to which they should be allowed to do this is limited. The great majority of Metinvest investors seem to accept the firm’s plans, and if the solution to this collective action problem is riding roughshod over the prospectus rights of the 3%, then so be it.
The situation is in some sense the Ukrainian sovereign’s dilemma writ small. It looks as though the IMF could decide to consider a $3bn Ukrainian government Eurobond bought by the Russian National Welfare fund in 2013 as official debt, not private. This Russian ‘bail bond’ was essentially a loan to prop up the previous Yanukovych regime — which unlike the current government is largely responsible for the parlous state of Ukraine's finances. But classifying it as official debt would mean that Ukraine cannot impose a haircut on the bond and still keep borrowing from the IMF. This in turn means that the pool of private debt the Ukrainian sovereign is trying to restructure falls from $20bn to $17bn, and the haircut that Ukraine would need to impose in order to have some hope of financial sustainability has to rise.
But a group of Ukraine sovereign bondholders do not want to take any haircut. They believe that Ukraine’s problem is one of liquidity, not solvency. And as in the case of Metinvest, they are prepared to push their concerns at the expense of Ukraine’s increasingly fragile economy. They are not a mere 3% of Ukraine’s total debt. They hold more than $8bn. But they are still wrong. They are almost certainly wrong about Ukraine’s problem being one of liquidity rather than solvency.
Although there is no certainty when it comes to macro-economic outlooks, most analysts and many investors believe some kind of haircut is necessary to lower the risk of outright default. But the Ukraine sovereign holdouts are definitely wrong to put their private interests in front of the political and economic future of a country. Luckily, Ukraine has the possibility of instituting a debt moratorium and, judging by comments from finance minister Natalie Jaresko, is prepared to use it. A debt moratorium shelves the rights of investors to receive coupon payments or principal, and Jaresko would be right to use it, particularly as the IMF has suggested this would not preclude it continuing to offer financial support.
The obligations of private companies and governments to investors extend only so far, and at a certain point should be ignored. The capital markets will be the judge of whether either Metinvest or Ukraine is punished in basis points if either entity plays tough with bondholders. But creditor warnings that heavy handed negotiating tactics threaten market access ring false. The market has, with open arms, welcomed back far less reasonable borrowers in far less sympathetic circumstances.