VZCZCXRO3708
PP RUEHDBU RUEHSL
DE RUEHKV #1472/01 2401701
ZNY CCCCC ZZH
P 281701Z AUG 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 8331
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RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY
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C O N F I D E N T I A L SECTION 01 OF 04 KYIV 001472 
 
SIPDIS 
 
DEPT FOR S/EEE - MORNINGSTAR/NESHEIWAT, EUR/UMB, EB/ESC/IEC 
- GALLOGLY/GREENSTEIN 
DOE PLEASE PASS TO JELKIND, LEKIMOFF, CCALIENDO 
NSC PLEASE PASS TO KKVIEN 
 
E.O. 12958: DECL: 08/27/2019 
TAGS: EFIN ETRD PGOV PREL EREL ENRGUA EPET ECON
PINR, UA 
SUBJECT: UKRAINE: NAFTOHAZ FOREIGN DEBT LIKELY TO BE 
RESTUCTURED 
 
Classified By: ECON Counselor Edward Kaska for reasons 1.4 (b) and (d). 
 
¶1.  (C) Summary.  Naftohaz's $500 million Eurobond, due 
September 30, will likely be restructured into a new $1.75 
billion bond instrument backed by a sovereign guarantee.  The 
new instrument would also incorporate $1.25 billion in 
bilateral debt that Naftohaz owes to four foreign banks that 
comes due over the next few years.  According to the GOU's 
recently-retained advisor, the proposed restructuring would 
benefit Naftohaz and the GOU while providing reasonable terms 
to Naftohaz's current creditors.  The proposal allegedly has 
the support of Naftohaz's bilateral creditors, but a minority 
group of the Eurobond holders, possibly linked to Dmytro 
Firtash and Gazprom, has voiced opposition to any 
restructuring.  The IMF has stressed that any restructuring 
be "voluntary," while the World Bank commented that a 
restructure deal would depend on a sovereign guarantee and an 
acceptable coupon rate.  The proposed restructure terms would 
provide cash-strapped Naftohaz much needed room to meet its 
monthly gas bills in 2009 and 2010.  End summary. 
 
POSSIBLE RESTRUCTURING TERMS 
---------------------------- 
 
¶2.  (C) Naftohaz and the GOU have hired Cyprus-based Squire 
Capital to advise on the possible restructuring of Naftohaz's 
$500 million Eurobond and $1.25 billion bilateral debt. 
Squire Capital's Robert Grant (protect throughout) told us 
that the GOU and Naftohaz are working on a bond instrument 
that would roll over the Eurobond and four outstanding 
bilateral bonds into a single instrument backed by a 
sovereign guarantee.  Grant explained that cash-strapped 
Naftohaz would not be able to pay the $500 million Eurobond 
when it comes due September 30, and that Ukrainian law would 
prohibit the GOU from covering Naftohaz's debt.  The 2009 
budget law, however, allows up to $2 billion of Naftohaz debt 
acquired before 2009 to be restructured and backed by a 
sovereign guarantee.  The new bond instrument, according to 
Grant, would be structured under this provision. 
 
¶3.  (C) Grant expected terms for the bond restructure to be 
announced within the next two weeks.  One scenario would have 
the restructuring offer released on September 7, with a 
21-day window for noteholders' meetings and a planned close 
ahead of the Eurobond's September 30 maturity.  However, 
Grant said there is still discussion within Naftohaz and the 
GOU on when the restructuring offer should be made, with some 
favoring a mid-September opening date.  Under this second 
timeframe, the offer would close after September 30, allowing 
Naftohaz to send a strong signal to bondholders that it would 
not pay the matured Eurobond and would only entertain the 
restructuring option.  Grant also described an "early bird 
special" being vetted that would incentivize bondholders to 
sign on to the restructure by giving a more favorable coupon 
exchange after the offer is released. 
 
¶4.  (C) The restructured bond would have the full sovereign 
guarantee of the Ukrainian government and would not include 
any covenants related to Naftohaz.  It would also remove the 
negative pledge on Naftohaz's gas transit revenues by current 
debt holders, allowing Naftohaz to seek other financing based 
on the collateral of future transit revenues. 
 
¶5.  (C) Grant told us that the GOU would agree to a coupon 
rate between 8 and 10 percent, suggesting that it was 
unlikely Naftohaz would go beyond a single digit rate.  He 
believed the new bond instrument would have enough liquidity 
to trade 100 basis points above other Ukrainian sovereign 
debt.  The restructured bond would mature in 2014, an 
advantage for the GOU, Grant noted, as Ukraine has few 
sovereign obligations coming due that year. 
 
"PLAN B" 
-------- 
 
¶6.  (C) Grant stressed that the GOU wanted to mitigate 
against the possibility of a Eurobond default through the 
restructuring proposal, but he suggested that the GOU and 
Naftohaz had developed a "Plan B" in case bondholders would 
not agree to its terms.  Without telling us the exact 
 
KYIV 00001472  002 OF 004 
 
 
details, Grant described the plan as "ugly" and "much more 
painful," while having the same end result for Naftohaz. 
Such a plan would likely involve a significant haircut for 
bondholders after Naftohaz's default on the Eurobond.  He 
stressed that creditors had not been apprised that a "Plan B" 
had been developed, though its existence would be revealed 
"at the last minute" if needed. 
 
BILATERAL CREDITORS ON BOARD 
---------------------------- 
 
¶7.  (C) Grant told us that Naftohaz's bilateral creditors 
have, in principle, agreed to the proposed debt 
restructuring.  The four banks (including Credit Suisse, 
Deutsche Bank, and DEPFA) had been primarily concerned that 
the new instrument would be backed by a sovereign guarantee. 
The banks were initially reluctant but came around after 
being assured they would not take a haircut in the deal. 
Grant said that three of Naftohaz's bilateral creditors met 
with Prime Minister Tymoshenko on August 24 to discuss the 
possible restructuring.  Without explicitly mentioning the 
possibility of default, Tymoshenko reportedly told the 
creditors that neither Ukraine nor the creditors could afford 
to miss this "opportunity" to restructure, and that no side 
wanted to "go down a road" that would be "painful" for all 
involved. 
 
¶8.  (C) Grant explained that the bilateral debt had been 
raised at very low rates (between 2.5 and 5 percent), and he 
suggested that the proposed restructuring terms, while 
extending the debt's maturity, would also provide the banks 
larger yields and an instrument with greater liquidity.  One 
of the bilateral creditors, according to Grant, also owns a 
substantial share of the Eurobonds, bringing the total owed 
to the bilateral creditors up to $1.4 billion. 
 
EUROBOND HOLDERS BLOCKING RESTRUCTURE 
------------------------------------- 
 
¶9.  (C) Grant also discussed efforts of a minority group of 
the Eurobond holders to block any possible restructuring. 
According to press reports, a group led by Belize-registered 
Corlblow, which itself owns $11 million of the $500 million 
Eurobond, has consolidated the support of bondholders 
representing 20 percent of the Eurobond issue to prevent any 
restructuring.  Press reports also allege that Corlblow 
represents Russian interests.  Alexey Olshansky, former head 
of Sogaz Insurance, once wholly-owned and now minority-owned 
by Russia's Gazprom, has said he is the sole director of 
Corlblow and denied any connection between Corlblow and 
Gazprom.  Grant believes that the minority group could be led 
by Ukrainian business tycoon Dmytro Firtash and may have 
connections to Gazprom.  The minority group would need to 
amass support of at least 25 percent of the Eurobond holders 
to block the restructuring.  Grant suggested the minority 
group could be acting solely in its economic interests, but 
he expressed concern that it was being guided by political 
motives. 
 
POSSIBILITY OF FORCED DEFAULT 
----------------------------- 
 
¶10.  (C) Naftohaz might be forced into an "eventive default," 
Grant told us, if it is not able to release its financial 
accounts by September 6.  On August 6, one of its bilateral 
creditors wrote Naftohaz requesting financial accounts. 
Grant said that Naftohaz's auditor, Earnst and Young, was 
working with Naftohaz to meet the September 6 deadline, but 
he said that it would be difficult for them to do so.  If the 
accounts are not released by September 6, or if they show 
that Naftohaz is unable to make its debt servicing payments, 
the bilateral creditors could call default and force an 
accelerated repayment of the outstanding $1.25 billion in 
loans. 
 
IFI OFFICIALS WEIGH IN 
---------------------- 
 
¶11.  (C) Grant told us that IMF resident representative Max 
Alier had been reluctant to support the restructuring 
 
KYIV 00001472  003 OF 004 
 
 
proposal and had urged the GOU to make any proposal 
"voluntary."  Grant characterized Alier as having his "head 
in the sand," refusing to acknowledge the importance of the 
GOU's willingness to take on a sovereign guarantee and an 
increased coupon, while not demanding a haircut from 
creditors.  Suggesting that the IMF should "tone down" its 
resistance, and that it should not adopt positions that could 
ultimately cause the Fund to bail out a state-owned energy 
company, Grant said that the government would seek to avoid 
IMF involvement in the deal.  Grant also noted GOU concerns 
that the IMF official would leak information on the 
negotiations, pointing to previous statements Alier had made 
about sensitive discussions with Naftohaz. 
 
¶12.  (C) Although Grant said that he had not spoken directly 
with other IFIs, World Bank country director Martin Raiser 
appeared apprised of the negotiation's details on August 27. 
Raiser told us that creditors had proposed their own terms 
for restructuring Naftohaz's $500 million Eurobond, and that 
they would insist on a sovereign guarantee.  He said it was 
still unclear whether the Ministry of Finance would accept 
the coupon proposed by investors.  Raiser speculated that, 
despite the bad advice being offered by close associates of 
the Prime Minister, including financier and longtime 
Tymoshenko associate Oleksandr Ginzburg, who are "buzzing 
around the honey pot like bees," the GOU would not force 
investors to take a loss on the Naftohaz debt.  "Tymoshenko 
is unpredictable," Raiser said, "but she is not reckless." 
Raiser said that having just disbursed its latest $3.3 
billion loan tranche in the form of budget support, the IMF 
would be deeply embarrassed by any restructure arrangement 
where the GOU would impose punitive terms on investors. 
 
RESTRUCTURING WOULD GIVE NAFTOHAZ MUCH NEEDED RELIEF 
--------------------------------------------- ------- 
 
¶13.  (C) If the proposed restructuring goes forward, Naftohaz 
will gain much needed cash relief.  According to the plan 
outlined by Grant, Naftohaz would postpone payments of 
roughly $550 million in 2009 and $450 million in 2010, 
necessary due to its strapped financial position and monthly 
struggle to make gas payments to Gazprom.  Grant noted that 
the GOU, out of political and economic necessity, would 
choose to make gas payments before paying foreign creditors. 
A missed gas payment would trigger harsh sanctions by Gazprom 
and would be a severe political blow to Tymoshenko.  Grant 
said that the foreign debt restructuring would be 
characterized by the GOU as the first of a multi-step process 
to completely reform Naftohaz. 
 
COMMENT 
------- 
 
¶14.  (C) The proposed restructuring could provide a 
win-win-win opportunity for bilateral creditors, bondholders, 
and the Tymoshenko government.  Naftohaz and the GOU would 
clearly profit from a reduction and postponement of the 
energy company's substantial foreign debt servicing, avoiding 
what analysts had perceived as a possible default scenario. 
For Naftohaz's bilateral creditors, the plan would yield a 
much-desired sovereign guarantee and the potential for higher 
rates of return in exchange for a few years' extension of 
maturity.  The group with the smallest gain would be the 
Eurobond holders; they would sacrifice immediate cash for 
payment in five years.  However, they too could benefit, as 
Naftohaz would likely otherwise fail to repay the full amount 
of its Eurobond obligations in September. 
 
¶15. (C) Should Naftohaz not be able to get the support of 75 
percent plus one of Eurobond holders, it is not clear that 
the GOU would resort to "Plan B."  Naftohaz has been able to 
meet its financial obligations throughout this year with 
creative financing solutions and could resort to some of 
those same solutions to cover the bond payment, if needed. 
UkrExImBank Deputy Chairman Nikolay Oudovichenko told us that 
Naftohaz had incurred "affordable losses" but had enough cash 
on hand to cover its bond obligations.  He pointed to the 
recent injection of UAH 18.6 billion from a bond issuance 
approved by the Cabinet of Ministers in July for Naftohaz's 
statutory capital.  This leads us to question if Naftohaz 
 
KYIV 00001472  004 OF 004 
 
 
would, in the end, default on its Eurobond obligations. 
PETTIT