The headquarters of Franklin Resources, parent company of Franklin Templeton, is seen in San Mateo, California. Franklin Templeton has come to grips with the fact that it won’t be able to avoid losses on its $7bn investment in Ukrainian bonds.

Bloomberg/London

Franklin Templeton has come to grips with the fact that it won’t be able to avoid losses on its $7bn investment in Ukrainian bonds.
The investment firm and three other bondholders this week offered the eastern European nation a small amount of debt relief, the first time they’ve entertained the possibility of a write-down on their principal holdings. The size of the so-called haircut they proposed is 5%, a person familiar with the negotiations said on Thursday. That compares with the 40% Ukraine was said to have asked them for last month.
While investors hailed the offer as a step toward ending a standoff, sending bonds toward their best monthly rally on record, Ukraine is running out of time to get a deal in place before its first Eurobond matures September 23. The nation needs to alter terms on $19bn of debt as a condition for International Monetary Fund aid aimed at pulling the economy out of a recession that’s deepened in the 16 months since a battle with pro-Russian separatists started in the east.
“The creditors have bitten the bullet,” Jakob Christensen, an analyst at Exotix Partners in London, said by e- mail on Thursday. “It’s give and take from here, so a compromise is probably the most realistic. I don’t think the IMF and the government will be satisfied with a small principal haircut. They will need more like 25%.”
Trading in the bond market suggests investors are optimistic the creditor group - which owns $8.9bn of the nation’s debt - will convince the government to back down on its demands for big losses. The sovereign’s $2.6bn of notes maturing in July 2017 rallied 9.9 cents on the dollar in July to 58.43 cents in London on Friday, including a 1.9 cent advance for the day.
The restructuring deal will probably end with a principal cut of about 35% and a 4% reduction in interest payments, analysts at Oxford Economics including Evghenia Sleptsova said in a research note on Tuesday. Bonds are currently pricing in a haircut of less than 35%, they said. While the 5% write-off represents a concession, the bondholder group’s proposal is subject to a number of preconditions and other detailed terms, according to a second person with knowledge of the talks. Both asked not to be named because the talks are private.
Until now, creditors insisted losses on principal weren’t needed to meet the conditions of the IMF’s $17.5bn loan. Their earlier offer focused on pushing back due dates and reductions in interest payments. BTG Pactual Europe, TCW Investment Management Co and T Rowe Price Associates are also part of the committee.
The group has said the burden of granting Ukraine debt relief is unfairly falling on their shoulders, noting in a June 24 letter that less than 30% of the nation’s $70bn of public and publicly generated debt was being identified for losses.
The government, by contrast, pointed to the state of the economy and finances in its plea for a break on the debt it owes. Gross domestic product is poised to shrink 8.5% in 2015, the biggest drop in Europe, the Middle East and Africa, according to forecasts compiled by Bloomberg. Foreign-currency reserves at about $10bn are less than half what they were at the end of 2013, before Russia’s annexation of Crimea sparked the separatist conflict.
If the two sides fail to finalize an agreement by the time of the second IMF review in mid-September, Ukraine may withhold payment of debt due that month, analysts at Moody’s Investors Service including Kristin Lindow said in a research note on July 27.
Ukraine is proposing a direct meeting with creditors next week, the first person said. The $500mn note due Sept. 23 rose 3.71 cents to 61.67 cents on the dollar yesterday.