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— Analysis —
Ukraine survived, thanks largely to deft footwork and big loans from the International Monetary Fund. The latest, a $4.5 billion tranche of a $16.4 billion IMF loan, is scheduled for a Nov. 15 release. That doesn't mean the country has fully recovered. Ukraine is faring "better than we expected," says Michael Bleyzer, the founder and CEO of SigmaBleyzer Investment Group LLC, a Houston private equity firm specializing in Eastern Europe. But he quickly adds: "They're not out of the woods yet."
Ukraine's collapse was particularly extreme but not unique. What has happened there helps illustrate the plight of many developing economies, especially those in Europe in the aftermath of last year's financial crisis. Major economic problems continue to hammer the country. This year, Ukraine's economy is forecast to fall 14%, according to a recent IMF report, one of the worst performances anywhere in the world. The local currency, the hryvnia, officially devalued 35% last November, has actually plummeted by almost half in the black market. The country relies on production of heavy industry such as steel and chemicals and sales abroad to fuel growth. Exports fell almost 50% for the first seven months of the year. Add to this the continued uncertainty over how the country will pay for billions of dollars of disputed gas imports from Russia. The banking system remains on life support. According to figures compiled by Taras Burhan, senior lawyer at CMS Cameron McKenna LLP, based in Kiev, 12 of 198 registered banks are being liquidated and 16 are under temporary administration appointed by the country's central bank, the National Bank of Ukraine. Seven of these have agreed to be recapitalized by giving up at least 75% of their shares to the government. What eventually will happen to these banks is unclear, as is the fate of two of the five largest banks, which have refused government assistance to shore up capital. In the six months after the onset of the financial crisis, a quarter of all deposits were yanked from the banking system. "You've started to see cash come out of the jars and from under the mattresses" and flow back into the banking system, says Scott Brown, a lawyer with Kiev-based firm Frishberg & Partners. But he adds: "I'm not sure how effective bailouts will be." And then there is uncertainty about dozens of other banks. "Large banks, the state will support," says Bogdan Borovyk, a Kiev partner at international law firm Beiten Burkhardt. Midsized and small banks, he believes, will be allowed to fail. Foreign banks, which flocked to Ukraine just a few years back, are now trying to figure how to exit. Sweden's Swedbank AB, for example, paid $735 million in February 2007 to acquire TAS-Kommerzbank, based in Kiev. Then, it was all cheerleading for "an important tiger economy with impressive growth rate and positive development." But now, "we've lowered our ambitions in Ukraine, as we no longer consider it likely that the country will return to the levels of long-term growth that we had previously anticipated." Italy's UniCredit Bank also invested heavily in Ukraine, through acquisitions of a Polish and a Hungarian bank both active in the Ukrainian market. UniCredit stumbled badly after last year's financial crisis, blaming its exposure in Ukraine and other Eastern European markets. A bitterly fought presidential election scheduled for January compounds difficulties. The three candidates "are at each other's throats instead of running the country," complains Alex Frishberg, who heads Frishberg & Partners. Corporate restructuring and insolvency is especially problematic. For the past year, it's been the land of the walking wounded. It may take another year to see just how many companies ultimately succumb. "You don't see big names yet, even though they're very close to default," says Burhan. "Within the next year, you'll see landmark cases." Last year, the country's nonperforming loans topped 14%, according to figures compiled by the nonprofit Bleyzer Foundation, allied with SigmaBleyzer. The official number of insolvencies is expected to double this year, Borovyk says. But these busted companies are small concerns, Borovyk and others say. Insolvency specialists in Ukraine believe just a minute fraction of large companies in grave difficulty are seeking the courts for relief. Nor are angry creditors flocking to the courts. "Nobody wants to be too aggressive, because what does that get you?" asks Frishberg. "What a lot of creditors are doing is trying to restructure," adds Frishberg's partner, Brown. "They go for negotiation, take the subtle, gentle approach to debtors." The problem is straightforward: Forcing a company into insolvency almost always ends up in liquidation. What's more, it could take up to two years for the courts to act. In the meantime, creditors are almost powerless to act, and debtors can use the time to siphon off assets, a favorite technique in the chaotic days after the collapse of the Soviet Union. So creditors gain little or nothing. "Bankruptcy procedure is not the most efficient way to get funds back," Borovyk says. That postpones the day of reckoning but does little to solve the underlying problem. Burhan, for one, believes foreign creditors may eventually test the Ukrainian system by filing for relief outside the country. Lawyers hope Ukraine's insolvency laws will be strengthened to better support creditors. But no one expects any movement until after the elections and the uncertainty that could follow. "The insolvency practice is developing and growing," Burhan says. "Unfortunately, it takes time." For the past year, it's been almost a game -- at least publicly -- of don't ask, don't tell. Stanislav Dubko, CEO of local debt-ratings service Credit-Rating offers this telling number: In the first four months of this year, there were only 54 corporate defaults. A mere six were investment grade. But it would be a mistake to view this as evidence Ukraine has dodged the bullet. "All companies are in financial difficulties," Borovyk says. There are signs exports are recovering, but no one expects consumer demand to come back soon. Like many Central European countries, Ukraine binged on foreign-currency loans to fuel consumer spending, made all the easier by foreign bank investments. Foreign investors "put a lot of pressure on banks to lend," says Frishberg & Partners' Brown. Bank lending rose by 70% from 2006 to 2008, the IMF says. Half the loans were issued in foreign currency. Imports flooded Ukraine. Foreign currency loans carried lower interest rates than did those denominated in hryvnia. It may have made sense to buy a car, an apartment or a shop in dollars or euros when the exchange rate was stable. But after the devaluation, repayment carries a nasty 35% premium. At the same time, apartment prices collapsed by at least half. The country is rife with repossessed cars. Business in shops is way off. "They gave hard-currency loans to those who didn't have hard currency revenue," says Dubko. "It's a huge problem for borrowers and banks." Nonperforming loans spiked to more than 14% last year, the worst in Europe. This year, it should be even higher. The head of Austria's Raiffeisen International Bank-Holding AG told Reuters in September that the lender expects to lose 10% of the €5 billion ($7.4 billion) it loaned in Ukraine. That may be wishful thinking. Foreign investment into Ukraine, booming from 2005 until the middle of last year, stopped cold. There are rumblings once more, although this time it's about distressed investing. "We're about to close on deals, by the end of the year," says Bleyzer, who claims his company is the largest private equity player in Ukraine, with a further $150 million to invest. Bleyzer, whose fund looks at consumer staples such as food and beverage, says the valuation gap is narrowing and companies are finally facing reality. "There are good opportunities, and there will be more," he says. |
Earlier this year, odds were pretty good that Ukraine would follow Iceland into financial ignominy and go broke. The once-booming economy of this former member of the Soviet Union was in free fall. In the first quarter of this year, gross domestic product fell by more than 20%, the poorest showing in Europe. Ukraine's debt -- both public and private -- was crushing. Its external debt had tripled in three years. Many of its banks were insolvent.
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