Last week Ukrainian markets were driven by global sentiment and sovereign Eurobonds lost 2-3 points on the back of negative headlines about Greek banks coming from the ECB. Five-year CDS spreads for Ukraine closed 64bp w-o-w wider at 855bp on Friday, up 6bp from the end-2011 level. The market grew quieter on Friday, capping the week’s sell-off. The long end of the sovereign curve came down by about 2.5 points w-o-w with Ukraine 20s and 21s finishing at 87.25/88.25 (10.04%/9.85%) and 87.5/88.5 (10.13%/9.94%). The market, preoccupied with global events, did not react to PM Azarov’s announcement that agreement has been reached on the $2bn VTB loan (see below). On the corporate side we saw selling pressure in Oschadbank, which slipped by more than 3 points w-o-w to 84.0/86.0 (13.8%/13.03%). Corporates were also better offered, but not much was traded on low levels. Strong 1Q12 financials didn’t help MHP as its bonds were re-priced around 2 points lower to 93.5/95.5 (12.98%/12.11%). Bonds are off to a better start at the beginning of this week, signaling some rebound.

After a promising 1Q12 marked by positive expectations fueled by the ECB’s monetary easing, EU (especially GIIPS) banks are finding themselves in a new round of turbulence facing emerging challenges to asset quality, adverse operating conditions and restricted access to market funding (though the fact that out of the approx. EUR 1 trillion of LTRO 1 and 2 tranches EUR 800bn was re-deposited with the ECB points to a sufficient cushion for the EU banks to meet their obligations falling due in the next two years). Against this backdrop, Ukrainian banks’ modest 4M12 performance does not come as a surprise.

We recommend buying DTEK 15s which are trading with an attractive 206bp spread to the sovereign curve (11.3% YTM). The company recently reported strong 2011 financials and is set to benefit from a recent privatization spree during which it acquired stakes in two generating companies, one integrated electricity and heating utility and three electricity distributing companies, accumulating controlling stakes in all six assets. DTEK also gained control over the two most prized state coal mines and purchased a controlling stake in another mine.

Ukraine’s 5-year CDS spreads closed 26bp w-o-w wider at 791bp last week (-58pp YTD), in line with CEE credits’ dynamics (CDS for Hungary, Bulgaria, Romania and Poland widened by 23bp w-o-w on average). As a result, Ukraine’s sovereign curve moved up by 30bp (mainly on the long end), with Eurobond prices declining by 1-2pt on small volumes (though a slightly improved mood at the end of the week provided for some recovery, pushing quotes up by 0.25-0.5pt). Ukraine 20s and 21s thus finished the week at 89.5/90.5 (9.6%/9.4%) and 90.25/91.25 (9.9%/9.4%). Positive news on the extension of a $2bn VTB loan maturing in June, announced by an NBU representative (though with no additional details yet), and growth in NBU reserves in April did not affect the market, which was mainly driven by global sentiment. Among corporate names, we saw buying interest in DTEK 15s, which dipped by only 0.25pt w-o-w to 96.25/97.25 (10.9%/10.5%).

It seems that “sell in May and go away” is firmly cementing itself as a new post-2008 tradition. Last week the MSCI World index was down by 1.8% w-o-w while the MSCI Emerging Markets and Frontier Markets indices shed 4.1% and 1.6% respectively. Deteriorating U.S. data (jobs creation and other readings) in the last two weeks, persistent worries about China (exports, IP, new loan growth) and re-surfacing large-scale threats to Europe and its weakest periphery such as Greece, all pushed the uncertainty and volatility in global stocks to new levels.

Last week was quite sluggish for Ukrainian Eurobonds but they continued to enjoy investor demand supported by positive performance of the whole CEEMEA universe on the back of fresh inflows into EM debt funds and strong Ukraine-specific technicals – as quite a few market players remain underweight or short, there is not much debt on offer to threaten the recent rally. Thus by Friday, Ukraine 20s and 21s increased by 1.25-1.5pt to 91.25/92.25 (9.3%/9.1%) and 92.25/93.25 (9.3%/9.1%), respectively.

The NBU announced today its reserves rose by 1.7% m-o-m or $532m in April, to $31.7bn (still down 0.4% YTD).
The increase resulted mostly from the central bank’s F/X purchase interventions as the effects of the revaluation of non-USD denominated reserves, change in the gold holdings and volume of government F/X operations were relatively small.

Last week’s AGM of UniCredit owned Ukrsotsbank, Ukraine’s 5th largest bank, approved conversion of the parent’s subordinated debt into equity in order to strengthen the bank’s capital adequacy. Ukrsotsbank will issue 5,708,068,338 new shares, increasing their total number by 45% to 18,403,054,388 and thus enlarging its equity by 18% or UAH 1.26bn ($158m) based on the issuance price of UAH 0.22/share. The first stage of share subscription will be held between July 17-Aug.6 and the second stage is scheduled for Aug. 7-10. As the share capital increase (SCI) involves no cash injection and given the positive (albeit insignificant) effect on interest costs stemming from the elimination of subordinated debt, the share price should correct down by 20%, from UAH 0.21 to UAH 0.17, on technical earnings dilution (before accounting for the positive effect stemming from long-term asset expansion capability improvement thanks to own capital base growth (CAR up by 3.17pp to 15.75%) and reduction of F/X risk exposure thanks to conversion of F/X debt into hryvnia equity).

Russia agreed last week to lift an import ban on three Ukrainian cheese plants, including Milkiland’s Mena Cheese, which jointly accounted for 66% of Ukrainian cheese exports last year. These plants have already undergone quality tests by Russian experts and submitted action plans to resolve remaining concerns.

Ukrainian Eurobonds experienced a volatile week under pressure from negative mood swings in global markets, but sovereigns still managed to close higher w-o-w. Ukraine 21s rose by 1.5pt w-o-w to 89.5/90.5 (9.60%/9.41%) while quasi-sovereign Naftogaz added 1.0pt to 97.5/98.5 (10.69%/10.21%). City of Kyiv bonds enjoyed a strong price rise: Kyiv 16s and Kyiv 15s rose by 1.8-2.0pt in just one day and were quoted at 85.5/87.5 (13.27%/12.48%) and 86.0/88.0 (13.86%/13.17%), respectively at the end of the week. Metinvest’s good 2011 results had little impact on the market, with most investors maintaining a conservative outlook for metallurgical companies. Metinvest
15s were quoted at 99.0/100.5 (10.63%/10.05%) and Metinvest 18s at 92.0/93.5 (10.63%/10.26%). In addition, Oschadbank’s 2011 IFRS results showed rather good performance including a decline in exposure to Naftogaz from 51% to 35% of total loan book; on the week Oschadbank 16s rose by 1.5pt to 87.5/89.5 (12.40%/11.69%).