Ukraine's smaller bondholders unfazed by moratorium threat

LONDON, May 20 (Reuters) - Many holders of Ukrainian bonds are unperturbed by Kiev's threat to halt debt payments, noting that a moratorium would merely bring forward a widely anticipated default and could even result in a better long-term deal for investors.

Kiev has ratcheted up pressure on its creditors, the biggest of which is investment firm Franklin Templeton, by passing a law allowing the government to call a moratorium on sovereign bond payments. The finance ministry said it would do so unless a "good-faith, collaborative" solution was found.

The move comes after dealings with a creditor committee ended in acrimony last week, with both sides slamming each other in public for lack of "engagement".

The committee itself has not commented on the new law but Russia, which holds $3 billion of Ukraine's bonds and is its second-biggest creditor, has attacked Kiev as "unprofessional".

But other, smaller bondholders appear less than outraged.

"This is in line with what I expected, as it's been a deadlock with creditors and this way they increase their bargaining power," said Rogge Global Partners' head of emerging debt Michael Ganske, who holds a "very small" Ukraine position.

About $23 billion worth of sovereign and sub-sovereign debt is earmarked for restructuring in total. The bonds fell up to 1.5 cents across the curve after Ukraine announced the new law.

The creditors' committee opposes a "haircut" or writedown of the bonds' face value, saying the proposals it has put forward will allow Kiev to make the necessary $15.3 billion in savings. Committee members together control $8.9 billion of bonds or about half Ukraine's outstanding sovereign bonds.

Ukraine says it is impossible to get debt to a sustainable level without a haircut.

But the crux of the matter is the deal's timing.

Ukraine had hoped to reach an agreement by end-May, ahead of a review needed to unlock its next tranche of International Monetary Fund loans, but this was widely seen as unrealistic.

While the IMF money is officially tied to Kiev's progress on debt restructuring, the general view is that Western lenders are unlikely to halt aid. Deadlines for a deal could therefore be pushed back indefinitely, many say.

Paying anything in the meantime could be counterproductive for Ukraine, said one bondholder who is not part of the committee and spoke on condition of anonymity.

"If you are continuing to pay coupons and principals it's going to be harder to negotiate the bondholders' group down," the bondholder said.

"There are benefits for all parties to get Ukraine onto a sustainable path ...So if the strategy is to stop paying and bring the creditors to the table, hopefully the two sides will reach common ground."

TAKING A BREAK

The idea of a moratorium is not new.

Even before Kiev set out its debt restructuring parameters, experts such as Gabriel Sterne at Oxford Economics had suggested a period free of debt servicing would allow it to rebuild its economy while evaluating the real state of its finances.

Easing short-term payment pain can improve solvency, and in the most optimistic scenario, a significant haircut may not be needed at the end of the grace period, Sterne argues.

Ukraine's debt repayment schedule supports this argument, with some hefty redemptions in the next couple of years .

"A couple of years of grace period with low or zero interest payments is probably a good idea," the bondholder said, though he noted that with pro-Russian separatists still fighting government troops in eastern Ukraine, all bets on economic recovery were off.

The threat of a moratorium may also seem less worrying because for many months, a default had appeared inevitable, with bonds trading at less than half their face value.

Meanwhile, Ukraine's powerful allies are backing its approach.

U.S. Treasury Secretary Jack Lew this week called for "sacrifices" from bondholders while his predecessor Lawrence Summers advised Ukraine to default rather than repay its "selfish" creditors. .

And unlike the creditor committee, many bondholders grudgingly acknowledge that Ukraine's situation probably makes a haircut necessary.

"I think without a principal haircut it is pretty hard to make the numbers work, especially the debt to GDP (ratio)," said one European fund manager who also owns the bonds. He was referring to the IMF's targets on debt sustainability.

"I'm not sure (the moratorium) really changes anything, everybody is already expecting a restructuring." (Additional reporting by Marc Jones and Karin Strohecker; Editing by Catherine Evans)