Russia’s corporate and Eurobond bond markets have been quiet over the summer, but for the first time since the 1998 financial crisis, the sovereign bond market has sprung back to life and it rallied strongly in August. After a frenetic season last year, Eurobond issues have died down, leaving Russia’s banks as the most active issuers. The leading banks are tapping international markets to lend to the local customers, using the cheaper funds and longer maturities to open up a gap with their smaller peers, which do not yet have the confidence of international investors.
International issues are currently doubly attractive as strong rouble appreciation on top of the healthy interest rates means banks can make money just by borrowing. Still, the supply is thin as most of Russia’s companies do not need the money.
“There is not much supply as the leading corporates are all flush with cash and if they need more money they are more comfortable with the cheaper syndicated loans,” says Mikhail Galkin, a credit analyst with Trust Bank.
Rating boost
Russia is enjoying a re-rating, which has tightened the spread between Russia’s sovereign bonds and the benchmark US treasury bills, falling from about 280 basis points last summer to 130bp by the end of August.
“If you’d told me that spreads would tighten by more than 100bp over a year in the middle of last year, I would not have believed it. This has been an incredible rally,” says Pavel Mamai, a credit analyst at Renaissance Capital.
The Yukos fracas spooked portfolio investors, but largely passed by the bond markets, which were more focused on Russia’s outstanding macroeconomic results and the country’s step up to investment grade by the three major rating agencies at the start of this year.
Rouble bonds have also rallied, with much of the buying by foreign investors, attracted by the double plus of high yields in an otherwise lacklustre global market and rouble appreciation. Brokers report that the enthusiasm for Russian bonds means that foreigners are diving into the uncharted waters of second and third-tier junk bonds, but even in these risky investments yields are down below 11% – slightly less than inflation.
“There was no summer slowdown in the rouble bond market. Indeed, the market rallied, as there is plenty of liquidity chasing bonds,” says Mr Mamai. “The supply of bonds can’t keep pace with the amount of money flowing in and demand it is creating.”
Market rally
However, the big story has been the recovery of the domestic sovereign bond market – the OFZ and to a lesser extent the MinFins – that has lain moribund since the 1998 financial crisis. The rally took off at the start of August and sent prices up 6% in two weeks just as the RTS passed its all-time high, with the longest maturity bonds leading the charge. The yield on the OFZ 46018 bond, which matures in November 2021, saw its face value rise by 5.8% in the first two weeks of August and its yield fell below 8% for the first time in the market’s history.
The OFZ had been trading on a par with Gazprom and City of Moscow’s benchmark domestic bonds, which are still in high demand by foreign investors.
Gazprom issued its cheapest ever Rbs5bn ($175m) four-year bond in August with a yield of just 6.95%, well below organiser Renaissance Capital’s expected yield of 7.25%-7.36% and about 150bp less than comparable bonds from the likes of the Russian Railways corporation. Russian bond traders say the Gazprom bond was as cheap as an OFZ and driven artificially low by foreign demand.
“The key reason is a great deal of free roubles on the market. The high demand for municipal bonds and large-cap corporate bonds among non-residents has nearly ousted Russian investors from the corporate debt market,” says Anna Matveeva at Troika Dialog.
But Mr Galkin argues the OFZ should sell at a 40bp premium to even the bluest of the corporate bonds as they are backed by the state. The market suddenly woke up to the mismatch in August and a month later, OFZs were trading at a 40bp spread over Gazprom’s and City Of Moscow’s bonds.
Popular option
OFZs are particularly popular among foreign investors, who appreciate their low risk and were switching out of corporate bonds into the state bonds as the rally built up some momentum. However, traders say everyone was getting into the game by the middle of the month, including small banks that are not normally players on the bond markets.
“It has been six weeks of madness,” says Mr Galkin. “This is already a Rbn20bn market – big and liquid. The market remains bullish and interest is shifting from hunting down yields among the second and third-tier corporate bonds to what is the least risky bond in the country. The rally in government bonds was inevitable. There are roubles everywhere.”
The rally is likely to continue as some Rbs20bn of OFZ are due to mature in September, most of which will probably be ploughed back into the market.
Analysts estimate the yield could fall by another 0.15% in the next month or so thanks to the ongoing rise in the Central Bank of Russia’s (CBR) reserves and appreciation of the rouble. Mr Galkin also believes there are more price adjustments at the long end of the yield curve, which remains steep.
Government plans
Behind the rally in the OFZ is a change of tack at the Finance Ministry, which has begun to boost liquidity of the bond market to tempt investors. According to the new budget, passed in August, the government will issue eight times more domestic debt next year than the $1.1bn it plans to raise abroad – mainly from the European Bank for Reconstruction and Development and World Bank for structural reforms – and is willing to pay a bigger yield premium to bring in the investors.
The government has found itself in a bind with the state pensions, which are growing faster than the funds ability to invest them. The state pension fund is currently limited to buying state bonds and is by far the biggest player in the market. The banks hold some state bonds, which they can count towards their obligatory reserves but the sums are small.
Vnesheconombank (VEB) has taken on the job of managing the so-called “savings part” of the state pension fund – the pension money of Russians that chose not to allocate it to a private management company– and has 97 out of every 100 roubles invested into pensions. This fund has already built up to Rbs95bn and it is growing fast.
Vladimir Dmitriev, chairman of VEB, estimates that the funds will increase to $30bn by 2012 and $70bn by 2025. At this rate of growth, the domestic capital market will struggle to absorb the inflows and there are several moves afoot to create new investment opportunities. The government is already expanding its own borrowing, but also intends to allow pension funds to invest in high-quality foreign assets and blue-chip Russian corporate bonds.
General reform
The boost OFZ received is part of a more general reform to the bond market driven by the CBR. In the last week of August, the CBR allowed commercial banks to use their corporate bond holdings as collateral for overnight loans and so broadened the number of instruments used to manage liquidity.
A short list of half a dozen blue-chip bonds has been approved for use in the scheme. The CBR ruled that only companies within two notches of the sovereign rating are eligible – a list of seven companies and eight banks. Although the CBR has promised to expand the scheme, at this stage these bonds can only be used to cover CBR credits for a few days at a time. Analysts welcomed the change as a big step forward.
“Under current rules, banks can only use sovereign bills or physical assets like their buildings to guarantee loans from the CBR. It limits them to a tiny base as the biggest part of their assets – corporate bonds or receivables from loans – are ineligible as collateral,” says Richard Hainsworth, CEO and chairman of RusRatings, the leading domestic rating agency.