Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Bonds hold back

Ben Aris reports from Moscow on how the banking crisis and policy changes have all but stalled the domestic bond market.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

The exponential growth of Russia’s domestic bond market has been stopped in its tracks by a combination of a change in Russia’s monetary policy and this summer’s mini-bank crisis.

Market players are expecting the volume of issues to resume its rise in the autumn but not the number of issuers. The domestic bond market is now closed to all but the best companies.

Both the number and size of rouble bond issues had been doubling every year since the market reappeared in 2001 (see chart, opposite), but over the course of the first half of this year, liquidity in the banking sector dried up and forced many to sell their portfolios in an effort to boost liquidity.

A sharp frost hit the rouble bond market in April after the Central Bank of Russia (CBR) abruptly changed its monetary policy to stop the rouble’s relentless rise against the dollar (see pages 74-76 for details), which, at a stroke, cleared the market of foreign investors.

“The interest of non-residents was a major force [in the domestic bond market] but now they have no interest,” says Simon Vine, the head of investment banking with Alfa Bank. “The combination of rising interest rates, the devaluation of the rouble and higher hedging costs works against them. Before, they were enjoying capital gains, an appreciating currency and high yields.”

A sinking ship

Mr Vine estimates that foreign institutional investors held about half of Russia’s blue chip corporate bonds and hedge funds had bought about one-quarter of the second-tier company bonds. A rising rouble coupled with high yields made these bonds doubly attractive, but once the rouble began to fall against the dollar they left en masse.

The bank crisis only made difficult market conditions worse and as the dust settles, second and third-tier issuers have been effectively pushed out of the market.

“This spring, before the crisis, there were lots of issuers waiting to borrow. But the crisis hit the second-tier issuers the hardest. Second-tier banks were big buyers of these bonds, as they were looking for the high yields,” says Nikita Riauzov, head of MDM bank’s fixed income department. “But the crisis has made everyone look at not only the quality of the issuer but also the liquidity of the bond. During the crisis, the smaller banks found they couldn’t sell these small bonds at any price.”

The sell-off was selective. The small banks rely on the interbank market for money to make loans and make their margin on the difference between rates on the interbank market and commercial credits. A handful of big banks provide the liquidity on the interbank market, but as the mini-crisis unfolded, the big banks cut their credit lines to the second-tier banks, who, in turn, cut off the small banks, which led to a sell-off in the domestic bond market, almost exclusively confined to the smallest players.

“There was a sudden liquidity squeeze and a lot of banks sold, but the biggest players held onto their portfolios. The prices [of bonds on domestic secondary market] were depressed but not by very much – by about 100 basis points,” says Sergei Pakhomov, the chairman of the Moscow municipal debt committee. “In Russia, a 1% fall is not considered a great fall. Prices have recovered, but they are still not quite at the same level as this spring.”

The Moscow city government’s benchmark seven-year bond was trading with a yield to maturity of just under 8% this spring and is now going for 9%

The turbulence on the domestic market has caused several blue-chip companies to postpone bond issuance plans over the summer.

The domestic debt market had more or less recovered the lost ground by the end of August and market players are expecting a fresh round of issues this autumn. Petrodollars continue to pour into the country and there is plenty of money around as gross international hard currency reserves head towards a record $100bn, but smaller companies and banks have been shut out of the bond market.

“Bank liquidity recovered very quickly and the market is stable, although trading is thin, but we are expecting things to pick up again this autumn,” says Mr Pakhomov. “The banks will go back to buying first-rate regional and corporate bonds. We have a busy autumn with three issues and expect the same from other big companies.”

Until this spring, Russian bonds were a plain vanilla product and in the rush to snap up paper, few investors were concerned about the risk; the best companies could command the lowest yields, though the difference was not great, but prices for smaller companies have shot up.

“This autumn, we won’t see the second and third-tier companies issuing because there are no buyers, even if they pay 16%-17%. If they offer 20% then investors will worry that the company is in trouble and also not buy them,” says Mr Riauzov.

Timely reminder

The banking crisis brought a timely reminder after KreditTrust bank declared itself bankrupt in June and defaulted on its Rbs400m ($13.7m) rouble bond – Russia’s first bond default since the 1998 financial crisis.

“It was a timely slap on the wrist that has made people not just more risk sensitive but conscious of the liquidity of an issue. The result is that bond issues won’t go outside the circle of the top 30 banks and Russia’s blue chips. All the little banks have dropped out of the market and have already switched from bonds to bank credits,” says Mr Riauzov.

Defaults have been expected since the re-emergence of the bond market but, since the only defaults have been on small bonds by recent standards, the market was able to shrug them off. However, the spread in yields between big liquid blue chips issues and the smaller illiquid bonds has widened to at least 5% now.

“Buyers are looking harder at the quality of the issuer and the liquidity of the company or region. Small regions that want to issue a single bond of between Rbs500m and Rbs1bn will have to pay for the illiquidity of the issue. Investors prefer big bonds of Rbs5bn-plus. The market is more mature and some issuers will have to delay their issues even longer,” says Mr Pakhomov.

Both issuers and investors are holding back until the end of the banking crisis is played out this September when the first round of banks is accepted into the new deposit insurance (DI) scheme.

“Investors are afraid of the next stage. In September, the CBR will announce which banks are in the DI and there are rumours that only one in four banks will be admitted into the scheme,” says Mr Vine. “The question is: what happens to the rest?”

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe , Russia