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Bonds prove irresistible

Russia’s bond market has been quiet after last year’s banking scare. But it looks set to take off again with a bang, as Ben Aris reports from Moscow.
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Russia’s bond markets are buzzing after a six-month hiatus caused by last summer’s near-miss banking crisis and perceived increases in political risk.

The Eurobond market continues to plough ahead undaunted by the Kremlin’s antics while incoming petrodollars are feeding domestic investors’ appetite for fresh rouble bond issues that are starting to reappear. Russian Eurobonds are already doing well partly due to the dearth of sovereign issues since 2002. The Standard & Poor’s upgrade at the start of this year was widely expected and already priced into bond prices, but nevertheless spreads tightened against the benchmark US treasuries.

With record hard currency reserves and a 4% of GDP budget surplus in 2004, the government is not short of money and stayed away from the market. However, the supply of sovereign debt was increased with the appearance of the so-called Aries bonds; the cash-strapped Germans securitised part of their Russian debt to the Paris club, adding about $5bn to the outstanding $47bn of Russian sovereign Eurobonds. At the same time, the Kremlin continued to restructure the so-called Soviet “commercial debt” (the MinFin 5) converting it into Eurobonds with 10 and 30-year maturities (Russia 10 and Russia 30), which added more than $2bn to supply.

“Eurobond issues this year have been well received but investors say the spreads will tighten further, especially with the corporate Eurobonds. As the sovereign bonds are already tight, more people are being pushed into the corporate Eurobonds,” says Pavel Mamai, a fixed income analyst at Renaissance Capital.

The equity market may remain the white-knuckled, roller-coaster ride it always was but Russia’s sparkling macroeconomic performance has made the bond market irresistible. With few sovereign bonds coming on to the market last year, investors have turned to the corporate issues, especially the quasi-sovereign issues by the likes of state-owned gas monopoly Gazprom.

Corporate debt rise

Corporate external debt has increased from about 5% of outstanding Eurobonds in the mid-1990s to almost half now. Despite last year’s banking crisis, Russian companies collectively issued $8.23bn of Eurobonds, only slightly down on record-breaking 2003’s $8.58bn of issues.

New Eurobond issues got off to a strong start in the first two months of this year as Russian blue chips tapped huge pent-up demand after a six- month absence. More than $2.5bn of Eurobonds were issued, leading analysts to believe, 2005 will match, and maybe beat, 2003’s all-time high. And as consumer spending takes over as the main economic driver, the type of company coming to market is changing.

Mobile TeleSystems broke the ice in January with a $400m seven-year Eurobond issue with a coupon rate of 8.05%, the lowest yet among outstanding telecoms issuers and down substantially from about 11% it was paying a few years ago. The company says it will use the money to expand into Russia’s regions through acquisition, in its battle for market share. Its main rival, VimpelCom, quickly followed with a $300m five-year bond with 8% yield at the start of February. But the banks are coming up and will probably be the most active Eurobond issuers this year.

Banks attract interest 

“The difference last year was we saw a more diverse group of issuers. Quasi-sovereign issuers have dominated in the past, but we are seeing a lot more banks come to market,” says Mr Mamai. “And there is a lot of interest in them. Investors thought they were too risky before, but not any more.”

Russian banks have spent the past 18 months building up their credit histories with bond traders and are now tapping the market in earnest, as yields fall to the point where they can profitably use the money to refinance long term credits. The state-owned banks have been particularly active.

Vneshtorgbank (VTB) continued its drive to become Russia’s second largest bank. It raised a huge $750m 10-year bond at the start of February as part of its plan to raise up to $3bn from abroad this year. The bank benefits from its state-owned status and the bond was issued with a 6.315% coupon rate, significantly undercutting the yields for commercial bank issues.

VTB’s deputy chairman Alexei Akinshin says that it also hopes to issue $300m-$500m with 20 and 30-year bonds this year, to refinance its more expensive short-term borrowing and so continue to cut overheads.

Still, there are only about a dozen companies that can tap the international capital markets and the most appealing – oil companies in particular – are so flush with cash that they will not come to market. However, analysts are expecting consolidation in other sectors soon that should bring larger mergers and demand for big lumps of money.

Consolidation in the telecoms sector is well under way and the privatisation of state-owned holding company Svyazinvest later this year should accelerate it. And with seven major groups, the steel sector is a top candidate for consolidation, but yet to actively tap the bonds markets.

The domestic rouble bond market was badly hurt by a combination of the CBR’s (Central Bank of Russia) attempts to hold back rouble appreciation and the resulting bank crisis. Issues and volumes that had been doubling nearly every year since the market reappeared in 2001 came to a near standstill in the second half of 2004.

With the bank crisis firmly behind them and plenty of liquidity on account, bond traders are back in business this year, although they complain that the pipeline of new issues remains far from full, bar a few staples such as the Moscow city government. Although issues are still thin on the ground, trading in the 230 corporate rouble bonds picked up sharply over the first two months of this year.

“There is a massive demand from investors for paper with high yields and short maturities,” says Michael Workman, head of fixed income at TRUST Investment Bank. “But there is still a shortage of supply.”

Pent-up demand means that second and third-tier companies will be allowed to come back to the market, after being shut out in the wake of the mini banking crisis, but they will have to pay big yields of 15% against the 6%-8% that the state companies command.

Growing market

“The market is growing and will continue to grow because of all the liquidity. Banks have something like $25bn of cash on correspondent accounts with the CBR and are not able to invest it all because of the lack of paper,” says Igor Kotlyarchuk, head of fixed income trading at Alfa Bank.

Moscow city government’s bonds are the rouble bond market’s benchmark and its plans were almost completely unaffected by recent upsets. The city says that it hopes to issue Rb12bn ($430m) worth of seven-year rouble bonds this year, part of which will be used to refinance its outstanding $1bn worth of rouble bonds.

Like the Eurobond market, the issuers of rouble bonds continue to diversify. Alliance Russian Textile has already registered its debut issue, a Rb1bn four-year bond offer due in early March that will yield 15% and should be snapped up by investors.

Among the blue-chip issuers, Russia’s United Metallurgical Company, one of the country’s largest steel producers, plans a Rb3bn three-year bond soon.

But Gazprom’s five-year Rb5bn rouble bond will be the big event of the year among domestic bond issues. The bond has been delayed by uncertainties over government attempts to merge the company with Rosneft. But it is expected to yield 8.25% and 8.50% when it is issued sometime before spring and could usurp the Moscow city government’s as the market’s benchmark.

Enticing rouble bonds

Most Russian rouble bonds are issued with negative real interest rates. The appeal to companies is obvious, but banks are enticed into buying them as margins over deposit rates are still satisfactory. And if they use plentiful dollars to buy bonds, rouble appreciation makes the investment profitable.

This double benefit has enticed foreign investors – mainly hedge and specialist funds – back into the rouble bond market. Before the double whammy of bank crisis and the CBR’s 2004 foreign exchange policy started to bite, foreign investors held up to half the blue-chip rouble bonds; since the start of the year they have built their positions up again and now account for about 40% of the market, says Mr Kotlyarchuk.

The supply of rouble bonds will receive a boost this year as both the World Bank and the European Bank for Reconstruction and Development plan to tap the paper-starved domestic market with bonds that will be used to finance their projects.

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Read more about:  Central & Eastern Europe , Russia