Roadblocks ahead for Russia’s bond market rehabilitation

Russian borrowers have staged a massive comeback in the international bond market with a string of tightly priced transactions, but a heavy reliance on local buyers and continued sanctions for some of the biggest issuers mean that the highly technical market is not quite back at full force yet.

Credit Bank of Moscow, Metalloinvest, Rusal, PhosAgro and KOKS printed US$2.7bn of bonds in late April and early May 2017, in the clearest showing yet that the deal drought that followed the US and European Union’s 2014 sanctions over Russia’s involvement in East Ukraine is over.

Credit Bank of Moscow has been in the market three times in 2017 – raising a total of US$1.6bn across its capital structure – while May’s issuance marked Rusal’s second 2017 foray in dollars.

“It has been very good for the Russian market,” said Andrey Solovyev, global head of DCM at VTB Capital. “Russians are back.”

But while ample supply is there, demand is being driven entirely by technical factors rather than a fundamental improvement in Russian credit, according to multiple investors and bankers.

“Russian credit has rallied a lot and it’s at the tighter end,” said Tim Ash, senior emerging markets sovereign strategist at BlueBay, “but there has been a shortage of paper. International investors are buying Russian paper, but demand is technical because there has not been much issuance.”

The swing to investors buying Russian debt for fundamental reasons is a long way off, with Moody’s highlighting on May 22 that the country’s economy faces credit challenges including hydrocarbons-related economic volatility, weak potential growth, chronic underinvestment and restricted international market access.

“Fundamental reasons for buying the paper for me would include things like economic growth, and that just isn’t happening,” said Ash.

Technically enough

Bankers have faith that the technical factors supporting the market are strong enough to see successful issuance stories for the foreseeable future, thanks in part to the large amount of debt maturing in the country.

“The technical bid is extremely strong, and I expect it to last through 2018, at least,” said Blazej Dankowski, head of Russia and Kazakhstan DCM at Citigroup.

He said that Russia’s 2017 debt maturities come to US$27bn, and US$39bn for 2018.

“Then you have strong inflows into emerging market funds of almost US$30bn this year,” said Dankowski. “There have only been US$11bn of deals this year to date in Russia, so there are significantly more bonds maturing than there are available for investors to buy in the primary market, and new money keeps coming in.”

Nonetheless, the super-tight pricing will be an increasingly tough pill for international investors to swallow.

“While international investors have participated, they have generally viewed hard currency bonds as fair value to expensive,” said Helene Williamson, head of global emerging markets debt at First State Investments.

The spate of issuance in May demonstrated just how much pricing is a focus for issuers.

Aluminium producer Rusal, rated Ba3/B+ (Moody’s/Fitch), printed a US$500m May 2023 note with zero new issue premium, while Metalloinvest printed a US$800m 2024 bond at 4.85%, which a lead banker put at a negative premium.

PhosAgro (Ba1/BBB-/BBB+) raised US$500m with a 4.5-year maturity, rather than opting for a far more common five year tenor, to ensure a sub-4% coupon. The trade landed at 3.95%.

Rusal and Metalloinvest’s notes were bid flat to reoffer on May 26, according to Thomson Reuters Eikon, while Phosagro’s bonds were tighter, at 3.744% on the bid side.

Much of the support for deals comes from domestic buyers, with a lead putting domestic allocations for Phosagro’s deal at around 23%, and at 33% for KOKS’ trade.

Williamson said: “Local investors have shown strong interest in new deals in the hard currency space. US dollar liquidity in Russian local markets have been the main driver for tight pricing levels.”

Not that this is necessarily an entirely negative thing, as local buyers can act as a safety net when international investors sell out.

“Local support has been sizeable for quite a while,” said Dankowski. “And it is helpful not only in primary activity but also for international investors, as they will be more confident that local accounts will absorb selling in times of volatility.”

Nonetheless, for Russian names to be able to fully reclaim their mantle as one of the major forces in emerging markets, they need to be able to attract a more international buyer base. Bankers are encouraging issuers in the country to pay higher spreads to get more overseas interest.

“Russian issuers should leave a few basis points on the table, as this brings in the international investors - it’s a two-way street,” said Solovyev at VTB Capital. “Local buyers are cash-rich; however, if you come to the international bond markets, you cannot push prices too far if you want to attract a solid international investor base.”

Credit Bank of Moscow demonstrated how eager international accounts are for a bit of premium. It printed a perpetual non-call 5.5-year Additional Tier 1 trade at 8.875% - about 150bp back of its Tier 2 debt and around a 50bp premium over the spread that comparable compatriot issuer Alfa-Bank pays for its AT1 debt.

The vast majority of CBM’s debt was allocated to international investors. Russia took just 17%, while the UK accounted for 30%, the US 19%, Europe 10%, Asia and the Middle East 10%, Switzerland 9% and the rest of the world 2%.

“Some of the biggest [international] investors never left Russia,” said Dankowski at Citigroup. “But what I’ve noticed over the last year is new entrants, like small funds from the US, come in with tickets.”

The tickets are on the smaller side of around US$10m to US$20m, in keeping with the smaller size of the funds looking to buy the debt, said Dankowski.

He added: “This shows that Russia has started to open up to everyone again.”

Money for what?

While cheap money is readily available to Russian borrowers, questions remain about what they are actually using it for, after years of slashing investment and capital expenditure to ride the dual storms of sanctions and lower oil prices.

“There has been a splurge of supply but the fundamental problem in Russia now is what to do with the US dollar liquidity? What are they borrowing for?,” said Ash at BlueBay. “The Russian economy is struggling and there is a lack of investment and growth in Russia.”

Gross capital investment in Russia fell by 9.9% in 2015 and again by 1.8% in 2016, according to Moody’s, with the ratings agency highlighting a failure in Russia to invest in industries away from oil.

But some corners of the market have noticed that sentiment towards investment is shifting in Russia.

“Recently, the mood seems to be changing, with Russian companies considering expanding capex programmes again,” said Dankowski. “Holding cash is so expensive that I don’t think people are doing that.”

However, this remains anecdotal. The main reason issuers are coming now, according to Ash, is because they can.

“There is a desire to get dollars while the markets are open because no one knows what might be coming,” he said. “No one ever imagined what has happened in Ukraine, no one imagined sanctions.”

Solovyev at VTB agrees that a big driver for Russian issuance is opportunism.

“Russia is not isolated from international events, and rising interest rates will have an effect on the cost of financing for Russian borrowers, so they are being proactive now,” he said.

Bound by prohibition

While many companies were not sanctioned by the US and EU, those that were - including Sberbank and VTB - made up some of the country’s biggest issuers in the early part of this decade.

Many agree that Russia cannot be considered rehabilitated until sanctions are lifted - the timeline of which has grown increasingly murky with the election of Donald Trump as US president.

The US administration has frequently given varying and contradictory views on Russia, while the Federal Bureau of Investigation is investigating key members of Trump’s administration for alleged ties to the Kremlin.

“The US and Europe would need to normalise relations with Russia and lift sanctions before the country’s international rehabilitation could be viewed as complete,” said Williamson at State Street. “While tight bond spreads might be seen as an indication of recovery, US probes and geopolitics remain headwinds.”

A new Euroclearable sovereign bond led by international banks would help perceptions, said Williamson.

This could be a problem. At the end of April, Russia’s finance minister, Anton Siluanov, said that when the next sovereign trade comes it will be run by domestic banks only.

The sovereign had tried to woo international investment banks, and hired London-based adviser Newstate Partners to help with the cause, according to several sources. Meanwhile, finance ministry officials met with banks in April.

Bankers told IFR at the time that they did not think it was worth the reputational risk.

But there are enough encouraging noises from investors that a sovereign issuance would no doubt find plenty of buyers, regardless of which bank was arranging the process.

“The economy is generating a current account surplus, and future rate cuts that would stimulate growth are possible, with inflation trending toward targets,” said Williamson. “With risks fairly balanced, Russian Eurobonds represent an appealing buying opportunity if there is any widening in spreads.”