Daniel Salter of Renaissance Capital -

--Russia's intervention comes under the pretext of defending Russian speakers in Ukraine from the actions of an interim government in Kyiv, which is not recognised by Moscow (given the collapse of the agreement between deposed President Yanukovych, representatives of opposition parties and EU foreign ministers).

--However, it appears likely in our view that Russia is also focused on guaranteeing long-term access to its naval base in Sevastopol (the current lease has been extended to 2042) and/or impeding any expansion of NATO to include Ukraine. Russia's sensitivity here dates back to the collapse of the Soviet Union, where there is some dispute as to whether Russia was offered promises that NATO would not expand eastward in exchange for Gorbachev agreeing to German reunification. We believe the wording of the 30 March referendum is therefore likely to provide a clearer indication of what whether Crimea eventually emerges as a) more autonomous within Ukraine, b) independent in its own right, or perhaps c) heading to a closer relationship with Russia.

--Does this mean that Eastern Ukraine is next? Not necessarily, in our view. Crimea may well prove to be a special case in Ukraine. It is the country's only ethnic Russian region, and the only region with a strategic Russian naval base. Many Russians see Sevastopol as a Russian city (dating back to 1783) that happens to be in Ukraine, and is a place of historic importance and the site of important sieges in both the Crimean War and World War II, with Crimea only transferred to Ukrainian jurisdiction by Khrushchev in 1954. We see Eastern Ukraine as less strategically important for Russia, and a full East-West split for Ukraine would make the election maths for Russia a lot more difficult in the (larger) Western Ukraine. Yanukovich's election majority in the 2010 presidential elections was just 900,000, of which 800,000 of the majority was in Crimea. A loss of Eastern Ukraine would likely result in the (larger) Western Ukraine likely becoming more openly hostile to Russia and perhaps attempting to fast-track its way into NATO and the EU, in our view. In this respect, we think Russia might prefer to see a more decentralised, federal Ukrainian state evolve, with a weaker central government.

--Summing up. As a base case, we see tensions remaining heading up to the 30 March Crimea referendum, but we doubt that either Russia or Ukraine is interested in starting a fully fledged war. The two countries share 1,000 years of history, dating back to Kievan Rus; many Russians have family roots in Ukraine, and there is a strong feeling of kinship between the two populations. We would look for de-escalation including international monitoring (perhaps by the OSCE) as the best entry point into the market. We are not there yet; in the meantime, we believe the market is likely to remain nervous, and fearful of second-round effects (sanctions, expansion of military action in to Eastern Ukraine, etc).

--The market has gapped down 12% today [March 3], but we think there likely has not yet been significant redemption-related selling, which may keep downward pressure on the market over the coming weeks. We therefore are neutral Russia right now, bearing in mind the five investment themes below. Over the coming weeks, signs of Russian troop activity spreading towards Eastern Ukraine and/or moves toward economic sanctions on Russia would make us more cautious. Meanwhile, progress toward a diplomatic solution (e.g. coming up with an international monitoring programme for the Crimean referendum, perhaps under the auspices of the OSCE) would likely make us more positive.

1. For now, be wary of Ukraine-exposed corporates.

Those with Ukraine exposure include Gazprom, Russian mobile operators, as well as Austrian and Hungarian banks; we believe all are likely to remain under pressure so long as there is no diplomatic solution in sight for Ukraine.

2. We expect economic downgrades.

The longer the current uncertainty continues, the greater the negative impact is likely to be on Russia's economy, particularly if international lenders hold off from issuing credit lines and/or if Russian companies delay investment decisions. We expect GDP forecasts to come under pressure.

Sberbank and VTB are the obvious companies we see with share prices that are likely to come under pressure from economic downgrades; they are also primarily rouble assets, with little ability to hedge a weaker rouble.

3. Focus on rouble hedge stocks / exporters for now.

Surgut (preferred shares), Lukoil and Norilsk Nickel are all companies with relatively low levels of debt, with dollar revenue and rouble costs. Investors might want to look at Moscow Exchange as a beneficiary of the increased trading volumes currently seen in Russia. Where to hide outside of Russia - we see the MENA region as the obvious haven, benefitting from any political risk-related uptick in oil prices, combined with pegged currencies. In Central Europe, Czech looks less-exposed than either Poland (geographically) or Hungary (businesswise).

4. Use redemption-related selling to buy into the long-term winners.

Investors have been reluctant to pay what they have considered high valuations for some of our favoured "new Russia" plays. We see the current sell-off as providing a good long-term entry point into names such as Magnit, Mail Group and Yandex.

5. Progress toward a diplomatic solution on Ukraine.

Progress towards a diplomatic solution (e.g., coming up with an international monitoring programme for the Crimean referendum, perhaps under the auspices of the OSCE) would likely make us more positive on Russian market/economic proxies as well as stocks with exposure to Ukraine: Sberbank, Gazprom and Russian mobile operators.

The risk we see for the mid-term Russian valuation story is that current events leave international investors convinced that 1) "siloviki" are very much driving policy right now in Russia; 2) liberal reforms are likely on the back burner; and 3) tensions could flare up again in the future, causing a similar sell off.

For Ukraine's debt to Gazprom, our oil team refers to Vedomosti, which cites a figure of $3.35bn (though half of this may have recently been repaid, according to Reuters).

Banks

Updated data on Russian / CEE banks' exposure to Ukraine - Russia Inc on the hook, Raiffeisen the biggest international player, OTP as a percentage of assets

In light of the weekend's escalation in Crimea, see below the Ukraine exposure of key listed Russian and CEE banks.

The data has been updated for YE13 reported data as per the National Bank of Ukraine website and latest FX. This is the exposure that they have on their local balance sheets and excludes any additional exposure they may have from their home-market balance sheets.

FSU banks are all subject to risks related to a Russian macro-slowdown and currency weakness; while in CE3, OTP stands out as a risk. Komercni is the clear relative safety trade, in our view.

Specifically on the Russian banks' exposure

Given Russia's role in this confrontation, benchmark listed names like Sberbank (first and foremost) and then VTB will always sell off, irrespective of their own involvement in Ukraine. The fact that they have risk assets exposed to Ukraine simply makes it more of a justifiable sell off, in our view.

According to Fitch Ratings, Russian banks' total exposure to Ukraine is substantial, at around $28bn. They estimate (and logically it follows) that Russian state-related banks that hold the bulk of this exposure, with approximately half at their Ukrainian subsidiaries (which are, to a large degree, parent-funded) and half booked directly on parent banks' balance sheets or at other group entities. Fitch estimates that the most exposed banks (relative to equity) are Vnesheconombank (VEB, 74%), Gazprombank (about 40%) and VTB (at least 14%); Sberbank (8%) and Alfa Bank (3%) are less vulnerable.

VTB and Sberbank have direct credit exposure from their Ukrainian subsidiaries of $3.0-3.5bn, respectively; the rest, if any, will come from parent balance sheets. The risk is mainly corporate loan exposure, hence, it is a macro/currency risk from here.

VTB's risks mainly come from its local subsidiary (assets of about $3bn, equal to 11% of parent equity), although it has also said that at end-2013, it was directly exposed to the Ukrainian sovereign for around RUB20bn ($0.7bn). VTB's direct exposure to local corporates from the Russian balance sheet, if any, is not disclosed publicly.

Sberbank's local subsidiary is relatively small (c. $4bn, or 7% of equity) and there is limited direct exposure to local corporates. Sberbank has openly stated that it has no more Ukraine sovereign exposure.

General points and views

As a rule of thumb, Ukraine has not been a happy hunting ground for foreign banks that invested in the market at exceptionally high valuations during 2005-2008, and have been broadly suffering ever since. Ukraine is a banking market where local Ukrainian banks tend to do best, followed by Russian banks.

In a change from five years ago, the top banks today in Ukraine are primarily Ukrainian - either private (e.g. PrivatBank) or state-owned (e.g. Oschadbank and Ukreximbank).The largest foreign bank today in Ukraine is Raiffeisen, which is fifth in terms of assets, followed by UniCredit's subsidiary Ukrsotsbank, in sixth. At eighth, Sberbank completes the list of international banks in the top 10.

Raiffeisen may be the largest international bank in Ukraine, but OTP has the largest asset exposure as a percentage of its business.

Erste sold its (small) unit in 1H13, which is the typical end result after an international bank spends a number of years in this market; Bank of Georgia, Home Credit and Rencredit all did the same.

The majority of foreign banks in Ukraine have reported closures of some branches and cessation of credit activity in one form or another in recent years.

We would expect other FSU banks, like Bank of Georgia and Halyk, to also be under some pressure for mainly indirect reasons. Potential for further rouble weakness could weigh on their local currencies and the risk premium for the region as a whole will go up, in our view.

Czech Republic (Komercni), followed by Poland is where we see safety trades within the financials space in this region. Hungary (OTP) simply has too much risk associated with it for this environment, in addition to sufficient direct exposure to both Russia and Ukraine.