Tim Gosling in Moscow -
Bond markets across the globe are getting giddy and Russian issuers are rushing to join the party. How long will the dance last and will there be a hangover?
In the wake of the carnage in late 2008, investors could pick up blue-chip paper such as the one-year Norilsk Nickel bond or even Gazprom debt for silly money, with yields on the secondary marked soaring as high as 25% as investors ran for cover. But these bargains were short lived. The market has been recovering since spring 2009 and had returned to pre-crisis levels across the board by the end of February. A wave of Russian Eurobond issues is now breaking on the shores of the international capital markets as the rouble continues to strengthen and the Central bank of Russia (CBR) looks increasingly isolated in its relaxed monetary policy.
Russian corporates managed to issue around $10bn in Eurobonds last year, but this was almost entirely confined to quasi-sovereigns. Gazprom's GAZ-19 arrived in April 2009 with a coupon many considered tight at 9.25%. The same paper was trading at 119.35 for a 6.4% yield in early March. Now, with banks like VTB and Alfa back on the market, joined by lesser lights such as Alliance Oil, the party is starting to get going with $20bn-30bn worth of issues anticipated this year (compared with an average of around $15bn per year between 2005 and 2007).
Bond issues are back in vogue, as despite the crisis most banks are sitting on the huge piles of cash they built up, ready to fight the much talked about second wave of the crisis, which is now looking increasing unlikely. This cash comes with a cost, so banks are casting about for something to do with their money and investing into high-quality bonds is an obvious answer. At the same time, international money is being driven towards the high-yielding Russian paper by the extremely low interest rates at home: US bonds are yielding less than 3% at the moment. The irony is that it was exactly this combination of yield-hungry foreign investors coming from low-rate markets that caused the just-punctured bubble to form in the first place.
And Russian corporate bonds are amongst the most appealing securities on offer. As the economy moves back into growth mode, the state's robust macroeconomic fundamentals make investing into Russian bonds an attractive proposition.
In the face of this, issuers are winding the Eurobond market tighter as they set the terms to investors who have few high-yielding assets to target for the moment. "A lot of fund managers have been complaining since September that they don't like the prices, but they can't leave these huge inflows in cash," points out one broker based in London.
He mentions Alfa Bank's $600m, five-year issue in early March, which was originally offered at a yield of at 8.25% but pared back by 25 basis points (bps) by issue. "Investors resigned themselves to an 8% coupon," he says, "although secondary activity suggests that they weren't quite as keen as for the recent VTB or Bank of Moscow issues. I think buyers (many Asian) are simply holding it." Around a week later, however, spreads on Alfa's paper had tightened 2% or so.
Russia's domestic ruble bond market is also catching fire. Dominated by junk bonds before the crisis, today there is a range of high-quality issues following the rush last year of corporates to turn domestic securities acceptable for repo by the CBR into cheap dollar financing. By the end of 2009, the corporate ruble bond market had seen 163 issues raise nearly RUB800bn ($25.8bn), while CBonds predicts a further RUB650bn this year.
However, local bonds have always been the last port of call for international investors given their wariness of the longer-term stability of the Russian currency and the illiquid nature of the market. Alexey Bulgakov, senior fixed-income analyst for Troika Dialog, points out what they've been missing: "They've been very slow to return, but those that did three or four months ago are very happy. The returns are supernatural. Since the end of December, Evraz bonds, for example, have reaped an annual return of 80% - and that's in roubles!"
As the Eurobond market continues to tighten however, local money could lose some of its current 95% share of the domestic bond market (pre-crisis it shared the market with international money fairly equally). A premium still persists, because there simply aren't that many international accounts in the local market and therefore they're not hoovering up all the paper. The London broker reports that many clients are now seriously considering opening accounts to take on this deeper exposure to the Russian currency, which is expected to continue to appreciate.
The only thing that looks likely to stymie the obvious enthusiasm for Russian paper is the sheer size of issues that are in the pipeline, with Russia about to roll out its big guns.
Russian Railways launched its debut Eurobond roadshow on March 15 and hopes to raise $1bn with a 10-year maturity. At the other end of a crowded spectrum is a forthcoming RUB1.5bn domestic issue from retailer Victoria Group. On top of this is the Russian state, which in December roadshowed sovereign Eurobond issues that could start in April and bring in between $3bn-$18bn (depending on how oil prices develop this year), and are bound to be snapped up by investors. Deputy Finance Minister Dmitry Pankin claimed in February that the new issuance would slash borrowing levels for the sovereign "by several tens of basis points."
Right now, there is enough liquidity about to ensure Russian bonds remain attractive even at tighter yields. However, the expanding supply of paper will begin to meet a greater percentage of demand as central banks around the world start trying to drain liquidity out of their economies. At that point credit spreads - already back to pre-crisis levels - will have no fundamental reason to drop further. "The likelihood of default amongst Russian corporates is now higher," Bulgakov points out. "Cash flows have dropped and leverage risen. Yes, overall Russian corporates are relatively underleveraged still, but the distribution of debt is also very narrow."
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