Tuesday, 25 September 2018

From Russia without love

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The Russian Finance Ministry achieved its primary objectives of re-pricing the sovereign curve and establishing benchmarks for future issuance through April’s dual tranche transaction. However, the bonds’ subsequent slump has seen angry investors holding large losses and left a bad taste ahead of upcoming Russian corporate and CIS sovereign supply. John Weavers reports.

The Russian Federation returned to the Eurobond market on April 22 in rather different circumstances to its previous visit just prior to the 1998 domestic debt default. The sovereign raised US$5.5bn from five and 10-year issues, pricing in line with official guidance at 125bp and 135bp wide of US Treasuries. This translated into a 10-year yield of 5.082%, inside the Polish, Italian and Spanish sovereign curves and just wide of Brazil, Ireland and Portugal.

Such an impressive result reflects the huge strides the country has made in getting its economic and fiscal houses in order over the past decade or so. Hugely assisted by the surge in oil prices since 1998’s nadir, when crude slumped to just US$12 per barrel, the Russian authorities have nevertheless played their vastly improved hand very well. After saving much of their booming oil revenues for a rainy day, the central bank and finance ministry were able to provide substantial state assistance and ensure that no Russian credit suffered an international bond default. It thus escaped the fates of Kazakhstan’s over-borrowed banking sector or Ukraine’s high-profile Naftogaz restructuring.

Russia has had a “good” crisis. Given the increased focus placed upon state finances, it is no surprise that the country’s outstanding credit position has encouraged investors.

William Weaver, head of CEEMEA DCM at Citigroup, stressed that the deal priced “at an unprecedented level through an issuer’s curve and yet achieved one of the largest deal sizes in EM history.”

“We expect to see a period now where corporates and sovereign-related entities will tighten their own credit spreads, now they finally have a sovereign benchmark after 12 years,” said Jonathan Brown, head of emerging markets and European credit syndicate at Barclays Capital.

Woeful secondary performance

But while Russia’s return to the international bond market achieved the Finance Ministry’s primary objectives of repricing the sovereign curve and establishing benchmarks for future supply, the bonds’ subsequent slide left investors deep underwater. The leads seemed to be paying the price for premature and inflexible guidance, the downside of its pricing intransigence being a woeful secondary performance that followed half-point losses in the grey market.

Those that had hoped for substantial secondary support from leads Barclays capital, Citigroup, Credit Suisse and VTB capital were disappointed. The 3.625% 2015 retreated to 98.05 on the bid side the day after launch from its 99.475 reoffer (3.741% yield) as its spread over Treasuries surged from 125bp to 153bp.

The 5.0% 2020 fared only a little better and was quoted at 98.10 the next morning, 1-1/4 points below its 99.363 reoffer price (5.082% yield) as its Treasury spread widened 13bp to 148bp. Early the following week both bonds traded as low as 97 1/2.

“Latent interest for the five and 10-years is substantial,” said George Niedringhaus, head of syndicate at VTB Capital. “Plenty of investors were priced out of the trade, but wished they had been in.”

Although circumstances conspired against the bookrunners as market conditions deteriorated before launch, some market observers pointed out that they had exposed themselves to such a scenario by releasing price whispers so far ahead of pricing.

A syndication manager away from the deal said the leads had found themselves “boxed in” by the Finance Ministry, which would not budge an inch on price.

Although there was talk of a US$16bn book, the leads said the transaction was only twice subscribed. Even then, it was suggested many of the orders were soft.

A leading London-based fund manager who did not participate in the deal said that the bonds were too expensive for his taste. “We are already market weight in Russia and would only have been interested if the bonds came cheaply which they clearly did not. The new paper obviously increases Russia’s share of the EMBI Global but to restore our marketweight position we will be looking to pick up some corporate and/or quasi sovereign paper or perhaps even these new benchmarks if they back up sufficiently,” he said.  

Finance Minister Alexei Kudrin’s assertion that there would be no further issuance this year should provide some short-term support, he added, but new investment-grade buyers will be very unhappy to find themselves in the red. “This may well deter their participation in subsequent EM deals,” the fund manager warned.

However, another buysider was doubtful: “We have heard all this before but at the end of the day investors will inevitably judge future Russian sovereign and non-sovereign deals on their merits. Talk of an investor backlash almost never materialises.”

Meanwhile, not a million miles away

The deal is unlikely to deter other potential sovereigns from the CIS region, although fewer liberties will be taken on pricing. Among 2010’s candidates, the Republic of Belarus (B1/B+/NR) has mandated BNP Paribas, Deutsche Bank, RBS and Sberbank to arrange a much-discussed debut later this year.

The Republic of Azerbaijan (Ba1/BB+/BB+) is also considering a debut Eurobond for “a couple of hundred million dollars”, according to Sevinj Hasanova, deputy economic development minister. The Caucasus state mandated Citigroup and Deutsche Bank for a debut US$500m five-year sovereign deal in 2007 but the offering never surfaced.

Several investment banks have been in discussions with the Republic of Ukraine (B2/B–/B–) about a return to the Eurobond market. The installation of a new and apparently stable government following January’s presidential election has triggered an astonishing recovery in bond prices and revived speculation about a new sovereign deal as early as this quarter.

Given this recovery and a generally “hot” secondary market, single-digit issuance is easily achievable, a goal that acting Finance Minister Ihor Umansky targeted back in January 2010.

In late April 2010 the new government stated that Ukraine plans to issue a US$1.3bn Eurobond to plug an anticipated budget deficit and repay accumulated debt.

Ukraine must pay domestic creditors 27.227bn hryvnia (US$3.403bn) this year, while Ukraine’s foreign debt due in 2010 is 10.772 billion hryvnia.

The Ukrainian government has made a commitment to the IMF to try to hold its budget deficit to 6% of GDP. Parliamentary approval of a new budget and IMF support are two obvious prerequisites for a new deal, according to origination desks, some of which have serious misgivings about working with Ukraine, given the country’s controversial track record in the Eurobond market.

In May 2008, the Finance Ministry famously boasted that it had hired BNP Paribas, JP Morgan and Standard Bank to arrange a US dollar benchmark for zero fees. That deal was subsequently pulled, as market conditions deteriorated. Previously, in June 2007, Ukraine had paid the penalty for vanity pricing when it launched a downsized deal with a shortened tenor, outside initial guidance.

That US$500m 6.385% five-year paper was printed at 130bp over Treasuries, 10bp wide of price talk in a transaction arranged by Citigroup, Credit Suisse, Deutsche Bank and UBS. The deal size was below expectations for US$700m of new debt, while the tenor was shorter than the 10-year targeted.

A 10-year proved impossible to deliver because the Treasury insisted that the new bond pay less than the 6.58% November 2016s (printed seven months earlier, also through Citigroup, Credit Suisse, Deutsche Bank and UBS), a requirement even a new seven-year could not achieve.

With 10-year US Treasuries yielding 5.17% at the time, a new Ukraine 10-year with an appropriate spread over Treasuries of 160bp (well below the 2016s’ 197bp) would have secured a yield of about 6.77%. But as US five-year yields were 5.085% at launch, the new Ukraine five-year was able to print 19.5bp inside the 2016s’ reoffer yield.

The Republic of Kazakhstan (Baa2/BBB–/BBB–) has been playing down speculation of a near term sovereign Eurobond that grew after Finance Minister Bolat Zhamishev suggested in November there could be a US$500m issue in 2010 to provide a benchmark for corporate supply.

Speaking on December 29 2009, Economy Minister Bakhyt Sultanov said it was “too early to discuss” an international bond issue given “the high cost of borrowing on international financial markets and the ongoing restructuring of Kazakh bank debt”. The Republic, which faces a 2010 budget deficit of T721bn (US$4.9bn), or 4.1% of GDP, is looking to borrow about T650bn domestically, according to Sultanov. A loan of up to US$1bn is also being sought from the World Bank, he added.

The country’s last outstanding government Eurobond issue, for US$350m, expired in May 2007. But despite the absence of any sovereign paper, Kazakh five-year CDS has continued to trade.

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