As Russia confronts financial crisis, investors in its sovereign dollar bonds are braced for things to get worse before they get better, even though few expect a full-blown sovereign default. The Russian state, they say, is a diligent payer of debts however belligerent the rhetoric of its leaders.
But Russian companies are heavily indebted and with Western sanctions over Moscow's role in Ukraine making it hard for them to access capital, the national balance sheet may have to shoulder much of the burden. Optimists will point to Russia's 1998 crisis, when oil hovered at $10 a barrel and hard currency reserves fell below $15 billion. Through crippling recession, rouble collapse and a huge domestic debt default, Russia faithfully honoured its international 'Eurobond' debts.
Sixteen years on, Moscow has $400 billion on its books, or four times the total debt due next year. Hardly anyone believes it will default. Yet its sovereign bond spreads, a gauge of the risk premium over US Treasuries, are over 500 basis points, or well above those of junk-rated Jamaica or Lebanon. What's more those prices are probably justified, says Michael Cirami, emerging debt portfolio manager at investment managers Eaton Vance.
What changes the equation from 1998 is the rise in Russian companies' external indebtedness. "The concern we had here was that in the event of a crisis this corporate paper was going to migrate over to the sovereign balance sheet," Cirami said. "We're going to see trouble in the Russian corporate sector ... The question is to what extent does the state step in and support key entities, at which point it puts another dent in the credit metrics of the sovereign."
Investors are already treating Russia as being as risky as a junk-rated credit, according to this graphic, which compares credit default swaps (CDS) and credit ratings of several countries: http://link.reuters.com/zaw82w The cost of insuring exposure to Russian debt via five-year CDS has tripled this year to 450 basis points, or 300 bps higher than what is usual for BBB/BBB-minus investment grade credits.
And debt yield spreads have risen 300 bps since end-November while some bonds, such as the 2020 issue, are trading at 95 cents in the dollar, versus 115 cents in January "At current spreads, Russian sovereign debt is some of the cheapest investment grade credit out there," said Peter Marber, head of emerging debt at fund manager Loomis Sayles. Marber says Russian bond prices are getting "interesting" but he remains underweight, meaning he holds less Russian debt than the country's weight in benchmark indexes.
Investors were significantly underweight Russian sovereign debt, J.P. Morgan's client survey showed at the end of November. Older investors recall that those who bought Russian dollar bonds at 50 cents in the dollar in 1999 reaped rich rewards. That trade may work again - provided one is patient. "For investors that can get access to Russian assets, and have long-term holding periods, we believe these are attractive levels to own Russian sovereign credit," UBS analysts said.
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