The squeeze on Russian foreign exchange deposits is pushing domestic investors into the US dollar-denominated debt of the country's issuers, leading to liquidity fears at an already strained time for the secondary market. Sberbank became the latest Russian state-owned bank to cut its deposit rates on foreign currency last Thursday. The move was the most recent in a series of cuts that could force Russian borrowers to adopt new issuance tactics at an already strained time.
Sberbank docked its one-year fully flexible dollar deposit to 2.6% from 3.1%, and its inflexible one-year deposit to 3.1% from 3.6%, according to a Russia-focused source. Returns from one-year foreign exchange deposits from the country's state-owned lenders have been slashed by up to 500bp in the last 18 months, according to Alexey Bulgakov, a senior credit analyst at Sberbank.
This has pushed Russian local investors, predominantly comprising banks, to look elsewhere. One syndicate banker told IFR that latest estimates from his US employer puts Russian domestic holdings at a third to half of the market, up from historical norms of 10%-15%. Sberbank's outstanding dollar February 2017s were yielding 4.608% on Monday, while VTB's dollar April 2017s were bid at 5.160%, according to Tradeweb. Corporate debt offers even more, with Lukoil's most liquid short-dated bond, its US $1.5bn April 2018s, offering a yield of 5.442%.
"In December 2014, state banks offered one-year dollar deposits at around 6%-7% a year," Bulgakov said. "But the currently offered rate for new deposits is around 2%-3%." He believes that Russian accounts moving into the dollar debt of their compatriots is a direct function of the decrease in deposit rates. "Russian bonds offer decent yields in comparison to other bonds world-wide and local investors think they understand the risks, so they invest in the bonds," he said.
The liquidity concerns stem from the fact many of the investors that are picking up the debt are holding it with a long-term mindset, according to three banking sources. This is compounded by the fall-off in new issuance over the last two years, which encourages investors to hoard what they can get. "There's a lot domestic of buy-and-hold out there," said a bond trader. "And where are international investors going to find the paper, given that they need to, considering [Russian issuers'] weighting in indices?"
Gazprom, for example, makes up 1% of Bank of America Merrill Lynch's closely tracked global high-yield index, and more than 2% of the US bank's European currency high-yield index, according to analysts. The drop-off in liquidity has already had a noticeable effect on secondary market prices. Possibly the most infamous recent example of liquidity leaving a Russian bond is the sovereign's 2030 notes. Russia's largest single outstanding issue was once heralded as a bellwether for the health of the entire CEEMEA market. But it is now largely ignored, as the bonds have had so much liquidity drained out of them that they have traded with a cash price of around 117 for months despite sizeable swings in the rest of Russia's sovereign curve.
Liquidity was sucked out of the notes after domestic money poured into the bonds as a carry trade to take advantage of cheap FX repo rates with Russia's central bank. Sberbank estimated in April that almost US $10bn of the US $13bn issue had vanished from the market in this way. The Central Bank of Russia has since suspended the repo product. Now, potential Russian issuers are planning on moving away from their secondary prices when it comes to marketing new deals. "If we were to do a deal, we would ignore the secondary market and tell investors 'this is the price we think fair' and let them decide," said a treasurer at a regular issuer from the country.
This will probably not be a popular move among investors, according to an emerging markets syndicate banker. "It is not reflective of broader marker risks like illiquidity, and you could argue that it does not factor in where fair value is for Russian risk," he said. However, he was sympathetic to issuers' plights. "I can understand issuers wanting to do this, as it is probably fair to say that the secondary market is not reflective of credit risk," the banker said.
Deals sold like this would likely have to be kept small, so they could be placed with a core group of dedicated buyers of a particular credit's debt, the syndicate banker added. Pricing deals from investor and issuer negotiation rather than technical analysis of outstanding debt was normal in Russia in the past. New deals were once priced away from existing curves, resulting in the secondary curve moving to be in line with the price of the new issue, according to the treasurer.
"Maybe good old-fashioned absolute value investing will make a comeback in the wider markets ... However, we would still be aware that the secondary curve would affect investor marking-to-market," he said. A spokesperson for Sberbank did not confirm or deny the information in this article despite repeated requests from IFR.