THE RUSSIAN BOND MARKET:EXTRA JUICE LEFT IN 2010

With Russia – Singapore relations gaining momentum the current situation and dynamics of the Russian market provoke surge of interest. To satiate the enquiries the 103rd Meridian East starts the series of publications on the Russian market. To nsure our readers get only reliable and comprehensive information we asked the leading experts of VTB Capital to share their expertise.

VTB Capital (www.vtbcapital.com), the Investment Business of VTB Group, focuses on arranging operations in the debt, equity, global commodities markets, developing private investments, asset management, advising clients on M&A and ECM deals in Russia and abroad. VTB Capital operates in Moscow, London, Dubai and Singapore with headquarters in Moscow. We aim to provide our clients with products and services of the highest quality and to find innovative solutions for the contemporary market. In 2009, VTB Capital was named #1 Eurobond and local bonds bookrunner in the CIS and Eastern Europe and #2 ECM bookrunner in Russia/CIS.

103rd Meridian East has asked Vitaly Bouzoveria, Head of FI Sales & Trading at VTB Capital, to comment on how the Russian bond market is moving on.

The Russian bond market has a relatively short history. Having emerged in the mid-nineties as mostly a sovereign bond market, it faced a hard landing in August 1998, when Russia defaulted on its local GKOs. Then it stayed almost dead for a few months and re-emerged in 1999. From the year 2000 onwards, the market has experienced a period of sensational growth with almost no defaults until late 2007.

Mr. Bouzoveria, ñould you give an overview of what the ussian bond market looks like today?

As of today the Russian bond universe is represented by approximately 1200 issues from over 630 different names and an aggregate market cap of USD 300bn. This volume is almost equally split between local currency papers (trading mostly on the local stock exchange) and foreign currency bonds (mostly Euroclearable and based on the English law). An average Eurobond issue is larger than a local bond issue, while the local bond market is more granulated with a larger variety of names and issues available.

As of January 2010, the top quality corporate bonds offered yields in the range of 7–10 % in local currency and 4–8 % in US Dollars.

Usually investors classify Russian bonds into four basic categories (although there are no official criteria):

1st Tier: BBB to B ratings (Top Regional, Top Municipal, High Grade liquid bonds);

2nd Tier: B to B- rating (Strong regions, Sound Banks, Regional Telecoms, Transparent Retailers, Utilities);

3d Tier: CCC+ and lower ratings
(Consumer Goods, Developers /
Construction, Industrial Companies);

Defaulted bonds, distressed issuers.

How did the Russian bond market fare in the crisis?

During Q4 2008 – Q1 2009, trading volumes in the local market declined drastically, but recovered in the second half of 2009. The same is more or less true for the Eurobonds market: the estimated turnover for 9m2009 was around $100 bln., while the number for the whole of 2008 is about $164 bln.
The Russian Eurobonds share in the total EM trading volume is estimated at about 15 %.

What is the outlook for 010?

Last year the average total return for Russian bonds was around 30 %. This is quite remarkable. And yet, there is still some juice left in the Russian bond market in 2010.

What makes you think so?

First of all, in the coming year, inflationary pressures in the G7 economies might remain muted due to the continued ‘de-leveraging’ of households. The unemployment is still high and central banks are not likely to raise the rates. I think that the Fed Funds rate will stay at its low point throughout 2010.

So the dollar carry trade will probably continue to build. This will help push the prices of financial assets and commodities higher and bring new capital flows into the Emerging Markets. Sure, this process may be interrupted from time to time by negative surprises in either the credit markets (e. g. Dubai World) or economic statistics. But such corrections are unlikely to be very deep and prolonged.

What about the Rouble debt market?

The rouble has good chances to gain a bit more in 2010, while the Central Bank might cut local rates. The inflation and rates forecast is favourable, as the inflation in October-November was low.

From my point of view, new bond issuance will be growing as the budget deficits need to be financed. Plus the corporates' investment appetite is also picking up, while the bond market conditions are improving. There are also factors that will restrict new issuance volumes: the continued de-leveraging of certain corporates, a stronger focus of banks on strengthening the deposit base.

What are the major issuance trends for he urrent year?

There will be more issues on the local market. Not only because right now rouble funding is still more attractive from the spread over swaps perspective, but also because companies learned to manage their FX risk more accurately. In addition, the Russian regulators have signalled that they do not like foreign borrowings and may even impose "soft" capital control.

I would also note that local bond yields might move lower an additional 150–200bp. Analysts presume that the current spread between OFZs and the Central Bank’s auction overnight repo rate is too wide. New supply is likely to be digested by local banks (many of which prefer bonds to loans) as well as foreign investors. As to Eurobond / CDS spreads, they may tighten some more. Russian USD credit spreads may narrow by additional 50–70bp. Also, at current levels Russian spreads look quite rich relative to the rest of Emerging Markets and the current level of oil price.

Name a few key risks that are important to emember this year.

The key risk with the Russian Bond market is an early tightening of monetary policy in the US or Europe and the unwinding of stimulus measures. Other important risks related to investments in Russian bonds are corporate governance, the inefficient bankruptcy law (from the creditors’ perspective) and weak legal structures of local bonds.

Vitaly Bouzoveria, Head of FI Sales & Trading

Figure 1: The Russian bond market cap, 2004-2009

Figure 2: The Russian bond market structure, 2009

Figure 3: New issuance, 2003-2009

Source: Bloomberg, MICEX, VTB Capital Research