Global Investing

Russia’s new Eurobond: what’s the fair price?

March 22, 2012

Russia’s upcoming dollar bond, the first in two years, should fly off the shelves. It’s good timing — elections are past, the world economy seems to be recovering and crucially for Russia, oil prices are over $125 a barrel.  And the rise in core yields has massively tightened emerging markets’ yield premium to  U.S. Treasuries, offering an attractive window to raise cash.  Russia’s spread premium over Treasuries hit the narrowest levels in 7 months recently and despite some widening this week it is still some 75 basis points below end-2011 levels.

Initial indications from the ongoing roadshow are for a two-tranche bond with 10- and 20-year maturities, possibly raising a total of $3.5 billion.

But market bullishness notwithstanding, investors say Moscow should resist temptation to price the bond too high, a mistake it made during its last foray into global capital markets in April 2010. Fund managers have unpleasant memories of that deal, recalling that Russia unexpectedly tightened the yield offered by 25-28 bps, making the bond an expensive one for investors who had already placed bids. The bond price fell sharply once trading kicked off and yields across the Russian curve rose around 25-30 basis points. Jeremy Brewin, a fund manager at Aviva said:

Russia has a slightly disappointing reputation.. We all ended up paying a tighter spread than we expected. Everyone is concerned they will get pulled in too tight again.

James Croft, head of emerging debt trading at Mitsubishi-UFJ agrees:

The demand for Russian risk is such that getting this bond away should be no problem. The only impediment that could make the transaction harder is investors’ wariness, based on the negative experience of the last deal back in 2010.

So what would be a fair price? Russia’s current 2020 bond is yielding around  4 percent (click on graphic above to enlarge) and most investors are eyeing a 10-30 basis point premium over that. This would also ensure a decent premium to Mexico/Brazil, emerging oil-rich peers but with more diversified economies.  Mexico’s 2022 bond sold earlier this year is yielding just under 4 percent while Brazil’s 10-year bond yields 3.15 percent.

A 20-year Russian deal could price around 5 percent or slightly tighter, investors calculate.

Any lower and the sovereign bond may not withstand competition from Russia’s own quasi-soverereigns. Bonds from state-run  bank VEB are included in the JPMorgan EMBI bond index and the 2020 bond is yielding around 5.3 percent while another state-controlled bank, Sberbank, yields 5.70 percent. That’s a good 130-170 bps yield pickup over the sovereign. A reasonably-priced deal now will make investors more enthusiastic for a potential 30-year bond later this year, Aviva’s Brewin argues.

A new issue needs to be fairly priced, they can always come back later this year and bring another issue to market.

Comments
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Dear Ms. Rao,

A recent claim successfully put forth by the Russian Government before two French courts (see below) could have drastic financial implications for the Russian State’s budget, stemming from the existence of billions of unpaid russian sovereign debt.

We believe credit rating agencies and emerging debt managers should follow developments in this matter very closely.

The current investment grade ratings enjoyed by the Russian Federation are based on a negligent analysis of inaccurate financial data.

The public accounts of the Russian Federation’s financial position make no mention of (and therefore actively dissimulate) the existence of due debt issued or guaranteed by the Russian State prior to 1917.

It has been put forth to the French Senate (Sénat, Commission des Affaires Etrangères de la Défense et des Forces Armées, rapport no. 150 – 1997 – 1998, projet de loi relatif au règlement définitif des créances réciproques entre la France et la Russie, annexe au procès verbal de la séance du 3 décembre 1997) that the 1997 value of this debt was in excess of 40 billion US$.

If the leading credit rating agencies adjusted the Russian Federation’s public accounts, as they should, to include an additional liability of US$ 40 billion this would no doubt lead to a change in their opinion on that State’s capacity to repay debt, and so to the ratings they issue.

While credit rating agencies and the Russian Federation have both argued wrongly in the past, and still do, that debt issued or guaranteed by the Imperial Russian State is not a full faith and credit obligation of the Russian Federation, they may not be able to do so in the future because recent claims sucessfully put forth recently by the Russian Federation have drastically changed the situation.

By successfully claiming ownership, before two French courts (Tribunal de Grande Instance de Nice in 2009 and Cour d’Appel d’Aix en Provence in 2011), of the Orthodox Cathedral in Nice on the grounds that the building had been paid for out of the Imperial Russian State budget and that the Russian Federation was the successor governement to the Imperial Russian State, the Russian Federation has in fact asked the court to acknowledge what defaulted sovereign bondholders have been saying all along: that the Russian Federation is the successor government to the Imperial Russian State and as such is both entitled to claim its assets and bound to pay off Imperial Russia’s debt.

For more on the matter of negligent sovereign debt rating analysis, please visit our website at:

http://www.crao.eu

We thank you for your attention.

The Credit Rating Agency Observatory – CRAO

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