Contrary to the stereotypical image of Russians being dour and humourless, in general they are a drily mischievous bunch. Never has this been more evident than in April, when Russian oligarchs lined up to crack jokes after a particularly pointed set of US sanctions hit them.
“I lost $250m in one day. But there have been worse days when I’ve lost $1bn in a day. So, actually, it was a very positive day,” quipped Oleg Tinkov, founder and chairman of Tinkoff Bank, at a business conference in Moscow at that time.
It must have been hard for Russian businessmen to make light of the situation. The sanctions unleashed havoc in the market: Rusal’s bonds, for example, dropped from trading close to par to a price of 40 in a matter of minutes, as the new sanctions prohibited US investors from holding bonds in the Oleg Deripaska-owned aluminium company.
Russian companies and banks all suffered, with many bank bonds falling 10 to 15 percentage points as investors took bets in a blind panic about which issuer would be targeted next.
The terror that swept the market had abated somewhat by the end of the year. A swathe of investors, issuers and bankers agreed that the impact of the April sanctions was far deeper and more wide-reaching than the US could have anticipated or, indeed, wanted. Apart from the effect on US bondholders, aluminium prices surged 10%, hitting US manufacturers that use the metal hard.
But fears still persist at many funds of what could come next and how safe their money invested in Russia really is. Those fears deepened in November when the Democrats won control of the US House of Representatives at the mid-term elections. They are generally seen as tougher than the Republicans on Russia, because Donald Trump has tried to take such a conciliatory line with President Putin.
Sanctions sequel
Most believe the kind of sanctions the US imposed on Russia in April will not be repeated.
“The lesson the US has had to learn is that they need to carefully weigh the associated risks and repercussions before making moves,” says a source familiar with one Russian borrower’s plans and strategy. “That is why OFAC [the US Office of Foreign Assets Control] and the US Treasury have had to repeatedly loosen their stance and extend deadlines for compliance with the sanctions — they are clearly working out a way to reverse their actions and un-sanction Rusal and En+, or reduce the negative repercussions.”
The holding company of Rusal, En+, floated in London and Moscow in November 2017. Deripaska is trying to reduce his stake in En+ below 50% to get the sanctions lifted.
A representative of another Russian issuer, who also did not want to be named, agrees that it is not likely the US would ban investors from holding the existing debt of any more companies.
“The US could be thought of as a non-reliable source of capital, and that causes a problem,” he says. “[The sanctions] hurt them as much as anyone else, and they can’t really believe that Russia will change its policies under US pressure, so it’s somewhat pointless.”
Russian issuers acknowledge that further sanctions would be detrimental to Russian businesses, but they are not losing sleep over it.
Said Kerimov, the son of sanctioned oligarch Suleiman Kerimov, has a controlling stake in Polyus, Russia’s largest gold producer, and because of that Polyus was one of the companies investors were most worried about in April as a potential next target for the US authorities. But even Victor Drozdov, investor relations director at Polyus, is sanguine. “In Polyus’s case the transfer of ownership and control to Said happened a long time ago,” he says. “We continue to do our business as usual and focus on efficiency improvements, continue working with credit rating agencies and improving our metrics.”
Vladimir Zaluzhsky, head of the IR department at steel company Severstal, agrees. “You do what little you can do to mitigate the effect of potential sanctions,” he says. “We don’t sell steel to the US now that the 25% tariff has been introduced. Our export sales historically are very diverse globally, we sell even to such remote locations as Latin America. However, our key market, with around 60% of steel sales is, as before, Russia.”
Modelling the worst case
Prohibiting investors from holding existing Russian sovereign debt is widely thought to be too severe a measure for the US to contemplate, as it would hurt its own investors too much.
But a ban on buying any new issues of Russian sovereign debt is among the measures reportedly being discussed by US policymakers.
Some in Washington believe the government’s continued unrestricted access to the capital markets has undermined the effectiveness of previous sanctions, by letting the state raise money that it can lend on to other entities.
That discussion continued throughout 2018, even though treasury secretary Steven Mnuchin recommended at the start of the year that pursuing sanctions against Russian government debt would risk causing widespread financial turmoil.
Russian issuers are modelling this scenario in their stress-testing risk assessments for 2019.
“If there is a sovereign debt ban, the Russian government will turn to local markets and hoover up the liquidity locally,” says the second issuer who requested anonymity. “We estimate that at worst this could mean a pick-up in yields that means our cost of funding in the local bond markets could increase by up to 100bp. That’s not great, but it won’t cause us a lot of problems. Local stories are high interest margin stories, so we can bite that small bullet.”
But while issuers are confident of weathering a storm, they are making preparations for it. Severstal has converted most of the $1bn of cash on its balance sheet to euros.
“Selling up to 40% on export, we’re naturally hedged with the hard currency flows, which are both in dollars and euros,” Zaluzhsky says. “Though our maturing debt is in dollars, our debt is quite low and our revenues are only partially in roubles.”
Funding nearer home
Part of those preparations involve avoiding relying on funding from the US, or even internationally where possible.
Drozdov says Polyus has no urgent need to tap the bond markets, having managed to issue a $500m five year note in January, and having refinanced a $1bn Sberbank loan in August.
“Recently we have been more favourable towards executing buybacks than issuing new debt,” says Drozdov. “In September we stepped in to buy back $130m across four Eurobonds.”
He says Polyus prefers not to have large maturities looming within 12 months. “Our next significant maturity is a $700m bond due in 2020,” Drozdov says. “So we’ll be focused on refinancing that in 2019 at some point. We have the entire spectrum of refinancing options available, though public markets are not very attractive at the moment, but we’ll likely make a decision in the second half of 2019.”
Severstal also has no immediate plans to visit the bond market. It only has $135m of debt maturing in 2019 and has $1bn-equivalent of cash on its balance sheet.
Further out, Severstal has bigger maturities of $501m in 2021 and $879m in 2022. It also plans to increase capital expenditure substantially in the next two years — from $800m in 2018 to some $1.4bn in 2019. However, it believes the capex will produce higher Ebitda, so that it may be able to repay these debt maturities with cash.
With such plans in the works, it is not buying back debt, but nor is it issuing more. “We’re not motivated to buy back bonds in this market,” says Zaluzhsky. “Our bond prices look similar to the start of the year now.”
Shedding the ties
Tinkoff Credit Systems, meanwhile, last issued an international bond in the summer of 2017 — a $300m perpetual tier one capital security. Sergey Pirogov, head of corporate finance and a director of Tinkoff Bank, an online retail financial services company, says market sentiment towards Russian debt has deteriorated, partly because of sanctions. Tinkoff has moved away from international capital markets funding and has no plans to issue for at least six to nine months.
“We previously funded frequently, locally and internationally,” he says. “But now we’re 90% funded through retail deposits and 10% through the capital markets, most of which is done locally. We’ve repaid all the bonds we printed a few years ago, so now the only issue outstanding internationally is the perpetual Eurobond.”
One cheering development for issuers, in the nearly five years since the first set of capital markets sanctions on Russia was imposed in 2014, after it invaded Crimea, is that the depth and duration of funding available in the local market has improved greatly.
“Five years ago we were very limited in terms of size in that market, but now we can take pretty much as much as we want in five year paper,” says Pirogov. “So there’s no longer any reason for us to come to the international markets for senior debt. For capital, maybe, but not pure debt, that just isn’t on the cards right now.”
Tinkoff’s loan book is growing by more than 30% a year, so Pirogov is pleased its growth is not dependent on raising cash in international capital markets.
“As a local consumer company in a country where leverage is low and fiscal discipline has resulted in healthy government finances, it’s not been so bad for us,” says Pirogov. “Spreads have been distorted by the sanctions regime, but we’re seen as one of the good stories in Russia — we’re actually trading like we’re rated three notches higher than we are.”
Gazprom breaks the ice
It has, however, been tougher for exporters and commodity producers that need the dollar markets.
After the April sanctions, bond issuance ground to a complete halt. Even before that, with some of the largest Russian issuers such as state-owned Sberbank, Vnesheconombank and VTB still prohibited from raising bonds in the EU and US, issuance was far below the highs of 2013 when $52.7bn was printed in a year. But it had been on an upward trend. In 2017 $26.9bn of Russian overseas bonds were sold, and until April that pace had carried on, with $8.9bn-equivalent priced in the first quarter.
The freeze was not broken till November, when Gazprom issued a €1bn five year bond. Because of its unique importance to Europe as a supplier of gas, market participants believe it is the most unlikely issuer in Russia to be directly targeted by future sanctions.
That meant bankers and investors did not regard the issue as proving the market was open for other Russian borrowers. But it has given them hope.
“We’re starting to see the green shoots of improvements,” said Drozdov. “After seeing the Gazprom deal it’s clear the market isn’t completely shut down for high quality borrowers. If there is no further escalation of political tensions, most likely we’ll see more issuers going back to the bond markets.”
Then the Russian sovereign slipped in with a €1bn seven year bond at the very end of November, just days after provoking international criticism for seizing three Ukrainian navy ships. Many saw the move as a show of strength, illustrating Russia’s market access, despite the sanctions.
Investors have form for brushing aside sanctions risks. In 2014, less than six months after the first US and EU sanctions, non-sanctioned Russian entities were back printing successful bonds.
But the worry this time is stickier, because the April penalties obliged investors not just to cease buying bonds, but to dump what they already held. Another concern is that because the US chose to go after — and nearly cripple — private companies, rather than state-owned ones, any Russian name may now be fair game.
Snapping back
But in the sovereign’s wake, others said they might try to copy its choice of currency or look to Asia, rather than heading to the dollar market.
“We’ve historically only issued in dollars, but issuing bonds in euros in the future might be an option too,” says Zaluzhsky. “We’d also look at roubles probably.”
Drozdov says there would be wider considerations, though. “It is all about rationale,” he says. “It’ll depend on the functional currencies of the business as to whether it’s an option for an issuer. But it’ll be the more attractive option for some. Asia is an extremely tough market for a Russian corporate to succeed in — for it to work, a significant portion of your sales volume has to go into Asia, or you have to be a significant player on the international markets. Again, for some, it will work.”
Spreads and share prices have not yet normalised for most Russian issuers. Even Tinkoff, which says it has had a good crisis, is trading at $16-$18 a share, compared with $22-$24 before the April sanctions. But it puts that down to the rouble having fallen a sixth against the dollar, rather than any loss of confidence in the Tinkoff business. Bonds have regained much of their lost value, even while coping with higher US rates.
Polyus, whose bonds dropped from a cash price of 101 to 85 in April, had rebounded to 96 by November — a rally in spread terms of 300bp off the highs. Severstal, which took a seven point hit from a 107 cash price peak in April, was back up to 102 in November.
The year ahead could be another rocky one for Russian issuers. But they are braced for it. The US will have to do more than it has if it wants to stop Russia from having the last laugh.