Resurgent local bid forces foreign investors to amend pricing expectations on Russian corporate Eurobonds

by Tomas Cutts, and Dan Alderson

Russian bond markets are a world away from how they looked a year ago. The corporate Eurobond market has been in favour this year due to the looming volume of bond maturities in 2018 and 2019, with issuance accelerating in April on the back of hefty redemptions.

RUSAL underscored the global appetite for Russian paper in late April, when it priced a USD 500m 2023 bond at 5.3%. A frequent borrower this year, it was able to launch the deal with a relatively small premium to its January debut USD 600m 5.125% 2022 Eurobond (and a CNY 1bn panda bond issued at 5.5% in March).

Foreign investor demand for Russian risk remains strong, largely because of the high standing that Russian corporate borrowers enjoy compared to their emerging-market peers. But wider market dynamics have also whetted the appetite of foreign buyers, with interest rates in developed markets at record lows and EM debt benefitting from a global search for yield.

Increasing numbers of local accounts are seen in US dollar-denominated Russian corporate Eurobonds this year. The strong local bid is due to excess liquidity in the Russian banking sector, and Russian investors are less price sensitive than their foreign counterparts.

As a result, Russian buyers have remained on the books as ever tighter pricing prompted some foreign investors to drop out of deals. Local investors also view BB names more favourably than foreign buyers, meaning that they are more willing to participate in a wider range of issues.

The popularity of Russian Eurobonds has led to the re-emergence of ruble-denominated Eurobonds, enabling new names to come to market. These find foreign demand due to a yield premium over their US dollar Eurobond cousins, depending on investors’ ability to handle currency volatility.

From Russia with bids

Foreign interest in Russian Eurobonds waned after the imposition of sanctions in 2014. But after an initial sell-off, most foreign holders were content to keep their bonds and, with issuance drying up, local buyers struggled to find liquidity.

During 2014 and the first half of 2015, the supply and demand picture was skewed further by a series of liability management (LM) exercises from Russian borrowers seeking to use their excess cash to take out bonds at a discount.

Russian banks flush with dollar deposits continued to buy large amounts of Russian Eurobonds, mostly shorter than two years, and it was not until the third quarter of 2015 that the Eurobond market tentatively re-opened for business.

With maturities looming, several issuers last summer sought to take advantage of the tight spreads and issue five- to seven-year paper in conjunction with tender offers.

In June last year, Novolipetsk Steel launched a USD 700m 4.5% 2023 Eurobond alongside a tender offer. The order book was around USD 4bn, as reported, with European investors taking the largest share at 32%.

In the same month, EVRAZ launched a USD 500m long-five-year Eurobond at 6.75% alongside a tender offer. The company’s new issue enticed foreign investors to snap up 87% of the deal.

Both issues were specifically targeted at foreign investors as locals preferred shorter-dated paper.

For example, local demand for Lukoil’s USD 1bn 4.75% 2026 and Domodedovo’s USD 350m 5.88% 2021 notes issued in October and November 2016 was relatively small.

But the local bid on Russian corporate Eurobonds has increased in 2017. Although LM exercises are removing short-dated paper, domestic players are now willing to hold longer-dated paper.

A credit analyst noted that locals’ interest in staying in longer-dated Eurobonds is possible through their ability to hedge their positions using interest-rate swaps.

For example, book stats show that 57% of Polyus Gold’s USD 800m 5.25% 2023s were placed in Russia.

Other corporate borrowers have drawn similar levels of local bidders, from Russian Railways’ (RZD) USD 500m 4.38% 2024 notes, Sovcomflot’s USD 150m 4.85% tap, Borets’ USD 330m 6.50% 2022s and Norilsk Nickel’s USD 1bn 4.10% 2023 (see table below).

If the price is right…

The increased local interest in Russian Eurobonds stems from local investors being much less price sensitive than their foreign counterparts.

“Domestic investors are more willing to accommodate tighter pricing than international investors,” said Dmitry Gladkov, global head of financing at Renaissance Capital.

Additionally, local investors view Russian credits in a different light. One banker said that Russian BB names are not considered high-yield by local buyers, and are instead viewed as strong names.

The banker added that Russian demand was usually sufficient to cover the book size of most corporate Eurobonds. Polyus’ 5.25% 2023s saw the target size covered within one hour of the books opening, before peaking at USD 1.7bn.

Demand for Polyus’ bond eventually fell to USD 1.3bn for the USD 800m note, highlighting Russian investors’ higher price tolerance. Foreign buyers dropped off the order book as leads increased the deal size and tightened pricing to the lower end of the initial price thoughts (IPTs) (5.25%-5.50%) at 5.25%.

One Western Europe-based portfolio manager said that, although he had expressed interest in the bond, he did not participate because he thought pricing was too aggressive.

Aggressive pricing on Russian corporate bonds has continued, with a second analyst commenting that RZD’s USD 500m 4.375% seven-year Eurobond priced “a little on the tight side”.

Indeed, RUSAL’s debut USD 600m 5.125% five-year Eurobond launched in January this year was priced at par, but then fell to 99.25/99.40 and took until late February to recover back to par.

Russian corporate borrowers appear less worried about courting foreign investors than going for the best price. But the first analyst noted that, although pricing has been aggressive, it is fair given current market conditions, adding Borets’ USD 330m 6.50% 2022 offered good value for investors.

You can bank on it

The majority of local demand for Russian Eurobonds originates from Russian banks, a second banker noted.

The strong local bid in 2015 and early 2016 was largely due to Russian lenders being flush with US dollars.

Eurobonds provide a chance for these banks to obtain hard-currency exposure to good names, according to a third banker. Gladkov added banks rarely achieved significant access to high-grade names as many corporate borrowers tended to refinance or pay down their debts.

In addition, Russian lenders have accumulated dollars that need spending, according to the first banker, who noted that Sovcombank is one of the largest such investors.

Perfect timing

Although Russian investors are able to tolerate tighter pricing and lower quality names, local buyers nevertheless still like high grade corporates, according to Gladkov.

A fourth banker suggested that while Russian corporates remained well bid, the level at which recent deals have priced had surprised even local buyers. The banker highlighted RZD’s USD 500m 4.375% 2024 bond deal, which was expected to launch at 4.75%.

While most Russian Eurobonds have performed well, state-owned entities have outperformed corporates. The second banker said local demand does still depend on specific names, however, as well as the timing of individual Eurobond issues.

For example, local demand for RZD’s 2024 deal and Sovcomflot’s tap was 33%, but Severstal’s USD 500m 3.85% 4.5-year note attracted only 9% of local demand.

In good shape

Due to the strengthening Russian economy (and bond market), rare and debut issuers are looking to tap foreign and local demand.

Corporate fundamentals have played an important role, with low leverage key. The portfolio manager noted that most corporates have a “cushion” to protect them from further ruble depreciation.

Even weaker names are enjoying significant demand, with Borets’ USD 330m 6.50% 2022 (B+ by S&P Global Ratings, B1 by Moody’s and BB- by Fitch) garnering an order book of USD 1.5bn (including joint lead manager interest). The deal was launched below IPTs of 6.75%-7.00%.

Similarly, Industrial Metallurgical Holding (IMH) (B-, B3, B) priced its USD 500m 7.5% five-year LPNs at par. Shortly after issuance they traded slightly above this level, at 100.30/100.70.

The improving credit quality of Russian corporate paper means that deals generally trade very closely to the sovereign, with EVRAZ 2022s averaging 177bps over the Russia 2023 in April. This tightened from a 190bps spread to the Russia 2023 in January.

Excess demand and limited supply have led to current tight spreads, according to a fifth banker. He suggested further issuance from Russian corporate borrowers would lead to a widening of spreads.

Run on the ruble?

With tight pricing in the hard-currency Eurobond market, ruble-denominated Eurobonds are sparking renewed interest from foreign investors. Borrowers are capitalising on this, a sixth banker noted, adding that Russian issuers were becoming increasingly interested in ruble Eurobonds.

The second analyst said he thought there was value in ruble Eurobonds, but added the yield premium offered by the ruble [only] makes sense if you can handle the currency”.

The fifth banker said that foreign demand for ruble-denominated paper remained a question of quality versus price. “The stabilisation of the ruble has helped,” he noted.

The ruble has steadily appreciated year-on-year from around RUB 66 to the US dollar to around RUB 58 to the dollar at present. The ruble has fluctuated between RUB 55 and RUB 60 since February.

Although there would likely be further ruble Eurobonds, the sixth banker said that these deals are likely to remain an “exotic product.”

But, in lieu of the ruble Eurobond market emerging as a credible alternative anytime soon, foreign investors may be forced to reassess their price expectations to secure further Russian corporate Eurobond paper, given the strong local bid, and historically tight pricing.

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