Bloomberg News

Long Bond Sale Ditched as 10-Year Yield Hits High: Russia Credit

November 02, 2011

Nov. 2 (Bloomberg) -- Bondholder demands for the highest yields on record led Russia to abandon a sale of 10-year debt for shorter-term securities as the euro region’s crisis sent oil prices and the ruble tumbling.

Russia is offering 10 billion rubles ($320 million) of so- called OFZs due in 2017 at a yield of 8.1 percent to 8.2 percent today, the highest cost for the maturity on record, according to the Finance Ministry’s Website. The government ditched earlier plans to offer 2021 bonds after yields on existing 10-year debt jumped as much as 71 basis points this week to 9.42 percent, the highest level since their issue in April and topping rates paid at any 10-year auction, data compiled by Bloomberg show.

Investors are charging Russia the biggest yield premium in at least seven months relative to Mexico, which has the same credit ratings, because of concern the former Soviet nation’s reliance on oil for 40 percent of government revenue makes it more vulnerable to an economic downturn. Crude has lost as much as 4.3 percent in the biggest retreat in five weeks. The ruble slid 3.7 percent against the dollar this week, paring its biggest monthly rally since 2009.

“The market is on the downturn right now,” Evgeny Kochemazov, deputy chief investment officer at Alfa Capital Management in Moscow, who helps oversee $1.2 billion in assets including Russian sovereign debt, said by e-mail yesterday. “Now it’s better to stay in cash or the short-end.” Kochemazov said he doesn’t plan to participate in the auction.

Oil Falls

Investors are wary after a 17 percent slump in oil in the third quarter spurred as much as $19 billion of capital outflows from Russia, according to central bank estimates. The exodus drove the benchmark MosPrime interbank rate to the highest level since January 2010 at 5.81 percent on Oct. 26, data compiled by Bloomberg show. MosPrime was at 5.65 percent yesterday, up from this year’s average of 4.4 percent.

The selloff caused Moscow-based OAO Gazprom, Russia’s biggest company, to delayed its first offering of foreign debt in almost a year as corporate yields surged to the highest average level in two years relative to emerging-market peers last month, according to an email from UBS AG, the sale organizer. Gazprom Neft, the oil arm of Russia’s gas export monopoly, is planning to issue 60 billion rubles of 10-year bonds in its first sale in eight months, the Moscow-based company said in an e-mailed statement on Oct. 21.

Higher Yields

The 10-year sovereign bond is trading at yields above the record 8.37 percent paid at an auction on September 2008, data compiled by Bloomberg show. The rate was 319 basis points higher than similar-maturity Mexican peso debt on Oct. 31, up from a premium of as little as 61 basis points when the OFZ was first issued in April, data compiled by Bloomberg show.

Both governments are rated Baa1 by Moody’s Investors Service, the third lowest investment-grade category, and BBB by Standard & Poor’s and Fitch Ratings, the second lowest.

Russia last sold 10-year bonds on Sept. 14 at a yield of 8.1 percent, the highest at an auction since June. The government stayed out of the market for the next six weeks as borrowing costs continued to climb. Prime Minister Vladimir Putin said Oct. 6 that Russia would stop selling bonds to leave more cash available to companies.

Ruble Rebounds

The government returned to bond sales last week as the ruble rebounded, selling 9.7 billion rubles of notes due June 2015 at an average yield of 7.94 percent, the highest rate for the maturity in at least 15 months and up 69 basis points from the last time the debt was auctioned on Aug. 24. The ruble gained 6.4 percent against the dollar in October, its best performance since May 2009, as oil rebounded 16 percent on confidence European Union leaders would contain the debt crisis.

Russian bonds denominated in local currency posted returns of 8.3 percent in dollar terms last month, compared with a 5.6 percent average return for emerging market debt, according to the JPMorgan Chase & Co. GBI-EM Global Diversified index.

“After such a good rally over the last few weeks, I think that short term there might be potential for some sort of correction,” Sergey Dergachev, who helps manage $8.5 billion in emerging-market debt at Union Investment Privatfonds in Frankfurt, said in a phone interview on Oct. 31. “So to invest now in Russia ruble bonds is too risky now in my view.”

The ruble weakened 2.1 percent to 30.8000 to the dollar yesterday, its biggest decline since Sept. 19. Debt in rubles would become attractive again once the currency weakens beyond 32, Dergachev said. The currency hit a year-low of 32.715 on Oct. 4.

Investors increased bets that the ruble will continue to depreciate, with non-deliverable forwards showing it at 31.2941 per dollar in three months, from 30.6495 on Oct. 31.

Options Contracts

Options contracts are pricing in annualized swings of 17 percent over the next three months, according to implied volatility, more than the average of 11 percent for the measure this year.

The cost of protecting Russian debt against non-payment for five years using credit-default swaps surged 20 basis points to 220, up from 122 on April 6, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. They’re also used to speculate on bond movements.

Yield Spread

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries rose 16 basis points to 316, according to JPMorgan EMBIG indexes. The difference compares with 233 for debt of Mexico and 235 for Brazil, which is rated one step lower at Baa2 by Moody’s, its second-lowest investment grade level.

The yield on the country’s OFZs due in August 2016 rose 19 basis points yesterday to 8.08 percent. Dollar bonds due in 2020 fell for a third day, pushing the yield nine basis points lower to 4.48 percent. The yield on Russia’s ruble Eurobond due in 2018 jumped 22 basis points to 7.40 percent.

The Finance Ministry didn’t respond to an emailed request for comment on the change to the OFZ auction.

“With the current yields, I wouldn’t want to invest for 10 years,” Alexei Tretyakov, director of financial market operations at Moscow-based Nomos Bank, Russia’s second-largest private lender, said by e-mail yesterday. “The rapid surge in ruble bonds after the EU summit last Wednesday turned out to be unjustified.”

--Editor: Gavin Serkin, Laura Zelenko.

To contact the reporters on this story: Jason Webb in London at jwebb25@bloomberg.net; Scott Rose in Moscow at rrose10@bloomberg.net.

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net


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