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Rail Operator Revives Linker Sale to Fund Growth: Russia Credit

July 15, 2012

OAO Russian Railways revived an inflation-linked bond sale delayed by Europe’s debt crisis, joining borrowers capitalizing on falling yields as it seeks to expand capacity on one of the world’s longest networks.

The railroad monopoly is issuing 10 billion rubles ($306 million) of 20-year debt, redeemable in 10 years, with an initial coupon of 8.95 percent, according to a regulatory filing on July 12. That’s 84 basis points more than the yield on government securities due in April 2021 and 45 basis points above the coupon on similar-maturity notes sold by Federal Grid Co., the high-voltage power transmission monopoly, in July 2011.

The state-run railway, which shelved a May sale as yields soared amid Europe’s struggle to curb the debt contagion, plans to spend 3.8 trillion rubles by 2020 to help boost cargoes by 40 percent. OAO Gazprom (GAZP) and ZAO Russian Standard Bank sold bonds denominated in foreign currency after European leaders agreed June 29 to loosen bailout rules for countries including Spain.

”Russian Railways has a traditionally major borrowing program and it was difficult to sell ruble bonds in the first half of this year,” Dmitry Dudkin, head of fixed-income trading at UralSib Financial Corp. in Moscow, said by telephone July 13. “Issuers are gradually returning and the traffic will be both to the external and domestic markets.”

The yield on Moscow-based Russian Railways’ dollar bond due in April 2022, rated Baa1 at Moody’s Investors Service and BBB at both Standard & Poor’s and Fitch Ratings, climbed to a record 5.759 percent on May 17. That’s 154 basis points, or 1.54 percentage points, above debt of similar maturity and rating from Mexico’s state-run oil producer Petroleos Mexicanos.

Pension Funds

While Russia’s biggest corporate borrower in rubles for the past decade pulled its proposed sale two months ago, the company identified potential buyers for the inflation-linked bonds, primarily pension funds, according to Igor Golubev, an analyst with OAO Nomos Bank in Moscow.

“It’s a very convenient instrument for Russian Railways,” Golubev said by telephone on July 13. ”It’s long term and provides cheap funding.”

The bonds will be allocated in a week’s time after about 20 investors, including Russian and international banks, as well as funds, bid for the securities, Pavel Ilichev, deputy head of corporate finance with Russian Railways, said by phone July 13.

Starting with the third coupon, interest payments on the bond will be 210 basis points plus the consumer price index, according to the regulatory filing. OAO Rusnano, a state-run company that invests in technology ventures, pledged that its next coupon in October would pay 250 basis points above the August inflation rate on seven-year bonds sold in April.

Inflation Target

While inflation accelerated to 5.3 percent as of July 9 from 3.7 percent a month earlier because of higher food prices and an increase in utility prices, the central bank left its main interest rates unchanged on July 13. Rates remain “appropriate for the nearest future,” the board of directors said in a statement on the bank’s website.

Sergei Shvetsov, a deputy chairman of the central bank, told reporters on July 3 that the regulator expects to meet its 2012 inflation target of 5 to 6 percent. The bank aims to bring inflation down to as low as 4 percent by 2014, according to a three-year policy plan published in November.

Russian Railways may consider selling more inflation-linked bonds as early as “the autumn,” Ilichev said. The company is partly protected against price jumps because cargo rates are tied to such increases by the government, he said.

Real Income

The company, which operates more than 85,000 kilometers (52,000 miles) of track, plans to expand links in Asian parts of the country, the world’s biggest by landmass, and overhaul the Trans-Siberian link by 2020, according to a statement posted on its website on July 2. The investment program also covers overhauling rolling stock, as well as expanding routes to ports in the Russian Far East and to North Korea.

“Bonds linked to the consumer price index are attractive for all pension managers because they guarantee real income for the security’s life,” Alexander Popov, director of the trust management department at Vnesheconombank, which manages the Russian state’s pension fund, said by e-mail on July 13. The floating coupon also offers guarantees against a potential re- valuation, he said, declining to comment on the Russian Railways issue before the bonds are allocated.

The ruble has gained 2.6 percent versus the dollar since this year’s low on June 1, as a recovery in the price of Urals crude, Russia’s biggest foreign earner, has buoyed the outlook for assets of the world’s largest energy exporter. Urals gained 1 percent on July 13 to $100.97 a barrel, up from a June 21 low of $87.66.

Dollar Bonds

The Russian currency gained 0.5 percent to 32.6270 per dollar by the close in Moscow on July 13. Non-deliverable forwards, or NDFs, which provide a guide to expectations of currency movements and interest-rate differentials and allow companies to hedge against currency changes, showed the Russian currency at 33.1413 per dollar in three months.

Russia’s dollar bonds due April 2020 rose, cutting the yield 18 basis points to 3.302 percent. The yield on Russia’s ruble Eurobond maturing in March 2018 fell seven basis points to 6.291 percent on July 11. The price of the country’s ruble notes due August 2016 increased today, reducing the yield by eight basis points to 7.57 percent.

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries fell 11 basis points to 269, according to JPMorgan EMBIG indexes. The difference compares with 185 for the debt of Mexico and 202 for Brazil.

Protection Cost

The cost of protecting Russian debt against non-payment for five years using credit-default swaps declined 10 basis points to 203, down from 275 at the end of last year, according to data compiled by Bloomberg.

Russia is rated Baa1 by Moody’s, the third-lowest investment grade. The swaps cost 15 basis points less than those for Turkey, which is rated three levels lower at Ba1. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

Russian Railways is the latest in a line of companies coming to the market after the European Union summit defused tension on the market and improved investor sentiment, Nomos Bank’s Golubev said.

The EU has pledged as much as 100 billion euros ($122 billion) to help Spain fix its banks. Leaders of the euro-area agreed at the end of June to allow the region’s bailout fund to inject funds directly into lenders once they establish a single banking supervisor. After the Brussels summit, Gazprom sold almost $2 billion of bonds in euros and dollars, while Russian Standard Bank sold $350 million of debt.

“There’s good demand now for good quality issuers,” Golubev said.

To contact the reporters on this story: Ekaterina Shatalova in Moscow at; Mark Sweetman in London at

To contact the editor responsible for this story: Gavin Serkin at

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