Sales of structured notes denominated in rubles may quadruple in the next year as investors snap up the securities to profit from the economic rebound in the world’s biggest energy-exporting nation.
Issuance of credit-linked notes, whose returns are based on the performance of underlying debt, will surge three or fourfold within 12 months, according to Metropol IFC, an independent investment bank in Moscow. While banks disclosed 7.3 billion rubles ($243 million) of structured debt sales this year, the actual amount is “much larger,” said Tim McCarthy, who helps oversee $1 billion of emerging-market assets as a fund manager at Geneva-based Valartis Group Asset Management. Disclosed deals may reach $1 billion by the end of next year, he said.
Barclays Capital, Deutsche Bank AG and JPMorgan Chase & Co. are reviving the market for structured debt after 2.3 billion rubles of sales in 2009 as investors seek ways to sidestep requirements that include registering with a local broker, a process that can take as long as a year. Russia’s recovery from its worst recession on record is luring foreign investors expecting ruble bonds to catch up after underperforming Brazil and China this year.
“Russian structured notes are poised for significant growth in the next eight to 12 months, driven by investors’ appetite for riskier assets,” Mark Rubinstein, head of research at Metropol IFC, said in a phone interview.
Russian ruble debt returned 4.4 percent this year compared with 12.6 percent for Brazil and an average of 7.2 percent for the countries included in JPMorgan Chase & Co.’s Emerging Local Markets Plus Index.
Barclays, Deutsche Bank
Barclays, based in London, sold 2.5 billion rubles of 11.2 percent coupon structured notes due in December 2014 at a price of 118.683 to yield about 6.1 percent, according to data compiled by Bloomberg. The notes package the Russian government’s 11.2 percent coupon OFZs due in December 2014. Since the Barclays notes were first issued on May 21, the OFZs have gained 1.6 percent, lowering the yield to 6.6 percent.
Deutsche Bank raised 330 million rubles in a sale of three- year structured notes yielding about 5.3 percent on Sept. 24, data compiled by Bloomberg show. The securities are based on the same-maturity OFZs yielding 5.8 percent.
Banks sold a total of 12 ruble-denominated structured notes, also known as credit-linked notes or CLNs, led by London- based Barclays with four deals totaling 3.8 billion rubles, the data for this year show. Frankfurt-based Deutsche Bank has sold three of the securities totaling 1.5 billion rubles, JPMorgan, based in New York, raised 1 billion rubles from three deals and ING Groep NV sold two notes at 590 million rubles. Banks last year sold seven structured notes.
Issuance is picking up as investor confidence improves after Russia’s record 7.9 percent economic contraction last year. The economy will grow by 3.9 to 4.5 percent each of the next three years, Deputy Economy Minister Andrei Klepach said on Oct. 6 in Moscow. The recovery is being spurred by an increase in the price of oil, Russia’s main export, which traded above $80 a barrel through October.
The ruble will strengthen 6.9 percent against the central bank’s target currency basket of dollars and euros by the end of next year, according to the median of five forecasts on Bloomberg. 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 movements, show the ruble at 30.3933 per dollar in three months.
The ruble, which depreciated to a low of 31.8 per dollar in June, has climbed 0.3 percent this year, underperforming the Brazilian real’s 4.9 percent gain and the South African rand’s 8.5 percent rally. It slid 0.4 percent today to 30.19 per dollar by 1:42 p.m. in Moscow.
“The Russian CLN business goes in waves,” said Edward Franklin, an emerging-markets credit trader at JPMorgan in London. “The local currency weakened a bit from July onwards and I think once it broke through 31 against the dollar people started to think about adding CLNs again.”
Investors in structured debt avoid the need to set up an agreement with a local brokerage, which is a requirement for buying ruble bonds.
“The logic behind the existence of credit-linked notes is to allow offshore investors to gain access to borrowers in major jurisdictions,” Igor Zelezetskii, a structured finance analyst at Moody’s Investor Service in London, said in a phone interview. “Banks acting as intermediaries in the market usually have lending and legal expertise in the country.”
Bank Julius Baer & Co., the 120-year-old Swiss private bank, and Aviva Investors, the U.K.’s second-biggest insurer, are keeping out of ruble-denominated structured debt.
“We wouldn’t touch Russia here,” Thomas Maurer, a trader of fixed-income structured products at Bank Julius Baer said in a phone interview from his office in Zurich. “Maybe the only reason you would buy these CLNs is if you can’t find enough bonds to buy.”
Buyers of structured debt don’t receive the registration documents that allow holders of regular bonds to exercise legal rights in the case of default, according to Maurer. Buyers can typically only trade structured notes with the issuing bank, creating the risk they won’t be able to sell the notes when they want to, Maurer said.
“The liquidity is often very questionable and the exit of the trade if it’s structured may only be with the counter party, the one with whom you do the deal,” said Jeremy Brewin, who manages $2.4 billion of emerging-market assets for Aviva in London. “Structured notes are not a solution unless it’s extremely difficult to get access to the market and in the case of Russia it isn’t.”
In Indonesia, where investors are required to hold domestic bonds for at least a month, structured debt sales have tripled to $1.8 billion this year, data compiled by Bloomberg show. Issuance linked to Ukraine’s debt is almost four times higher than Russia at $948 million.
Russia “could be a much larger market,” McCarthy at Valartis said. Issuance may rise as the government plans to increase bond sales, providing a greater pool of securities to package into credit-linked notes, he said.
The Finance Ministry is targeting a record 1.3 trillion rubles of bond sales next year to fund a budget deficit it says will reach 3.6 percent of gross domestic product.
The government’s ruble bonds due in August 2016 fell today, pushing the yield up one basis point to 7.09 percent. The yield on Russia’s dollar bonds due in 2020 dropped two basis points to 4.158 percent.
The extra yield investors demand to hold Russian debt rather than U.S. Treasuries was unchanged at 198, according to JPMorgan EMBI+ Indexes. The difference compares with 140 for debt of similarly rated Mexico and 176 for Brazil, which is rated two steps lower than Russia’s Baa1 ranking at Moody’s.
The cost of protecting Russian debt against non-payment for five years using credit-default swaps declined 0.5 basis point to 133 today, down from this year’s peak of 217, according to data provider CMA. 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.
Credit-default swaps for Russia cost one basis point more than contracts for Turkey, which is rated four levels lower at Ba2. Russia swaps cost as much as 40 basis points less on April 20.
Banks are charging more for selling structured debt than they were before the global credit crisis, when fees for five- year notes dropped to 0.5 percent, Guy Thomas, the global head of emerging-market credit structuring at ING Groep NV, said in a phone interview from London. “They’ve widened considerably this year,” said Thomas.
Fees are as much as 60 percent lower on average than for Eurobond underwriting, Rubenstein at IFC Metropol said. Structured debt sales are “smaller and faster to do,” he said.
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