Bank of Moscow Bonds Sink on Missed Call Option: Russia Credit

Bank of Moscow to Forgo Call Option on $300 Million of Bonds
Bank of Moscow, the Russian lender will not exercise its right to redeem early $300 million of 7.5 percent bonds due 2015. Photographer: Anna Artemeva/Bloomberg

Bank of Moscow bonds tumbled to the lowest in almost a year as the lender controlled by Russia’s richest city passed up an option to repay debt early, stoking concern more banks will follow.

“It’s considered negative not to call a bond because investors expect to be paid on that date,” Rustam Botashev, deputy head of research at UniCredit Bank AG, said in a phone interview in Moscow yesterday. “I’m afraid more banks will end up not calling their bonds and it will just lead to higher costs for them in the end.”

Bank of Moscow said yesterday it won’t exercise its right to redeem $300 million of 2015 notes on Nov. 25. While the bank currently pays the 7.5 percent coupon, the rate drops to about 5.83 percent after the call deadline expires because of the decline in U.S. Treasury yields, data compiled by Bloomberg show.

The lender is the second in three months to break with market convention after VTB North-West, a unit of Russia’s second-largest bank, said Aug. 20 it would forgo a call option on $400 million of five-year bonds. Alfa Bank, the nation’s largest private lender, and Russian Standard Bank, controlled by billionaire Rustam Tariko, have options to pay 2015 debt in December. Russian bank debt is lagging behind emerging-market Eurobonds with notes due in 2011 from OAO Sberbank, the nation’s largest lender, little changed this year while JPMorgan Chase & Co.’s EMBI Emerging Markets Eurobond index rose 16 percent.

A slump in Bank of Moscow notes this week sent the yield up 53 basis points, or 0.53 percentage point, to 6.61 percent yesterday, the highest since Jan. 7, according to ING Groep NV prices on Bloomberg.

Negative Outlook

The bank, which is 64 percent owned by the city’s government both directly and indirectly, had its ratings outlook cut to negative by Fitch Ratings on Sept. 29, the day after President Dmitry Medvedev fired Yuri Luzhkov as mayor of Moscow. Fitch cited concern companies affiliated with the Luzhkov administration that have backed the bank may no longer provide support.

Bank of Moscow’s subordinated debt is rated BB+ by Fitch, one step below investment grade, and Baa2 by Moody’s Investors Service. Goldman Sachs Group Inc. and Credit Suisse Group AG also own stakes, according to the Moscow-based bank’s data.

Luzhkov, who served 18 years at the helm of the city that contributed almost 25 percent of Russia’s gross domestic product in 2008, was replaced by Sergei Sobyanin, Prime Minister Vladimir Putin’s chief of staff.

‘Good Bank’

“It’s a good bank that is important to the city but political change leads to heightened risk,” Tim McCarthy, who helps manage $1 billion in Russian and other emerging-market assets at Switzerland’s Valartis Asset Management in Geneva said in a phone interview yesterday. Valartis sold its 2015 Bank of Moscow callable bonds before Luzhkov’s ouster because it wanted to take “risk off the table,” McCarthy said.

Bank of Moscow has $307 million of debt due this year and $929 million due next year, according to data compiled by Bloomberg.

The interest rate on the 2015 notes switches to 456.7 basis points over five-year Treasuries on Nov. 25, according to the prospectus. Based on the current Treasury yield, that would make the coupon 5.83 percent, saving Bank of Moscow about $5 million a year.

‘Logical Decision’

Forgoing the call option is “the only logical decision because not repaying this means Bank of Moscow ensures a cheaper source of funding,” Maxim Raskosnov, a banking credit analyst at Moscow-based VTB Capital, said by phone from Frankfurt yesterday. “With all the political pressure and concern about the bank’s credit -- whether misplaced or not -- it’s also a tough ask to put an additional $300 million on the repayment schedule.”

Russia’s dollar bonds due in 2020 fell for a 12th day today, increasing the yield to 4.503 percent. Its ruble notes due August 2016 rose, reducing the yield 5 basis points to 7.17 percent.

Russian sovereign ruble bonds have returned 9.2 percent this year compared with 18 percent from Brazilian local-currency bonds, according to data compiled by Bloomberg.

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries rose 1 basis point to 212, according to JPMorgan Chase & Co. EMBI+ indexes. The difference compares with 127 for debt of similarly rated Mexico and 173 for Brazil, which is rated two steps lower at Baa3 by Moody’s.

The yield spread on Russian bonds is 31 basis points below the average for emerging markets, down from a 15-month high of 105 in February, according to JPMorgan indexes.

Default Swaps

The cost of protecting Russian debt against non-payment for five years using credit-default swaps increased 1 basis point to 145 today, 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, rated Baa1 by Moody’s Investors Service, its third-lowest investment grade, cost 12 basis points more than similar contracts for Turkey, which is rated four levels lower at Ba2. Russia swaps cost as much as 40 basis points less on April 20.

The ruble dropped 0.6 percent to 30.8425 per dollar, headed for its weakest close in more than a week. 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 31.0706 per dollar in three months.

Lower Rates

Callable bonds allow issuers to get lower interest rates compared with conventional debt, according to Botashev. The notes usually include a step-up coupon that’s higher than the original interest rate to penalize borrowers that don’t redeem their debt. Coupons on bonds issued by Bank of Moscow, VTB, Alfa and Russian Standard are all tied to five-year Treasuries. The Treasury yield has plunged 119 basis points this year, as the Federal Reserve kept its benchmark interest rate at a record-low 0.25 percent.

Deutsche Bank AG, based in Frankfurt, was the first major European lender to pass up the option to redeem subordinated bonds at the first opportunity when it instead switched to a floating interest rate in December 2008 as the cost of selling new debt surged amid the global funding freeze.

Alfa, controlled by billionaire Mikhail Fridman, pays a 8.625 percent annual interest on its $225 million of 2015 bonds until the Dec. 9 call option date, when the coupon drops to 628 basis points over the five-year U.S. Treasury yield. With U.S. yields at 1.27 percent yesterday, the new coupon would drop to 7.55 percent, according to data compiled by Bloomberg. That’s close to the yield of 7.67 percent, based on prices for the bonds yesterday.

‘More Substantial’

There is a “50-50” chance Alfa will choose not to redeem the debt as the “spread over Treasuries is more substantial than the other banks,” said Dmitry Dudkin, head of fixed income research at UralSib Financial Corp. “The low U.S. yields are driving this, not the will of Russian banks,” he said.

Alfa Bank’s debt is rated Ba2 by Moody’s, three steps below Bank of Moscow.

Mariya Trubnikova, a spokeswoman for Moscow-based Alfa Bank, declined to comment on the lender’s plans in an e-mailed response to questions yesterday.

Russian Standard is “unlikely” to exercise its call option because it has the highest credit risk of all four banks, Dudkin said in a phone interview in Moscow yesterday. The Moscow-based bank’s interest rate will drop by 168 basis points after the Dec. 16 options date to 7.2 percent, based on current U.S. yields.

Russian Standard

Russian Standard’s $200 million of notes due December 2011 were unchanged yesterday, with the yield at 8.97 percent, down from as high as 10.12 percent on Aug. 27. The bonds are rated B1 by Moody’s, five steps below Bank of Moscow.

Russian Standard isn’t ready to comment on whether it will exercise its call option, Artyom Lebedev, vice president of public relations in Moscow, said by e-mail yesterday. Lebedev said in January that the bank doesn’t plan to refinance any debt this year.

“Investors are resigned to it in the current circumstances,” said Ian Spreadbury, a fund manager at Fidelity Investment Services in London, which holds Bank of Moscow callable 2015 bonds. “We’ll probably see more of it.”

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