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Putin Threat Pushes Regions Debt Costs to Records: Russia Credit

Regions such as Yaroslavl, featured on the 1,000 ruble note, are paying record rates to replace shorter-term bank loans as President Vladimir Putin warns of financial mismanagement.

Yaroslavl, about 75 miles northeast of Moscow, sold 3 billion rubles ($94 million) of three-year notes last week at 9.1 percent, an all-time high for the region and Russia’s first municipal sale in three months. Volgograd, named after Europe’s longest river, set a record 9.67 percent coupon for the 1 billion rubles of five-year notes it plans to sell Aug. 29.

Putin warned July 17 that the finances of some of the country’s regions may spiral out of control if they don’t end their reliance on short-term bank loans. Local governments have grown more dependent on federal funding since market turmoil in 2008-2009 forced a retreat from the bond market.

“Regional borrowers are stuck between the hammer and the anvil; they have to balance their development plans with strict borrowing limits,” Konstantin Anglichanov, director of international public finance at Fitch Ratings in Moscow, said by phone on Aug. 24. “Their income resources are limited, unlike those of Russia, while their investments are rising.”

The yield on Yaroslavl’s 2013 ruble bonds surged to 11.4 percent yesterday, the highest level since October 2011. The premium over comparable federal debt widened to 519 basis points, within 69 basis points of a record high on July 12, according to data compiled by Bloomberg.

‘Significant’ Support

S&P in the second quarter downgraded Tver, the first for one of Russia’s 83 regional governments in more than a year. The region is rated B+, or four steps below investment grade and five levels below Russia’s sovereign rating.

“In the event of deterioration in the economy, the regions will need a significant amount of support from the federal budget,” UralSib Capital analysts led by Dmitry Dudkin said in a research note Aug. 16. “Most regional budgets are sensitive to the economic cycle.”

Russia had 384 billion rubles of regional bonds outstanding at the end of July, a decline of about 17 percent from its peak in January 2011, according to UralSib’s data.

Even the bigger, higher-rated regions are paying more to borrow. Nizhny Novgorod, a hub for billionaire Oleg Deripaska’s automaker OAO GAZ, is selling 8 billion rubles of five-year bonds with a 9.85 percent coupon, the most in nine months -- and the region’s debt chief is happy with the rate.

“We found an issuance window,” Sergey Avdonin said by phone yesterday from Nizhny Novgorod. “There’s temporary market euphoria. Investors are optimistic that a global crisis can be avoided.”

Bridge Financing

The money will be used to refinance existing debt and help fund infrastructure projects, including a new subway bridge over the Oka river, Avdonin said. Even with the higher coupon, Nizhny’s sale will help it replace more expensive financing and reduce the region’s debt level to about 60 percent of annual revenue next year from 65 percent now, he said.

To be an attractive borrower, a Russian region’s debt should be less than 20 percent of operating revenue on average, a low level compared with most countries, said Boris Kopeykin, a Moscow-based S&P analyst. Thirty-two regions have debt equal to 30 percent of revenue and the ratio exceeds 50 percent in 12 regions, Putin said July 17.

“The problem is that even such a moderate debt level often leads to a significant debt-service burden, which needs to be refinanced,” Kopeykin said by phone yesterday. “With short debt structures, even a small debt level needs to be refinanced every year.”

The ruble weakened 0.5 percent to 32.0200 per dollar by the close in Moscow. Non-deliverable forwards, which provide a guide to expectations of currency movements, showed the ruble at 32.5016 per dollar in three months.

Turkey, Swaps

The yield on the government’s domestic ruble bonds due in June 2017 slipped one basis point to at 7.60 percent. The yield on Russia’s dollar bonds due in April 2020 was steady at 3.025 percent. The yield on Russia’s international ruble bond due in March 2018 was little changed at 6.454 percent.

Russia is rated Baa1 by Moody’s Investors Service, the third-lowest investment grade. The cost of protecting Russian debt against non-payment for five years using credit-default swaps was little changed at 164, according to data compiled by Bloomberg. The swaps cost 16 basis points less than contracts for Turkey, which is rated three levels lower at Ba1 by Moody’s.

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. London banks were closed yesterday for a public holiday.

Higher Rates

The higher rates are luring investors.

Nizhny Novgorod received orders exceeding 29 billion rubles for its 8 billion-ruble sale when it stopped accepting bids Aug. 24, according to the regional government. Yaroslavl received 5.8 billion rubles of orders for the 3 billion rubles of notes it offered, according to Troika Dialog, which organized the sale.

“For investors, the situation with regional debt is not concerning, they see this as a chance to purchase debt at a high interest rate,” Andrey Bobovnikov, vice president of fixed income at Aton LLC in Moscow, said by e-mail Aug. 24. “Sub-federal debt usually shows resilience in times of crisis, especially since we haven’t seen any defaults in the sector since 1998.”

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