Putin's Pet-Project Bank Hitches Ride on Emerging Bond Rally

  • VEB bonds trade back in line with index as overhaul begins
  • New CEO pledges to tackle debt load before New York meetings

The rally in emerging-market corporate credit is helping turn the tide for a Russian state-backed development agency that has bankrolled many of the government’s costliest projects.

Vnesheconombank’s bonds have gained since January, driving their yield down 2 percentage points from a 2016 high of 8 percent in January and back into line with global emerging-market peers. The lender, hobbled by U.S. and European sanctions, is seeking a bailout after clocking up $18 billion of foreign debt for Kremlin-directed projects from the Sochi Olympics to covert acquisitions in Ukraine that have soured.

Even though half of VEB’s loans are problematic or impaired, investors are hopeful government backing will allow it to honor debts as new management culled from Sberbank PJSC, Russia’s biggest lender, begins the task of cleaning up asset quality. Russia granted VEB $2 billion in subsidies in February that helped avert a breach of debt covenants that would have triggered a default.

“The intended recapitalization is a signal that the money will be there if they need it,” said Anton Kerkenezov, a money manager who helps oversee about $3.5 billion of emerging-market debt at Aviva Investors in London and cited a risk rally as also helping performance. “VEB has been caught up in the wider rally in emerging market corporates.”

The average yield investors charge emerging-market companies in the bond markets has fallen more than 1 percentage point since Jan. 21 to 6 percent, according to Bloomberg index data.

Budget Strain

The bailout of VEB is straining government coffers during the biggest austerity drive in Vladimir Putin’s 16 years in power. Plunging oil prices are forecast to widen the budget shortfall to at least 3 percent of gross domestic product this year, the most since 2010. VEB was forced to halt new lending after it was slapped with sanctions following Russia’s annexation of Crimea from Ukraine in 2014. The first tranche of aid in the first quarter of 150 billion rubles ($2.2 billion) was drawn from a presidential reserve that contains pension money, Vedomosti reported today.

To meet $4 billion of debt coming due in 2017, VEB’s new chief executive officer, Sergey Gorkov, said this week he’s considering job cuts and asset sales. Gazprom PJSC may be asked to participate in the rescue by buying back its 2.7 percent stake from the state development lender, according to two people with knowledge of the matter.

Since Gorkov’s appointment Feb. 26, the premium investors demand to own VEB’s $1.6 billion note due in July 2020 instead of Russian sovereign debt of similar maturity has narrowed 66 basis points to 230, leaving the yield at the lowest since November. The bank will update investors in New York on April 18 according to a person with knowledge of the plans who is not authorized to speak publicly.

Sochi Hotels

VEB is an "improving credit story in the mid-term,” said Stanislav Bozhenko, Otkritie Capital in Moscow, who expects the spread to narrow by another 50 basis points as Gorkov announces measures to clean up its balance sheet.

The bank suffered losses on deals to unnamed Russian investors to buy steel plants in eastern Ukraine, many of which got damaged in the conflict over Crimea. The drain of the 2014 Olympic games endures in money-losing hotels and ski resorts VEB controls.

In his comments to reporters this week, the CEO said he’s drawing on examples of development agencies in Brazil, China, India, South Africa and Europe before presenting a new business plan by June 30.

"Everything’s going to be all right with VEB’s public debt," said Fedor Bizikov, manager of fixed-income portfolios at GHP Group in Moscow. “But the road will be bumpy.”

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