Russia Junk Rating to Give Buy Signal as Default Unlikely

A Russian downgrade to junk would have some investors seeing an opportune time to buy the nation’s bonds.

Lutz Roehmeyer at Landesbank Berlin Investment GmbH said he will add to his holdings in the event of a ratings-led selloff because Russia is unlikely to default. The nation’s assets have already fallen more than warranted, according to Michael Ganske at Rogge Global Partners Plc. Any market overreaction to a downgrade will offer a buying opportunity, Marco Ruijer of ING Investment Management said.

With sanctions over Ukraine and tumbling oil prices deepening Russia’s economic gloom, sparking an exodus from the ruble and government bonds, a cut to sub-investment grade could force ratings-sensitive investors to dump their remaining debt holdings. That presents a buying opportunity as the nation holds the world’s sixth-biggest foreign-currency reserves, especially if crude stabilizes.

“Russia is not a sell at this level and there is significantly more upside potential than downside risks in Russian bonds,” Ganske, who helps oversee $7 billion in emerging-market bonds and currencies at Rogge in London, said by e-mail Jan. 13. “All looks cheap, but probably quasi-sovereign energy and the sovereign.”

Standard & Poor’s last month put Russia’s rating, currently one step above junk, on negative watch and said today it will make a decision by the end of the month. Economy Minister Alexei Ulyukayev said on Jan. 14 that there is a “fairly high” risk that S&P will downgrade the world’s biggest energy exporter below investment grade.

High-Yield Bargains

While a junk score would force funds with a mandate to hold investment-grade debt to sell, it also offers high-yield bargains for investment houses that don’t face such restrictions, Dmitry Postolenko, a money manager at Kapital Asset Management in Moscow, said.

“For investors who are able to buy Russian bonds, the S&P downgrade is a buying opportunity,” he said. “Right now, we hold our money mainly in cash and we are trying to diversify our portfolio away from Russian assets. If we see lower levels after a downgrade, we might return some money to the market.”

Investors dumped Russian bonds in 2014 as the country’s annexation of Crimea led to economic curbs by the U.S. and the European Union, while the price of its main export commodity -- oil -- plummeted by half. Policy makers faced a dilemma between saving a sinking ruble and arresting the economy’s slide into a recession. The central bank more than trebled borrowing costs between March and December, exacerbating the bond slump.

Default Probability

Even as speculation about an imminent downgrade grows, Russian sovereign bonds are on course for the first weekly advance since November. As prices on notes maturing in August 2023 rose, the yield fell 182 basis points in the past five days to 14.38 percent by 6 p.m. in Moscow.

The cost to insure Russian debt for five years decreased 37 basis points this week to 540 yesterday, signaling a 31 percent probability of default within that time, CMA data showed. That, coupled with the central bank’s foreign-currency holdings of $386 billion, may indicate to some that the risk of bonds not getting paid is low.

The worst is not over for Russia, or its securities, Sergey Dergachev, who helps oversee 11 billion euros ($12.8 billion) of emerging-market debt as a senior money manager at Union Investment Privatfonds GmbH in Frankfurt, said. His company holds government bonds as well as OAO Gazprom, OAO Lukoil and OAO GMK Norilsk Nickel and doesn’t plan to add more.

‘Painful Situation’

“The economic situation over the short and medium term in Russia is very painful,” Dergachev said. “There is no signal that the U.S. and Europe will lift sanctions any time soon.”

If a selloff results from an S&P downgrade, investors like ING’s Ruijer, who helps oversee $7 billion of EM debt at ING in The Hague, would “see it as an opportunity.” Roehmeyer, who helps oversee $1.1 billion in emerging-market debt at Landesbank Berlin, said quasi-government bonds like the ruble debt of OAO Sberbank and OAO Gazprombank, would warrant a closer look.

“The banks are as good as the state and offer better yields,” Roehmeyer said. “When the selloff is running out, we will buy more because we see good fundamentals that should secure the bond payments.”

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