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The Big Take


RUSSIA IS SPIRALING TOWARD A $150 BILLION DEFAULT NIGHTMARE

What happens with bond payments due Wednesday could kickstart Russia's first
foreign-currency default since the 1917 revolution

By

Sydney Maki,

Eliza Ronalds-Hannon, and

Selcuk Gokoluk

+Follow
March 15, 2022, 4:01 AM GMT


Russian Police officers run to detain a man holding a poster that reads “No to
war,” during a protest outside the Kremlin on March 13.

Photographer: Getty Images


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Russia’s economy is fraying, its currency has collapsed, and its debt is junk.
Next up is a potential default that could cost investors billions and shut the
country out of most funding markets.

Warning lights are flashing as the government kickstarts the process of
paying $117 million in interest on dollar bonds Wednesday, a key moment for debt
holders who’ve already seen the value of their investments plunge since Russia
invaded Ukraine last month. 

The government says that all debt will be serviced, though it will happen in
rubles as long as sanctions — imposed because of the war — don’t allow dollar
settlements. Failure to pay, or paying in local currency instead of dollars,
would start the clock ticking on a potential wave of defaults on about $150
billion in foreign-currency debt owed by both the government and Russian
companies including Gazprom, Lukoil and Sberbank.



Such an event will revive memories of previous crises, including Russia in 1998,
when it defaulted on some ruble-denominated debt, and Argentina three years
later.

Signs of looming financial damage are becoming apparent at many of the world's
biggest money managers, including BlackRock Inc. and Pacific Investment
Management Co. But it’s not likely to be limited to these giant funds. Because
much of Russia’s debt was rated investment grade just weeks ago, the securities
were pervasive across global fixed-income portfolios and benchmarks, meaning the
impact could ripple across pension funds, endowments and foundations.

“This will be a monumental default,” said Jonathan Prin, a portfolio manager at
Greylock Capital Associates. “In dollar terms, it will be the most impactful
emerging-market default since Argentina’s. In terms of broader market impact,
it’s probably the most broadly felt emerging-market default since Russia itself
in 1998.”


WHAT RUSSIA OWES

Companies are on the hook for about $105 billion in foreign-currency debt



Source: Bloomberg



On the Bloomberg Terminal, click here for a full list of foreign-currency bonds

Russia is already a commercial pariah, crippled by sanctions and the exodus of
foreign firms such as Coca-Cola Co. and Volkswagen AG since the war started. The
government has responded with capital controls, restricting outflows of money to
protect the economy and the ruble.

Businesses and households are facing a double-digit economic slump and inflation
accelerating toward 20%. About half of the country’s foreign-exchange reserves
— some $300 billion — have been frozen, according to the finance minister.
Regardless of the Kremlin's policy on foreign debt payments, companies will find
it harder to service their obligations as falling demand hits sales and profits.



Because of the sanctions, and various decrees Russia introduced in response, a
default appears all-but inevitable. Swaps markets put about a 70% chance on it
happening this year. Fitch Ratings says it’s “imminent.” Indicative pricing on
the country’s bonds values some of them near 20 cents on the dollar. Just days
before the invasion, those same notes traded above par.


BOND DEADLINE

Russian bonds with interest due March 16 have slumped



Source: Bloomberg



In addition to bonds crumbling to distressed levels, the conflict has left its
mark on multiple markets. The ruble has plunged about 35% against the dollar
this year, and local stock trading has been shut for two weeks.

Russia’s late-1990s default was on domestic debt, so a foreign-currency
default would be the first since the aftermath of the 1917 Revolution, when the
Bolsheviks refused to recognize the czar’s debts.


WATCH: What Would a Russia Bond Default Look Like?

On Monday, Russia’s Finance Ministry issued an order to pay the $117 million,
although it didn’t specify the currency. Using rubles isn’t an option for this
week’s coupons, based on the terms of those bonds.

If Russia doesn’t meet its obligations, there’s technically a 30-day grace
period that gives it until April 15 to make good.


Russians stockpiled electronics and durable goods during the 1998 economic
crisis in anticipation of rising prices and the falling value of the ruble. 
Photographer: Pascal Le Segretain/Sygma/Getty Images


An official default declaration could also kick off claims on credit default
swaps, insurance-like instruments designed to cover losses if a country or
company fails to meet its debt obligations.

Will Russia Bonds Default? There’s Debate About That: QuickTake

According to Siobhan Morden, a fixed-income strategist at Amherst Pierpont,
Russia’s dramatic, and sudden, plunge from investment-grade to a financial no-go
area will worsen losses for debt holders.

“When a default is a slow train wreck due to policy mismanagement, you can
reduce the economic impact and contain losses by gradually selling assets,” she
said. “What makes this unique is this is a very sudden shock that catches
everyone off guard.”


DEBT TROUBLES

Key sovereign debt events since Russia in 1998



Source: Moody's Investors Service

Criteria for default events include missed payments, distressed exchanges,
restructurings

At Franklin Resources Inc., one fund marked down its Russia bond holdings by
more than half to $194 million as of Feb. 28. BlackRock funds exposed to Russia
fell by more than 90% after the invasion, and clients now have less than $1
billion invested, down from about $18 billion at the end of January. The decline
probably reflects a range of factors, from writedowns to client redemptions
since the war began.

Others with major exposure to Russia include Ashmore Group, an emerging-markets
specialist, while Capital Group and Fidelity are among the top holders of
Russia’s dollar bonds, according to data compiled by Bloomberg.

About $120 billion of the current outstanding government and company debt is
denominated in dollars, with the bulk of the remainder in euros, according to
data compiled by Bloomberg. Roughly $25 billion was issued by Gazprom, the
state-owned natural-gas giant. 

While the debt is substantial, it’s probably not enough to cause a systemic
problem for financial markets. That’s the view of International Monetary Fund
Managing Director Kristalina Georgieva, who said last weekend that banks’
exposure is “not systemically relevant.”


BAD DEBTS





Source: Bank of Canada/Bank of England (Updated 2021)

Criteria for database can be found at https://www.bankofcanada.ca/

A handful of the sovereign eurobonds do have contractual language allowing
payments in local currency, and some companies issued their debt via foreign
subsidiaries and have dollars offshore. Yet there’s still huge uncertainty,
especially as clearing houses including Clearstream and Euroclear have stopped
accepting the ruble as a settlement currency and have barred Russian entities
from most transactions. 

If bondholders don't get paid in dollars on Wednesday, it would be the start of
a very long, complicated process. History is an imperfect guide, but according
to World Bank Chief Economist Carmen Reinhart, Russia already holds the record
for the longest time between a default and some form of resolution with
creditors, the near seven-decade gap to 1986.

As for Russian companies, even before a single one misses a payment on its
obligations, another challenge is emerging: finding lawyers and advisers willing
to take their business. Last week, JPMorgan Chase & Co. declined to advise
search engine Yandex NV on a potential debt restructuring.


POSSIBLE DEFAULT SCENARIOS









In the meantime, multiple deadlines are looming. Steel and mining company
Severstal has a coupon due Wednesday, and both Evraz and Tinkoff Bank have
interest payments due Sunday. Gazprom has payments next week, with issuers
including Sibur and Polyus to follow.

Creditors of companies that fail to pay their debts will likely have limited
recourse in the near term, according to Tuck Hardie, a managing director in
Houlihan Lokey’s financial restructuring group.

“As a practical matter, people may have to just stare at each other for a little
bit,” Hardie said. “If the business is located in Russian sovereign territory,
you can’t go after its assets. If it’s not, you might see the companies
proactively file for court protection to prevent foreclosures, or you might see
them enter into forbearance arrangements with debtholders.”

Lee Buchheit, one of the world’s most prominent debt-restructuring experts, says
investors should get ready for a long haul. He suggests creditors may also be
particularly tough with Russia for moral, as well as financial, reasons.

“There is nearly universal support for Ukraine, even among normally hard-bitten
institutional investors. Some of those investors might want to strike a blow for
the cause,” said Buchheit. “One way to do that would be to vote to accelerate
Russian external bonds once the grace periods run out and pursue legal
enforcement of the instruments. I would not be surprised if some bondholders
decide to do this with greater alacrity than we normally see following a
sovereign bond default.”



 

— With assistance by Maria Elena Vizcaino, Laura Benitez, and Srinivasan
Sivabalan


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