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18.06.2008 - MDM Comment: Bond defaults looming in Russia
On Monday this week, Minnesko, a small Siberian timber company, missed a coupon payment and prevented bondholders from executing the scheduled put option on its tiny bond issue (RUB500 mn, or just over USD20 mn, Bloomberg ticker MINNES). Wires and newspapers have reported, citing the company's management, that Minnesko does not have the cash available to execute these payments, leaving shareholder bailout as the only recourse left to keep the company afloat. According to various media sources, shareholders have not reached a decision on this matter. The company's financial performance reportedly deteriorated last year after new export duties on timber made it unprofitable for Minnesko to continue sales to Japan.
The Minnesko case has a good chance of becoming this first serious or ‘true’ default in the post-1998 era Russian bond market. There have, of course, been 3 or 4 defaults, but these were triggered by regulatory actions (two small banks had their licenses withdrawn in 2004; alcohol maker Vinap had its operations banned), and, more importantly, they didn't affect any significant quantity of bonds held by non-affiliated entities.
Minnesko is actually the third company to stumble on coupon or principal bond payments in the recent months. The first two were Euroservice, an agricultural company, and the more famous story of Marta, a distressed holding with core assets in retail. However, both Euroservice and Marta have managed to obtain refinancing (in case with Marta, though, the story is not over, as a large ruble issue and a USD CLN are still outstanding). Another critical even is due this week: distressed perfumes retailer Arbat Prestige is due to redeem its RUB2 bn bond issue, last trades on which were below 70% of par.
It has been always hard to believe that in a market of over 500 different issuers, many of which are "B-/CCC"- like credits, there have been no defaults. There should have been some, as the simple probability considerations would suggest. At the same time, one may fairly argue that default risk is correlated with reality, i.e. during periods of excess liquidity, with rallying debt and equity markets, the chances of there being a default are much lower, a theory proven by the statistics available from more developed markets. Anyway, the fact is that until last August, investors were quite comfortably swallowing the debt of non-transparent and/or vulnerable Russian issuers at yields of between 10 and 12%. It is our view that fair re-pricing has not yet taken place on many of these issues.
Now it is almost certain that the Russian bond market will soon lose its “virginity” and have an end put to its "no default" status. Such developments will likely trigger tighter risk management practices at bond trading desks, and make life in Russia's "high high yield" or "3rd tier" bond segment tougher across the board – in terms of new issuance, spreads and general availability of financing.
