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19.09.2008 - MDM Comment: Mixed feelings

Perhaps it is not only us who harbor mixed feelings and doubts concerning the sustainability of the rally we are seeing today: The salvation of markets with deep-rooted problems cannot be that easy. It is not obvious that the US government’s balance sheet and credit ratings are able to accommodate such a large-scale acquisition of troubled assets. However, since we are not experts on the US, we better speak on what is happening in Russia.

And here we see a similar sequence of actions on behalf of the regulators. Yesterday, Russia’s government again fired its heavy artillery, adding to its earlier efforts to blast away at the malaise that has enveloped the markets.

First, the three largest banks were instructed to provide liquidity not only to smaller banks, but also to brokers. We are actually seeing liquidity being channeled down, although the rates charged by Sberbank, VTB, and Gazprombank are still extraordinarily high.

Second, it was decided that the Federal Mortgage Agency (Bloomberg ticker AIZK) will receive a RUB60bn equity injection in order to enable it buy out mortgage portfolios from banks – a smart move, in our view. First, this should provide a timely aid to smaller financial institutions that are too small and risky to have access to other pools of liquidity such as deposit auctions or repo from the Central Bank. Second, the quality of mortgages in Russia is undisputedly high from LTV and loan-to-income perspectives, so its not about buying toxic assets. Finally, for bond investors, the news is good, as it wipes out new issuance risk with regard to AIZK bonds.

Oil export duty cuts were announced. The move should improve the profitability of local oil companies and support their equity valuations.

Finally, the government reportedly said that some RUB500 bn (approximately USD20 bn) may be poured from the budget into local equity market in order to increase government stakes in state-controlled companies, and perhaps accumulate some equity of strong privately-owned companies. Apparently some of that money may arrive into the markets as soon as this year.

We believe that with the exception of the latter measures (direct intervention into equity markets), the actions of the Russian government make perfect sense. This is not a bailout of troubled institutions holding bad assets by a highly indebted government. We view the moves as more a case of insulating a fundamentally healthy economy from external threats by using a strong government balance sheet.

Having said all that, we would of course like to remind investors of the risks of being carried into false euphoria and recklessly joining the rally on the Russian markets. First, the US’s problems are not solved yet. Second, the liquidations by those who made a decision to sell Russian exposure are very likely to continue (funds may still be experiencing redemptions or preparing for already announced ones, etc.). Third, certain disruptions in the local financial system still cannot be ruled out as smaller institutions are benefiting from only a small part of liquidity support package, while refinancing risks in the corporate sector remain significant. Finally, the rating agencies may take a conservative approach and act or comment negatively on Russia’s sovereign ratings, particularly as this direct intervention into equity markets was announced. Moody’s yesterday made a constructively positive statement on Russia’s rating, although we are not sure if they were aware of all the recent decisions when issuing its commentary. Furthermore, S&P and Fitch are yet to state their points of view.

19.09.2008 14:50
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