Russia, in Default

Did somebody say “default”? The Moscow Times reports that major Russian companies are diving perilously into the red and flirting with collapse, leading Standard & Poors to downgrade Russia’s credit rating.

Standard & Poor’s lowered its outlook for Russia to negative on Thursday, warning of the costs of bailing out troubled banks, hours after data showed that Moscow spent another big chunk of its reserves defending the ruble.

Gold and foreign exchange reserves fell by $15 billion in the latest week to $515.7 billion on Oct. 17, raising further doubts about the sustainability of its currency policy as the cost of insuring Russia’s sovereign debt soared. “The outlook revision reflects the likelihood of a downgrade if costs to the Russian government of the bank rescue operations continue to increase,” S&P credit analyst Frank Gill said. Rating agencies see Russia’s reserves as a key factor behind its investment-grade debt rating. Russia has pledged a total of $210 billion to support the economy, including more than $70 billion from reserves. State-run lenders will receive $35 billion in subordinated loans to support the banking system.  “It is difficult at present to determine the ultimate impact on the public sector balance sheet of the banking system bailout, not least due to the uncertain outlook on asset quality,” Gill said.

As reserves dwindle, the cost of insuring sovereign Russian debt against restructuring or default hit record highs, with the debt now classified as distressed. Russia’s portion of the EMBI+ soared 135 points to 769 over U.S. Treasuries. Reserves are set to fall further when the government transfers the money for the rescue package. The Central Bank said it was not seeking nationalization of the banking sector but that it wanted to encourage consolidation.

The country’s reserves, which became the world’s third-largest during the period of high oil prices, have fallen from their peak of $597.5 billion on Aug. 8, when Russia sent tanks into Georgia. Since then, the Central Bank has been intervening in the currency market to support the ruble amid capital outflows, which are expected to continue to reach $20 billion in net terms in 2008. “[The latest fall in reserves] is due mostly to interventions, which is not surprising. There is an attack on the ruble under way,” said Nikolai Kashcheyev, analyst at MDM Bank. Russia runs a managed float of the ruble, and officials have pledged to support the currency as long as it is needed. Amid falling prices for oil, however, analysts question the sustainability of this policy. The Central Bank continued intervening on Thursday, fighting to slow the ruble’s slide as it breached 27 against the dollar to hit its lowest level since July 2006.

Falling Russian shares also put pressure on the ruble as an emerging markets sell-off engulfed Russian equity markets. Investors dumped Russian paper, driving the value of shares in Sberbank down nearly 10 percent before the MICEX exchange suspended them. The benchmark RTS Index closed down 4.4 percent at 636.5 points, and the MICEX Index lost 4.7 percent to finish at 598.9. The Central Bank decided Thursday to further cut the limit on currency-swap operations, used by speculators to bet on the currency’s depreciation, setting Thursday’s limit at 15 billion rubles. The Central Bank calculated that with the average price of oil at $66 per barrel in 2009 the reserves will fall while the current account will run a deficit. “[The outlook change] is a simple acknowledgement that Russia’s economy heavily depends on oil. Everyone knows about these risks, but today they simply came in the spotlight because of the oil price decline,” said Natalya Orlova, chief economist at Alfa Bank.

The Central Bank said Thursday that it had raised its main deposit rates by 0.5 percentage points from Friday to fight against capital outflows. The regulator said in a statement that it had raised one-day deposit rates to 4.75 percent from the previous 4.25 percent and one-week deposit rates to 5.25 percent from the previous 4.75 percent.

Here are the details on the massive corporate bloodletting now underway in Russia. First, the metals and mining firms:

Several metals and mining companies have stopped paying their electricity bills, threatening winter heating and electricity supplies for households, the head of the country’s biggest private electricity producer said in an interview Wednesday.

“We are now facing an increase in payment delays from big consumers, mainly metals and mining companies, both ferrous and nonferrous,” Mikhail Slobodin, president of Integrated Energy System, said in a telephone interview.  He declined to elaborate on the companies.  “The industry is using a legal loophole that prevents us from cutting them off from electricity supplies immediately,” said Slobodin, who also heads the Council of Electricity Producers, which comprises all major electricity generators.  “The payment delays take the planned money out of the whole financial system of the generators, which strains our winter-period preparation spending,” he said.

Big industries have started to cut jobs, salaries and output as demand has begun to fall and bank loans have become less accessible amid the financial crisis. At the current rate, electricity demand will only grow by 2 percent in October, less than half of the 5.5 percent growth seen last month, according to data from Integrated Energy System, or IES, controlled by billionaire Victor Vekselberg. IES has controlling stakes in electricity generators TGK-5, TGK-6, TGK-7 and TGK-9.  Other generators and distributors also raised concerns about payment collection Wednesday.  “Compared with September, we have 10 percent fewer payments from the industry so far,” said a senior manager with the Kostroma Electricity Distribution Co., who asked not to be identified because of the sensitivity of the issue.

Electricity producer OGK-1 is anticipating tough times. “We haven’t faced delays yet, but unfortunately we understand that this kind of problem will arise very soon,” said OGK-1 director for sales Vladimir Paley.  One major electricity consumer, Polyus Gold, said Wednesday that it was paying its bills on time. Novolipetsk Steel and Severstal did not return requests for comment.  The delinquent metals producers might be waiting for state loans to come through, said Irina Filatova, utilities analyst at Brokerckreditservis. “According to the law on electricity, the generators don’t have the right to cut off some consumers, and industries are on that list,” she said. Slobodin said he expected that electricity distributors would also delay payments. “Electricity distributors don’t have any assets big enough to use as collateral and have borrowed a significant amount of money, which has resulted in banks closing credit lines for them and taking the money back,” Slobodin said.  The Kostroma distribution manager confirmed that his company was facing problems with the banks.

Industry payment delays were to be discussed Wednesday at government meeting chaired by Deputy Prime Minister Igor Sechin, who is responsible for the electricity sector. The Energy Ministry did not disclose the results of the meeting. One of the issues on the agenda was a state loan sought by electricity producers in an open letter to Sechin last week. Slobodin said the decision would be made “in the next week or two.”

“The electricity sector needs 600 billion rubles from next year to build new electricity production facilities under our investment programs to expand capacity,” Slobodin said.  “If the situation improves, we may refinance the state loans on better conditions as early as 2010,” he said. “The main goal is to survive the next year.” He predicted a wave of job cuts and production optimization throughout the electricity sector as soon as the difficult winter period ended next year.

And then, Gazprom:

Gazprom CEO Alexei Miller said Wednesday that the company might have trouble obtaining new loans and refinancing debts, even after posting record earnings. “Deteriorating operating conditions for borrowers may also have an impact on management’s cash-flow forecasts,” the company said Wednesday in a statement.

The cost of default protection on bonds sold by Gazprom surged to a record Wednesday as concerns over how emerging markets will weather the financial crisis intensified. Miller said earlier this month that the credit squeeze was not a “troubling factor” for the company, which reported a 30 percent jump in first-quarter profit. “The feeling used to be that Gazprom was financially invincible, backed by their excellent earnings outlook,” said Artyom Konchin, an oil and gas analyst at UniCredit Aton. “They will have to manage their finances better than they used to.”

Gazprom closed down 7 percent at 118.22 rubles on the MICEX stock exchange. Shares of the state-run company have tumbled 71 percent from their May 19 peak as investors pulled their money out of emerging markets.  The cost of default protection on bonds sold by Gazprom increased 145 basis points to a record 1,285, according to CMA DataVision prices for credit-default swaps Wednesday afternoon in London. Companies trading at more than 1,000 basis points are considered “distressed” by investors. No data was available on volumes.

Gazprom and its subsidiaries have $55 billion in outstanding bonds and loans, according to Bloomberg data. The company is scheduled to repay $6.6 billion next year and $12.5 billion in 2010, the data show. The energy producer has already said it was reviewing its spending program amid tightening credit markets and lower revenue expectations. It has laid out plans to spend more than $30 billion this year on new projects as output drops at mature fields in western Siberia.

First-quarter net income increased to 273 billion rubles ($10.1 billion) from 210 billion rubles a year earlier, Gazprom said Wednesday.  “These are great numbers, the best numbers they’ve ever had, but they are more than half a year out of date, and the world is changing beneath our feet,” said Ronald Smith, chief strategist at Moscow-based Alfa Bank. Earnings were boosted by higher gas prices in Europe, where the company supplies one-quarter of all demand.

Gazprom’s prices in dollar terms rose 28 percent for European gas sales, reaching $345.5 for 1,000 cubic meters.  Natural gas price changes lag those of oil prices by about six months, meaning that Gazprom will continue to post “solid” financial results through the end of 2008, Citigroup said Wednesday.  The European gas price may peak at $500 for 1,000 cubic meters of gas in the fourth quarter before declining, Citigroup analysts Alexander Korneyev and Ildar Khaziyev wrote. Crude oil futures have tumbled 52 percent from a record $147.27 in July.  The exporter will have to “significantly” increase capital spending on gas production in the short term, limiting free cash-flow generation, Citigroup said.  Gazprom and the country’s three largest oil companies earlier this month appealed to Prime Minister Vladimir Putin to provide financing for energy projects should it become necessary.

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