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. Last Updated: 07/27/2016

London Club Settlement To Push Debt Prices Up

Russia's massive debt restructuring agreement signed Monday with the London Club of commercial creditors will polish its reputation as a credit-worthy nation and push debt prices up further over the long term, analysts said.


The government signed the historic deal with the world's top banks to restructure $33 billion in Soviet-era debt -- a move widely expected to help improve the country's credit rating and lure foreign investors who once deemed Russia a high risk.


"This deal will allow more conservative money to come into Russia and bring in a new class of investors that have been unable to buy nonperforming assets," Philip Poole, head of emerging markets research at ING Barings in London, said Tuesday.


Russia has paid no interest since it defaulted on the loans in 1991, but is expected to restart payments Dec. 2, when the London Club formally closes the deal with Vneshekonombank, the government's agent for the negotiations.


There is already a gray market for the debt on a "when and if issued" basis, spawned in 1996 after a preliminary agreement was reached on restructuring the debts. These securities, known as interest arrear notes, or IANs, and principle notes, called PRINs, hang on whether an agreement is concluded by the end of 1997.


Prices rallied as the deal inched closer, but barely reacted to Monday's signing of the deal, which was well known in advance. IANs rose to 84 1/4 with a spread of 345 basis points over U.S. treasuries. PRINs traded at 76 1/2 with a spread of 420 over U.S. treasuries.


Initially, the debt attracted highly speculative investors known as hedge funds, which bet on whether a deal would be reached in time. These funds already are withdrawing from the market, which is expected to draw a more balanced mix of investors, raising prices.


In the short term this could lead to volatility, Poole said.


"We may see some selling from the original holders once the deal is closed," he said. "This could lead to volatility as supply rises, but equally we will see demand coming through from conservative investors."


Analysts said the new flows into Vnesh debt would probably come from U.S.-based pension and insurance funds currently not exposed to Russia.


If the deal is formally closed Dec. 2 as anticipated, the loans will be transferred into new interest arrear notes and a new tradeable debt representing the principal.


"Russian debt paper will become more liquid, more tradeable," said Richard Gray, emerging markets debt analyst at Bank of America in London. He said expectations that the new interest arrears notes, as well as MinFin bonds, would become Euro-clearable could boost demand for Russian debt paper.


While short-term volatility could cause prices to tumble, most analysts believe they will rebound, buoyed by a Russian credit rating upgrade widely expected by mid-1998 at the latest, analysts said.


"This deal takes Russia out of default," said Eric Fine, head of Russia and East Europe research at Morgan Stanley in London. "If you take a broader six-month view, Russia is still fundamentally cheap."