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. Last Updated: 07/27/2016

City Offers Bonds-for-Flats Swap

For the second time in two months the city of Moscow has offered investors real estate instead of cash as payment for maturing municipal bonds.

Analysts said the offer could be a sign of financial difficulties Russia's capital is experiencing, but the city insists the offer is optional and intended to help investors.

On Friday, holders of 900 million rubles ($53.5 million at Tuesday's official rate) of nine-month papers issued by Moscow in January were offered the chance to swap these bills for a new two-year note that essentially can be used to purchase a flat or office space.

The swap offering, city officials stressed, was done on "a completely voluntary basis," and those who wanted to could receive cash for their bonds.

Roughly one-third of investors opted to receive the new "real estate" notes in exchange for the maturing papers.

Starting in six months, holders of these new bonds will have the right to receive one square meter of real estate per $1,000 of paper redeemed. Since the papers are denominated in rubles, the exchange rate on the date the papers are acquired is used.

The city made a similar offer for municipal bonds that matured Sept. 15, but the real estate was offered at a more favorable price.

"They [city officials] are scraping the bottom of the barrel" to pay back outstanding bonds, said one Moscow analyst who asked not to be identified.

The city possesses a glut of flats and offices that are sitting empty due to falling demand, said the analyst.

Alexander Sisuenko, an official of the Committee for Municipal Loans and Development of Financial Markets, said, "If investors want this type of option, why not offer it to them?"

Sisuenko said that on Friday, 597 million rubles was paid out in cash, 75 million rubles worth of bonds were canceled against taxes owed to the city and the rest, 228 million rubles ($13.5 million), were swapped for the new "real estate" paper.

Mechislav Klimovich, chairman of the committee, said last week that the offer of apartments instead of cash in September was intended to protect investors against the depreciation in the ruble.

Analysts suspect that Moscow, which last year soaked up 78 percent of all investment in Russia, is feeling the effects of the financial crisis. Rents have fallen on its huge real estate portfolio and taxes have dropped.

The city must cancel another billion rubles of bonds on Nov. 11, and on Nov. 30, will have to pay a $24 million coupon on one of its three Eurobonds.

On Oct. 30, Moscow must repay a 72 million Deutsche mark syndicated loan and on Nov. 2, it must repay a $25 million syndicated loan to ING-Barings. It also has to repay a $10 million loan to International Moscow Bank early next year, Klimovich said.

Moscow's leading financial institution, the Bank of Moscow, is suffering from problems endemic to the entire banking industry, but also has heavy exposure to such real estate deals, said one analyst. A large portion of budget revenues for the city came from foreign companies based in the capital; now these companies are either paying less, cutting back their scale of operations, or are altogether packing their bags and going home.

The result is a cash crunch for Russia's No. 1 city. Sisuenko said that the same real estate scheme will be used in three weeks when the next tranche of municipal bonds comes to maturity.

The new munis also carry an annual coupon of 14.5 percent, which according to an official press release, can be accrued for additional square meters of space.

"It makes sense to offer illiquid assets instead of cash," said Alexander Yermak, fixed-income analyst at Skate Financial Agency.

He said that the list of market-makers for Moscow municipal bonds is predominantly made up of financial structures associated with the city of Moscow, such as Troika Dialog and Guta Invest.