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. Last Updated: 07/27/2016

Regions Buckle Under Bond Burden

Like a bad dream, the Aug. 17 default on Russia's domestic debt keeps coming back as one Russian region after another declares itself insolvent.

Out of the 71 regions that followed in the federal government's footsteps, issuing a vast array of domestic bonds in the past few years, 50 have already failed to redeem some or all of them.

And Nizhny Novgorod, one of three Russian regions that have issued Eurobonds, may soon become the first defaulter on these securities in their history.

Regions began missing payments on their bonds even before the Aug. 17 federal default, as Russia suffered from a case of the Asian economic flu. The situation in the provinces is "a mirror image" of the national situation, except the federal government held out longer, said Alexei Zabotkin, an analyst with United Financial Group.

Many regions, knowing their budget revenues would be insufficient to pay the debts, issued bonds anyway, and others have been hit by poor tax collection since Aug. 17.

Local governments have issued some 20 billion rubles ($1.19 billion) worth of bonds, including 7.7 billion rubles of so-called agrobonds, which came into existence when the government allowed regions to securitize their debts to the Finance Ministry on 1996 loans that had been meant to prop up farms.

Before Aug. 17, all the defaults except one, declared by the far northern republic of Sakha on its treasury bills, were on the agrobonds. The frozen loans totaled $740 million. Euromoney magazine reported that by mid-August, 90 percent of the regions that issued agrobonds had defaulted on the debt, an estimated 60 percent of which was held by foreign investors.

Zabotkin called agrobonds an ill-considered scheme that allowed regions with "insufficient financial culture" to issue securities.

But since the August ruble devaluation, at least five regions have failed to redeem other debt instruments, including municipal housing bonds, telephone bonds and treasury bills styled after the now-infamous federal ones.

The Orenburg region announced Oct. 16 that it would redeem only 5.72 million rubles of a 50 million ruble, nine-month issue, which matured that day, and announced it was open to proposals from investors on restructuring the debt.

Banks and brokerages holding regional bonds as part of their own investment portfolios or on behalf of their clients have been trying to collect the defaulted debt through legal action.The investment company MFK Renaissance, a leading regional debt agent, has filed and won suits against several regions, but Yekaterina Malofeyeva, an analyst with the company, said the cash-strapped bond issuers have repaid little of the debt so far. The company is currently owed 1.5 billion rubles on agrobonds alone, Malofeyeva added.

Fortunately for the regions and investors, few of the regions got around to floating bonds on international markets.

Samara Governor Konstantin Titov boasted recently that his region was ready to issue Eurobonds, but then he canceled the plans because of the Asian crisis. "If I had issued [the bonds], I would now be broke just like everybody else," Titov said.

The cities of Moscow and St. Petersburg and the Nizhny Novgorod region placed $1.41 billion worth of Eurobonds before the crisis and are now struggling to service the debt.

Moscow sold three three-year Eurobond issues with a total face value of about $1 billion f one denominated in dollars, one in Deutsche marks and one in Italian lire f in 1997 and 1998.

St. Petersburg sold $300 million worth of five-year Eurobonds in June 1997, and Nizhny Novgorod's October 1997 $100 million placement of five-year bonds fetched the attractive price of 99.742 percent with a 8.75 percent annual coupon.

All three regions have met their Eurobond obligations, but while Moscow and St. Petersburg are likely to continue to do so, Nizhny may be unable to meet the next, $4.375 million coupon payment due in April, rating agencies said.

Standard & Poor's lowered its rating of Nizhny's Eurobonds to CC from CCC- last week after Nizhny defaulted on 217 million rubles in agrobonds.

CC is the lowest a region can go down the rating scale before D, which stands for debt in default.

"The CC rating highlights our skepticism as to whether sufficient revenues will be generated to redeem the next coupon," said Monica Richter, director of public finance ratings at Standard & Poor's.

"With the budget in the state it is in, meeting the obligations appears extremely difficult," said an official with the regional administration, who asked not to be identified. "The default is already happening. It's not as if we had the money in our pocket."

Sergei Minutin of the Nizhny administration's finance department said the region would be able to honor its debt if it manages to free up some $20 million in budget funds that have been frozen in foundering Inkombank.

United Financial Group's Zabotkin said the federal government would have to step in and help Nizhny pay its debt if the prospect of default arises. Otherwise, investors would expect Russia itself to default on its foreign debt. "No one has ever defaulted on Eurobonds. This is the worst thing that can happen," he said.

However, the government has only a moral obligation to bail out Nizhny, not a legal one, said Richter.

Expectations are somewhat better for Moscow and St. Petersburg, whose Eurobonds are rated CCC-, the same as Russia's.

St. Petersburg, which received a $30 million loan from the European Bank for Reconstruction and Development in September, will be in the position to redeem the next, $14.25 million coupon on its Eurobond, due Dec. 18, said Paul Fox, senior director in charge of credit ratings for local governments at Fitch IBCA agency.

"I believe they can get through the next few months unless tax revenues drop dramatically," Fox added.

Moscow has also managed to honor its debt, and Sergei Pakhomov, deputy head of the city's debt department, said it would pay the $23.75 million in coupon income that comes due Nov. 30.

Pakhomov complained that foreign investors have viewed all Russian regions as insolvent since Aug. 17, but said Moscow was actually more reliable than the state. "We had nothing to do with [the domestic debt default]," he said.

Moscow and St. Petersburg are now the only regions honoring all their bond obligations, analysts said.

Moscow has about 1.9 billion rubles worth of bonds on the market at the moment, and St. Petersburg 2.9 billion-rubles worth of bonds. They are traded far more actively than other regions' securities, MFK Renaissance's Malofeyeva said.

Both Moscow and St. Petersburg are currently planning new bond issues.