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. Last Updated: 07/27/2016

More Regions Default on Agrobonds




The agrobond default rate continues to rise as five more regional governments failed to make their payments last week.


A stunning 12 out of 14 regions have missed their deadlines since May and with a score of other due dates rapidly approaching -- that figure only looks to worsen.


More curious than the mass defaults, however, might be the investor interest toward the bonds in the first place, analysts said.


"From the beginning this was a risky investment, but it was made attractive by the risk premiums," said Ursula Beyreuther, a credit analyst at Deutsche Morgan Grenfell in London.


The roots of the current agrobond nightmare can be found in the bull market optimism of the first three quarters of 1997. Agrobonds are securitized regional debt originally owed to the federal government, but converted into one-, two- and three-year paper with annual coupons of 10 percent. In June 1997, the first of these bonds was auctioned off and eventually 82 out of 89 regions ended up participating. In all, $738 million of an authorized $1.5 billion was sold off.


According to Robert Devane, who until recently was the director of fixed income at Troika Dialog investment bank, the appearance of agrobonds with their 25 to 30 percent yields happened just as the Treasury-bill, or GKO, market was beginning to stabilize.


"This was in the context of last summer's bull market, when [GKO] yields were coming down sharply and investors started looking to sub-sovereign debt for the yields they wanted," he said.


In the market euphoria, risks were often underestimated or ignored. "From the beginning it was fairly obvious that there would be some defaults," Devane said. "But people a year ago were much more yield hungry and aggressive, and as a result, the fragilities of the market tended to be underplayed."


In addition, some of the Western buyers -- estimated to hold half of the agrobonds -- were given the hard sell on the bonds, according to Devane.


"For a lot of investors, the only reason they got involved was because of aggressive selling by a couple of players in the market," he said.


"There really was not enough information available on most agrobond obligers to allow investors to perform proper credit risk analysis," he said.


Deutsche Morgan Grenfell's Beyreuther said one of the reasons investors should have been wary is that in many cases the regions issuing the debt were not happy about doing so.


"Because of this, some of the regions did not view repayment as their highest priority," she said.


Devane said the conversion was technically voluntary, but said it was metaphorically like "two guys in a room with baseball bats saying, 'you don't have to sign up.'"


Investors may have counted on the Finance Ministry riding to the rescue in the event of defaults, even though it was not legally obliged to do so.


"In my opinion, it would have been reasonable for investors to assume that given the Finance Ministry's role in sponsoring the program, that they would be prepared to use their resources and influence to ensure the regions would" stand by their obligations, said Richard Deitz, head of fixed income at MFK Renaissance.


MFK Renaissance is a product of the merger of two investment banks, MFK and Renaissance Capital, earlier this year. The former won a tender to act as agent for the Finance Ministry on the agrobond sale and has come under criticism for overselling the risky bonds.


"[MFK] was the main one flogging them," said one Moscow trader.


Deitz, who was with Renaissance Capital at the time, said MFK only sold the bonds to Western and Russian banks, including Renaissance. These banks then either sold some to individual investors or kept some for their proprietary books.


Defending the sale of the bonds, he said, "Many things that seemed to be a good buy at that time, in retrospect we wish we'd avoided. That would include agrobonds, GKOs, all forms of Russian debt, and it would include all forms of Russian equity."


"I think it would be a little bit unfair to single out agrobonds and say that the gap between appearance and reality or outcome in the case of agrobonds was in some way meaningfully broader than" it was in some of these other instances, he said.