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. Last Updated: 07/27/2016

MinFins See Mysterious Boom

Russia's MinFin bonds, like the Soviet-era debt with which they are classified, have long been a prime candidate for default, pushing their prices on the secondary market way down in recognition that they are securities of very little worth.

But for the past few weeks, someone has apparently been buying some of them up.

Third-tranche MinFins, which mature this May, are seeing some movement, traders and analysts said this week. Fueling suspicions that some kind of Byzantine buyback is taking place, it appears that the buying is being done by Russia's big trio of state-controlled banks: Sberbank, Vnesh-ekonombank and Vneshtorgbank.

The issue, which had been inching up from a low of 16 cents to the dollar in mid-December, moved sharply upward to 43 by mid-January before slumping back to 26.50 on Friday. Several analysts have said that they think a stealthy buyback is the most likely explanation for this otherwise inconceivable behavior.

A debt buyback right now would be a boon to the government because the MinFins are trading close to historic lows, allowing Russia to reap substantial savings on the $1.3 billion it is scheduled to pay when the tranche matures in May. A further $300 million in coupon payments on different tranches are spread over the year.

MinFin bonds are debt instruments issued in lieu of hard currency accounts that were blocked in Vneshekonombank after Russia defaulted on Soviet debt in 1991. Though they are dollar bonds issued by the Russian Federation, MinFins are considered domestic Soviet-era debt.

The state has made it clear it will service a maximum of $9.5 billion in external debt this year, provided it can receive some $7 billion in new loans that are written into the 1999 draft budget. Payments on Eurobonds, of which $1.6 billion is due this year, International Monetary Fund debt - $4.5 billion - and World Bank debt of $600 million, will be given priority.

An official for Vneshekonombank, which is the paying agent for the bonds, would not say if the Finance Ministry has ordered a buyback. "As far as I know the Finance Ministry has no money to perform such an operation," said Andrei Akinshin, head of currency and finance operations.

"Of course, one cannot rule out that banks are buying up cheap bonds as a speculative exercise," he said.

"Sberbank, Vneshekonombank and Vneshtorgbank are probably the only banks with any funds at their disposal," he added.

Sberbank refused comment, saying the issue was classified.

One Finance Ministry official said he had no information about the purchases. "If these banks are buying up bonds, it is their business," said an official in the Finance Ministry's securities department. "We did not give them any such task and nor have we even discussed the idea."

However, it is highly unlikely that the banks would start buying up MinFins without a green light from the Finance Ministry, analysts said.

"It would be too risky an exercise for the banks to perform on their own, when all indications are the tranche will not be redeemed," said Dennis Smyslov, an economist with Global Fund Management. "I also doubt they have such a level of liquidity."

If the reports are true, then the purchases would be funded by Central Bank reserves, which have edged down to $11.6 billion despite the fact that the bank is soaking up 75 percent of exporters' dollars these days.

Economists say retiring the debt would make economic sense for Russia, even though the move is not market friendly. "It is not unusual for a debtor to repurchase its debt at a discount as a debt reduction exercise, and Peru, Brazil and possibly Poland have done it in the past," said Eric Kraus, head of fixed income at Dresdner Kleinwort Benson.

While some analysts believe MinFins could be redeemed if the state sells its 2.5 percent Gazprom stake before May, others say the state would face problems if it did that.

"The Paris and London Club people would be very upset if the MinFins were paid and they were not - it would cause very bad blood," said one economist.

The government would also be relatively safe if it decided to chuck MinFins, because they are administered under Russian law. MinFin holders, unlike Eurobond creditors, would not be able to seize state assets and there are no cross-default provisions.

Some analysts said the purchases could be part of a scheme under which bankrupt banks would be allowed to buy MinFins cheaply and then receive principal repayment, or be able to value the bonds in such a way as to revitalize their balance sheets. "Rumor is that local banks will be able to value the MinFins at 100 cents to the dollar and when they mature they will be able to maintain the bonds in their books as core capital," Kraus said.

"They could even flip them back to the government in lieu of taxes - it would be good for the government and the banks would be retiring their debt," he added.

One MinFin trader who requested anonymity said several Russian banks have been heavily buying MinFins. "There will definitely be restructuring of some kind for corporate holders, and Russian banks are hoping it will be to their advantage," the trader said. "In any case they are confident their account books will not suffer."

It is not actually unethical to buy back debt cheaply, analysts said, but it would be highly unethical if the state first sent signals of default to the market to let the price drop down and did not ultimately default.