While the recent confrontation between Putin’s Russia and Obama’s America has been a masterclass in how to manage one’s foreign interests (where one learns from Putin for those confused) in which Putin largely ignored every attempt at being jawboned by Obama, Kerry and their henchmen, what was left unspoken is that despite the superficial theatrics little would actually escalate since at the end of the day, Russia’s place in a globalized system (not to mention its commodities) is far too important to be jeopardized for political talking points.
Furthermore, as is well-known, when it comes to key players in a global fungible monetary system, a far more important decision-maker than the US government is the FDIC-insured hedge fund that controls all central banks: Goldman Sachs. Which is why it is certainly notable that moments ago none other than Goldman effectively downgraded Russia’s sovereign risk by announcing it is “shifting from constructive to neutral view on Russian sovereign risk.” With the legacy rating agencies now largely moot and irrelevant, what the big banks say suddenly has so much more import. But when the biggest – and most connected – bank of them all, outright lobs a very loud shot across the Gazpromia Russian bow, even Putin listens.
From Goldman’s Clemens Grafe
Shifting from constructive to neutral view on Russian sovereign risk
Russian CDS spreads have tightened by more than those of peers in recent months, as Russia’s fundamentals remain strong and Russia, in our view, is less exposed to the slower pace of Fed asset purchases and higher global interest rates than many other EMs. However, two recent developments cause us to shift from a constructive to a neutral view on Russian credit in the near term. First, banking sector liquidity conditions have tightened significantly as the regulator has substantially stepped up bank oversight actions by withdrawing licences from 30 banks this year (1.2% of retail deposits in the system). While we currently find little evidence of systemic banking sector stress, we believe the risk of bank stress developing – and of potential sovereign exposure – resulting from the regulator’s actions has nonetheless risen. Second, Russian bank and sovereign exposure to both Belarus and Ukraine – credits that have deteriorated substantially in recent years – is both large (around 2% of GDP) and expected to rise further, especially in light of the recently-announced Russian financial assistance package for Ukraine. In our view, both of these factors could be credit-negative for the Russian sovereign.
Russian credit has outperformed peers recently
CDS spreads of Russia’s peers (as measured by credit rating) have tightened by 25bp since June, while Russia’s spread has tightened by 40bp. Russia has, thus, outperformed peers in the past six months. This was in line with the argument that we made in early September that Russian fundamentals are stronger than those of peers on many of the metrics that are important for credit ratings and, in particular, in external variables (current account) and balance sheet (debt stock) metrics, which have been of high market relevance in recent months in the context of the focus on the Fed’s slowing pace of balance sheet expansion. We continue to think that Russia’s conservative fiscal policy, low debt levels and the central bank’s emphasis on bringing down inflation will cause Russia’s risk premium to decline in the long run.
Rising banking sector concerns potentially discounted by current market pricing
However, as we argued in September and as ratings agencies have also emphasized in the past, it is institutional factors such as the structure of the banking sector and potential sovereign exposure to bank bailouts that are holding back ratings upgrades and that prevent Russian risk premia from decreasing below their post-crisis range. However, in recent months the CBR has stepped up its bank regulation efforts to address this issue. In particular, the CBR has withdrawn licences from 30 banks so far this year. While the number of banks concerned is only slightly higher than in previous years (22 in 2012 and 18 in 2011), the size of the banks affected has been larger, with total retail deposits in banks concerned in 2013 of RUB177bn (1.2% of system retail deposits), up from RUB23bn last year. Deposit losses from these banks have so far been covered entirely by the national deposit insurance fund (Agency for Deposit Insurance), which currently has around US$4-6bn of funds available for this purpose. In the long run, we think that strengthening bank supervision is clearly positive for Russian risk.
However, in the short term, these bank closures have introduced some concerns in the banking sector. Liquidity conditions have tightened, with Ruonia having risen to 6.5%, the upper limit of the CBR’s interest rate corridor, and overnight and 1-month Mosprime rates have risen toward 7% (150bp above the main policy rate). While unsecured interbank funding has not been that important as a source of funding for Russian banks, access to this market for many second- and third-tier banks has recently tightened further. Daily Ruonia volumes have fallen from around RUB100bn mid-year to RUB60bn at present. While some of the tightening in liquidity conditions is likely due to seasonal factors (in particular, strong cash demand in December in anticipation of the holiday season), we believe that this is not the driving force behind the recent dynamics.
While, in our view, there is little evidence of systemic stress in the banking sector at present and while we think that larger banks would be well-insulated from any shocks, we do think the CBR’s recent actions have increased the risk of stress developing in the banking sector. CBR actions have focused on banks below the top 50 and, so far, we have not seen any of the larger banks affected by recent CBR actions. In addition, given that the equity capital in the larger banks is likely significantly higher, it is less probable that there would be a concern with these banks and many of these would also likely be deemed systemically-important. Although we think the likelihood of system-wide banking sector stress has risen, we nonetheless think it remains low. Given the system’s low dependence on interbank funding, a more serious deterioration would require large-scale flows of deposits, for which there is little evidence so far. At the same time, banks appear to have significant liquidity buffers, judging from loan-to-asset ratios for most smaller banks of 0.50-0.55.
That said, to quantify potential exposure, we present below a table of loans/deposits of Russian banks ranked by total bank asset size. What we find is that retail deposits in banks below the top 50 amount in aggregate to around US$100bn. While government deposit insurance is up to RUB700,000 per account and we do not have details on the distribution of retail deposit sizes, we would see US$100bn as an upper bound on potential sovereign exposure in the event of the emergence of real stress in the banking sector. This exposure, in our view, could justify a more cautious stance on Russian sovereign risk than we argued several months ago.
Balance sheet exposure to low-rated sovereigns also a potential concern
Russia has also increased its sovereign, corporate and banking-sector (largely state-owned) exposure to lower-rated CIS credits in recent years. This has happened as a result of financial assistance packages provided to neighbouring Belarus and Ukraine. While aggregated information on this exposure is very difficult to obtain, there are some data to suggest that this exposure is both large and increasing. In addition, credit risk has increased in both Ukraine and Belarus at the same time as Russia’s exposure to these credits has grown, as evidenced by their ratings downgrades and widening CDS spreads