Russian Bank at Center of Trump Storm Lures BlackRock, Fidelity
Investors are avoiding $6.2 billion of bonds issued by VEB Bank, involved in the Trump case.
(Bloomberg) -- Investors have plenty of reasons to avoid the $6.2 billion of bonds issued by Russia’s most politically connected bank.
VEB, as the state-owned lender is known, has been locked out of international debt markets by U.S. and European sanctions since 2014. It was saddled with bad loans after oil prices slumped, forcing the Kremlin to swoop in with a multi-billion dollar bailout. Revelations that the bank’s chief, Sergey Gorkov, met with Donald Trump’s son-in-law a month before the president’s inauguration then thrust it into the elections-meddling scandal. And now U.S. lawmakers have pressured Trump to strengthen Russian sanctions once again.
But some of the world’s biggest money managers -- flush with cash and attracted to VEB’s relatively juicy 5 percent yields -- have instead been loading up on the Russian lender’s bonds. BlackRock Inc. and Fidelity Investments are among those buying dollar-denominated notes in secondary markets, so much so that they now hold more of the debt than at any point since the sanctions. VEB, whose full name is Vnesheconombank, is seizing on the market’s embrace and holding meetings with international investors in spite of the optics.
“Western investors are a lot more comfortable with Russian credit risk as the segment remained resilient during a very challenging period,” said Apostolos Bantis, a credit strategist at Commerzbank AG in Dubai. “The Trump investigation and new sanctions won’t derail the momentum.”
BlackRock stressed that its purchases are fully compliant with financial sanctions, which also target Gazprombank JSC, Sberbank PJSC and VTB Group. A spokesman for the world’s biggest money manager said the overwhelming majority of its VEB positions are held by funds that mirror benchmark bond indexes.
During a series of meetings with some bondholders in the U.S. and U.K. in May, VEB executives discussed finances and strategy, according to people with knowledge of the talks. One presentation included a photo of Vladimir Putin shaking Gorkov’s hand, reminding investors that the Kremlin has their back.
An official for VEB declined to comment on its meetings with international bondholders, the effect of sanctions on its funding or the meeting between Gorkov and Jared Kushner, Trump’s son in law.
While VEB is prevented from selling new long-term debt in euros or dollars, bonds issued before the 2014 sanctions can still be traded freely, according to Philip Urofsky, a partner at law firm Shearman & Sterling LLP, which has advised banks and financial institutions on Russian sanctions. Trump signed legislation on Wednesday that could keep blacklisted firms out of foreign markets for years and gives Congress the power to block the president from lifting sanctions.
International buyers of outstanding notes aren’t breaking the law, but they may help VEB reenter the market should restrictions be eased, Urofsky said. The purchases have driven down existing yields, which are typically used as a benchmark for pricing new bonds, he said.
VEB’s $1 billion of notes due in November 2025 now yield 5.1 percent, near the lowest in four years, but multiples of the record-low 0.7 percent for a benchmark of European lenders, according to data compiled by Bloomberg and Bank of America Merrill Lynch. VEB’s bonds gained 4.8 percent this year, compared with 2.6 percent for European lenders, the data show. It’s a similar picture for other sanctioned Russian banks.
“It’s perverse in a way,” said Tim Ash, a London-based senior emerging-market strategist at BlueBay Asset Management, which oversees about $52 billion. “The sanctions create no new issuance, which means a shortage of supply. So, Russian credit has done well because of that shortage.”
Exchange-Traded Funds
BlackRock’s holdings of VEB’s international dollar notes ballooned to $124 million from about $1 million after sanctions were introduced, while Fidelity’s hoard rose to $126 million from $52 million, according to company filings compiled by Bloomberg. That’s the most VEB debt Fidelity has held since 2012 and a record for BlackRock.
BlackRock’s holdings increased in part because of an influx of new money into exchange-traded funds that invest in debt from developing nations. Between July 2014 and July 2017, the iShares J.P. Morgan USD Emerging Markets Bond ETF more than doubled to about $12 billion, according to data compiled by Bloomberg. While the absolute amount of VEB bonds included in the fund surged to $62 million from $24 million, their weighting held at about 0.5 percent.
JPMorgan Asset Management, T. Rowe Price Group Inc. and PGIM, the asset-management arm of Prudential Financial Inc., have also increased their positions in VEB’s external dollar debt, Bloomberg data show. JPMorgan and T. Rowe Price, which had no exposure in the third quarter of 2014, now own $58 million and $21 million respectively.
Government Backing
Officials for Fidelity, JPMorgan and PGIM declined to comment on their holdings. Fidelity and PGIM cited company policies against discussing individual securities. A spokesman for T. Rowe Price said the firm’s “modest position” in VEB’s outstanding debt had benefited its clients.
“The primary motivation for investors in Russian bonds is the yields on offer,” said Bantis at Commerzbank. “While the bank has faced many challenges of its own,” he said, “the government has proven its commitment to back it.”
Not all investors have piled into VEB’s bonds. Pacific Investment Management Co. has cut its holdings since the third quarter of 2014, when sanctions were tightened around the same time that the exit of founder Bill Gross prompted months of investor withdrawals.
Pimco now holds $75 million of VEB’s dollar bonds, down from a peak of $692 million, according to data compiled by Bloomberg. Vanguard Group, the world’s second-largest money manager, has trimmed its holdings to $9.5 million from $61 million in 2014, the data show. Officials for Pimco and Vanguard declined to comment on their investments.
VEB, the successor of a lender formed in 1922 as Russia emerged from revolution and civil war, was re-purposed by Putin in 2007 to finance projects prioritized by the Kremlin. To fund endeavors including the Sochi Olympics, VEB borrowed heavily in international markets, raising about $9 billion in dollars and euros between 2010 and 2013.
Russian banks ramped up foreign debt sales in the years before the spigot was shut off by western sanctions, issuing about $15 billion annually in 2012 and 2013, according to data compiled by Bloomberg. Sales dropped to an average of $4 billion between 2014 and 2016 as some of the country’s largest issuers were restricted from international borrowing.
Now, VEB is facing mounting losses on Kremlin-mandated projects and struggling under the weight of $13.8 billion of outstanding foreign and domestic bonds, said Evghenia Sleptsova, a London-based economist at Oxford Economics.
It’s being propped up by the government, which will inject 150 billion rubles ($2.5 billion) annually through 2019 and provide another 300 billion rubles of liquidity support, according to a presentation on VEB’s website. Given the connection, S&P Global Ratings gives both the bank and state the same junk grade.
“VEB is as solvent as the Russian sovereign is,” said Sleptsova at Oxford Economics. “Russia wouldn’t let VEB default unless it were prepared for a sovereign default.”
--With assistance from Lyubov Pronina Natasha Doff Jake Rudnitsky and Ksenia Galouchko
To contact the reporters on this story: Alastair Marsh in London at amarsh25@bloomberg.net, Sally Bakewell in New York at sbakewell1@bloomberg.net.
To contact the editors responsible for this story: Shelley Smith at ssmith118@bloomberg.net, Abigail Moses