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Fitch: Floating-Rate Loans May Raise Russia LRGs Long-Term Risks
October 17, 2016 / 10:51 AM / a year ago

Fitch: Floating-Rate Loans May Raise Russia LRGs Long-Term Risks

(The following statement was released by the rating agency) LONDON, October 17 (Fitch) Access to floating-rate bank loans should reduce Russian local and regional governments' (LRGs) funding costs in the short term, but adds to their exposure to interest rate risk, given their limited hedging capacity, Fitch Ratings says. On 6 October, the Russian government amended its federal procurement law, allowing Russian LRGs to borrow from banks at a floating rate, set with reference to the Central Bank of Russia's (CBR) key rate, which it cut to 10% from 10.5% last month. Previously, regions and municipalities had to pay a fixed interest rate when taking out bank loans. This change should reduce LRGs' interest expenditure, as existing fixed-rate bank loans are refinanced at a lower rate. Savings are likely to be small initially and will depend on the margin above the CBR rate that banks charge (this may be narrow, as overall bank funding costs are below the CBR rate). The long-term benefits may be more tangible if the CBR continues to gradually lower rates over 2017 and 2018 (we forecast 8.5% at end-2017 and 7.5% at end-2018), although banks have repaid much of the CBR funding made available in 2014-2015 and we forecast CBR funding will be fully repaid by end-2016. However, even though LRGs have until recently been restricted to fixed-rate borrowing, sharp rate rises have had a marked impact on their budgets due to their debt maturity profiles, which are typically short-term. This means fixed-rate loans and bonds have to be frequently refinanced. This was seen in 2015, when LRGs' interest expenditure rose by 20% yoy. This came after the CBR increased its base rate to 17% from 10.5% at the end of 2014, as the collapse in oil prices put the rouble under sustained pressure. Even though LRGs had borrowed in the market at fixed rates, short-term debt had to be refinanced at rates of close to 25% early in the year. The CBR's key rate should be less volatile than market rates, but the impact of changes to the policy rate will be felt more immediately. It is not clear how effectively LRGs would manage interest rate risk. They have exhibited prudent debt management, with a focus on minimising interest expenditure, but the previous restriction on floating-rate borrowing means that their ability to hedge against rising rates is untested to date. Russian banks do not have lot of floating-rate liabilities and interest rate risk hedging in Russia is underdeveloped and expensive. Their short-term debt maturity profiles have traditionally exposed Russian LRGs to refinancing risk; however, it is mitigated by the availability of cheap federal budget loans earmarked for repayment of maturing debt. Bank loans accounted for 31% of direct risk (bonds and bank loans plus 'other Fitch-classified debt', including federal budget loans) for regions at 1 September 2016. The proportion of market debt (bonds and bank loans) fell to 48% of total direct risk from 63% at the start of the year, but we think this is mainly due to a seasonal effect, and we expect the balance between market debt and federal budget loans to return to around 60:40 by year-end, as short-term loans from the federal treasury are repaid. Aggregate market debt to total revenue is low (17% in 2015). The aggregate RUB410bn surplus that the regions posted to 1 September is consistent with our view that signs of financial stabilisation are emerging. However, the surplus largely reflects delayed execution of capex, and we expect higher spending over 4Q to lead to a full-year deficit of around RUB180bn, or 8% of the regions' total debt stock (compared with 12% in 2015). Contact: Vladimir Redkin Senior Director International Public Finance +7 495 956 9901 Fitch Ratings CIS Ltd 26 Valovaya St. Moscow, 115054 Anton Lopatin Director Financial Institutions +7 495 956 7096 Mark Brown Senior Analyst Fitch Wire +44 20 3530 1588 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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