Streetwise Professor

October 25, 2008

I Know There’s Some Leverage in There Somewhere

Filed under: Economics,Russia — The Professor @ 8:48 pm

I’m still poking around for information on financing of Russian real estate.   Maybe I’ll ping Richard Hainsworth of RusRating, but pending that, I came across this suggestive quote in an article by Roland Oliphant:

One of the hardest hit industries is the construction sector, where investors had relied on cheap credit from banks to fund projects. Maria Puziryova, who owns a small architecture firm, said that as credit dried up, investors have either defaulted on payments or “postponed” projects, leaving contractors short of cash to pay their employees. She is yet to fire anyone, and hopes she will not have to, but may not be able to delay doing so for long. “We have some reserves from our budget, but it won’t be enough to last through this crisis for three months. The majority of companies are firing their staff right now because they can foresee that they won’t have the finances to pay them,” she said.

This doesn’t relate to the financing of the purchase of houses, but I still find it hard to believe that such purchases are primarily equity financed, especially in pricey Moscow.

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  1. The Financial Times has a very telling piece as to how leveraging built empires in Russia, and helped to drive the boom that made Moscow the world’s most expensive city. They examine the “empire” that Deripaska built, and that of the “minigarchs” who were less prominent but also built their mini-empires on debt. Many of these minigarchs from my experience were heavily involved in construction, notably in Moscow. Here are some excerpts from the Financial Times article “Close to the wind: Russia’s oligarchs”:

    Basic Element, Mr Deripaska’s holding company, does not disclose the total level of its debts. But by at least one account, Mr Deripaska borrowed to the hilt. “We bought this and then we bought that,” says a former business partner. “If he bought something he would immediately pledge it as collateral and borrow money for something else. This is how he built up turnover.” Alexander Temerko, former vice-president of Yukos, the defunct energy group, says: “Everything is fine when the market is growing. But this system of loans generating more loans is very dangerous when the market falls.”

    Basic Element denies it has any problems with liquidity, saying it does not intend to hand over any more shares to creditors. It managed to raise €500m in refinancing from co-shareholders in order to keep its 25 per cent stake in Strabag, the Austrian construction company, following a call by banks for more collateral.

    But the leverage that went into building Mr Deripaska’s empire, via which he controls 90 per cent of the country’s aluminium output, is symptomatic of a borrowing boom by Russia’s richest men. The hundreds of billions of dollars raised on Russian collateral helped make Moscow one of the world’s most expensive cities, in a country where the average wage is still only about $700 a month. “This was part of the expanding wealth gap,” says Chris Weafer from the Moscow-based Uralsib investment bank. “The growth of high-end restaurants and clubs and the purchasing of west end apartments in London is a reflection of that.”

    But when the market started to fall after the war in Georgia in August, cutting the value of collateral, the leveraging sparked a vicious circle of forced selling, helping send the Russian stock market down more than 70 per cent since its peak in May.

    The practice of pledging shares in Russian blue chips to raise billions of dollars in loans became widespread as the stock market climbed for nearly five years in a row. Russian banks and western ones led by Credit Suisse and Deutsche Bank headed the trade, say market participants. Estimates on how much money was raised by pledging Russian blue chips vary as widely as $40bn to $120bn. As a result, “no one knows” how much Russia’s actual debt is on top of the $527bn the central bank reports Russian companies and banks have borrowed from foreign banks, says Andrei Illarionov, a former presidential economic adviser.

    Mr Weafer agrees: “One of the reasons Russia’s market has gone down so much further is because investors fear there is a bigger debt problem than the official statistics show.” Among those worst affected, he adds, are a second tier of so-called minigarchs. “A lot of their fortunes were predicated on the growth of asset values. But now they are the most exposed.”


    Comment by Michel — October 26, 2008 @ 9:21 am

  2. Surely this just means that a lot of oligarchs are screwed. How does this affect Russian government finances?

    If anything it might be good for them since perhaps the state will now buy up many of the strategic industries on the cheap and undo the criminal prikhvatizatiya’s of the 1990’s, and the oligarchs can go to debtors’ prison where they belong. OK the latter is just wishful thinking but the former makes sense, I think.

    Comment by Da Russophile — October 26, 2008 @ 6:25 pm

  3. If the oligarchs default, then the assets they put forward as collateral will legally belong to Western banks and investors. This will certainly not please Moscow. So, you have two options: 1) Moscow pays the debt owed by Oligarchs to Western financiers quickly emptying the Russian treasury and making the Russian state ripe for a default and a massive devaluation of the ruble; 2) Russia let’s foreign companies claim possession of large swaths of the Russian economy; 3) foreign investors claim what they are owned and the Russian state disowns them (de facto nationalization) with foreign investors being told that the Russian state does not recognize their legal claims to what should be theirs. I don’t know which would be worse for Russia out of options 1 and 3: in the first Russia goes through another default and in the second they become an economic pariah state. As for the second option, I really doubt that after all their bluster Russia will really let Western interests claim large (if not majority) ownership in Russia’s so-called “strategic” industries. I would not gloat yet Da Russophile.

    Comment by Michel — October 26, 2008 @ 6:43 pm

  4. “As for the second option, I really doubt that after all their bluster Russia will really let Western interests claim large (if not majority) ownership in Russia’s so-called “strategic” industries. I would not gloat yet Da Russophile.”

    Firstly, it depends on what the oligarchs put up as collateral – their Russian assets or the vast amounts of foreign assets they’ve acquired in the West in the last few years (e.g. 10% of America’s steel-making capacity). Secondly, the collapse in value of Russian companies is in this respect actually a blessing in disguise – Western interests can claim ownership in Russia’s strategic industries, and be bought out by the Russian government (which still has 500bn $+!). They’ll probably want to sell anyway since Western banks need funds urgently now and will sell even under priced assets, especially in an emerging market.

    BTW, another thought I had recently. Doesn’t the fall in Russia’s foreign reserves keep nearly exactly matching the fall in the dollar? But the dollar is rising! The Euro has fallen! Measured in Euros, Russia’s reserves may well be higher now than they were a few months ago! ( And that is probably the more important indicator, since the vast majority of Russia’s foreign trade is carried out in Euros!

    “This doesn’t relate to the financing of the purchase of houses, but I still find it hard to believe that such purchases are primarily equity financed, especially in pricey Moscow.” – SWP

    Some construction companies will go bust. Creative destruction and all that. The main point is that it is unlikely to have a big impact on general consumption. In fact probably the biggest effect will be on countries like Tajikistan or Georgia where something a quarter of their GDP’s are due to remittances from their workers in Russia (who are heavily involved in construction).

    Comment by Da Russophile — October 27, 2008 @ 4:36 pm

  5. Da Russophile, I have to say, I have to admire the ways in which you seek to find a ray of hope where there is nothing but bleak financial reality.

    You write: “Russia’s reserves may well be higher now than they were a few months ago!” Perhaps you should inform the Russian media and economic specialists as to your economic insight. You have Russian media such as caught up in russophobia reporting this: “резервы ЦБ уменьшаются на $15–16 млрд в неделю. С 8 августа по 17 октября они «усохли» с $597,5 млрд до $515,7 млрд, или на 13,7%.” Can you imagine, they are reporting that Russian reserves have dropped since the war in Georgia by 13.7% or by 81.8 billion dollars. (source: And then they have the gall to say that the reserves are shrinking by $15-16 billion per week 😉

    Comment by Michel — October 27, 2008 @ 9:53 pm

  6. Michel did you actually read what I said?

    Yes, reserves dropped from 598 to 516, about 14%, from 8 Aug to 17 Oct.

    During that time the euro-dollar ER dropped from 1.5 to 1.35. So it Euros the reserves went from about 400 to 380 – 5%.

    So yeah, they’re not higher. But they aren’t much lower either.

    Considering most of Russia’s trade is in Euros, the latter figure is by far the more relevant one.

    Comment by Da Russophile — October 27, 2008 @ 10:01 pm

  7. Fine, I will accept you hypothesis that the total volume of Euros may have fallen relative to the dollar. However, that does not account for the remainder of the $80-or so billion decrease.

    Comment by Michel — October 27, 2008 @ 10:15 pm

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