GOR BAILOUTS DONE, DEBT RESTRUCTURING NOW FLAVOR

C O N F I D E N T I A L MOSCOW 000987

SIPDIS

STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON, WRIGHT
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR ELLISON

E.O. 12958: DECL: 02/09/2019
TAGS: EFIN ECON RS
SUBJECT: GOR BAILOUTS DONE, DEBT RESTRUCTURING NOW FLAVOR
OF THE YEAR; "MOSCOW RULES" COMING?

REF: A. MOSCOW 859

B. MOSCOW 743

C. MOSCOW 621

D. MOSCOW 534

E. (08) MOSCOW 1775

Classified By: ECON MC Eric T. Schultz, Reasons 1.4 (b/d).

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Summary
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1. (C) As we have previously reported (Refs A - D),the GOR
has made a major change in policy in the last two months with
respect to assisting cash-strapped Russian firms with their
foreign debts. Several recent cases have made clear that the
GOR is serious and that these firms can no longer expect
large state bailouts. They should instead seek to
restructure their foreign debts. Finance Leasing Company
(FLC),a tiny aircraft leasing firm, recently became the
first Russian state-owned company in more than a decade to
default on foreign debt. Privately owned UC Rusal, an
aluminum giant, is continuing debt-restructuring negotiations
with more than 70 creditors after GOR officials said they
would not bail out the cash-poor company. Alfa Bank,
Russia's largest private bank, was Rusal's only creditor not
to agree to the standstill partly because it too is hurting
for cash, partly because of the GOR's policy change. The
authorities' decision to stop bailing out Russian firms
should reduce pressure on Russia's resources, including its
reserves, which have fallen about $215 billion since last
August. However, the decision raises concerns among Western
bankers, who are turning to the GOR for assurances in default
and near-default situations. Several recently told us that
2009 and 2010 promise to be "years of restructuring" as
Russian companies attempt to unwind large debt positions
built since 2006. End summary.

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GOR Encourages Restructurings to Preserve Resources
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2. (C) The GOR has enough reserves to forestall another run
on the ruble, help Russian companies refinance debt on a
large scale, or fund large budget deficits for the next two
years. However, it does not have the resources to address
all of these challenges. As we have previously reported, the
GOR made the decision in recent months that it would no
longer bailout cash-strapped Russian firms but would instead
focus its remaining resources on social spending through a
sizable budget deficit funded out of its foreign exchange
reserves. Finance Minister Kudrin's Assistant, Vadim
Grishin, confirmed to us in March that the Ministry was
firmly signaling to both the companies and their creditors
that there would be no government bailouts. They would have
to restructure or deal with the consequences of defaults.


3. (C) Alexey Novikov, Standard and Poor's managing director
for Russia, told us contingent liabilities are a "big part of
the story," and the GOR's belated recognition that its
reserves cannot cure all was probably why it had changed its
policy on bailouts. Novikov said the sovereign's investment
grade rating was still probably safe as long as reserves
stayed above $300 billion and, like many local analysts,
predicted that the GOR would let the ruble fall if it again
came under pressure rather than running reserves down
further. That said, he could not rule out a credit downgrade
even if reserves held steady should the ruble depreciate
further amid indications that the budget deficit would be
larger than expected, causing the macroeconomic environment
to worsen significantly.

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Little-Known Company Creates Big Stir
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4. (C) Grishin told us candidly that the FLC case illustrated
the GOR's resolve to maintain its new strategy toward
cash-poor firms and their foreign debts. In December, FLC
became the first Russian state-owned firm to default on
foreign debt in more than a decade when it missed interest
payments on bonds worth $250 million. The GOR, which owns
about 80 percent of the company directly and through the
United Aircraft Corporation, the state-aerospace holding,
gave no indication it would bail out creditors, even though


investors in FLC's debt include about 50 foreign and Russian
financial institutions. UAC board member and Deputy Prime
Minister Sergey Ivanov later said UAC would help FLC "settle
the issue," but again gave no indication the GOR would make
good on the firm's debt.


5. (C) UralSib Chief Strategist Chris Weafer told us the case
was a "shot across the bow" for creditors and a firm signal
that the GOR would not bail out Russian enterprises and their
foreign creditors.

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The Rusal Saga Continues
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6. (C) Rarely does a day pass in Moscow when Rusal, its
affiliates, and Oleg Deripaska, its primary owner, do not
make headlines with regard to the company's massive debts,
much of it denominated in foreign currencies. The latest
headline was an agreement in late March by Mikhail
Prokhorov's Onexim Group to boost its stake in Rusal to
almost 20 percent as part of a very favorable (to Rusal)
restructuring of $2.8 billion owed by the aluminum firm.
Prokhorov is rumored to have agreed to these terms under GOR
pressure, given that the deal was based on what most analysts
considered a grossly inflated current market value for Rusal
of $45 billion.


7. (C) The aluminum company and related firms owe creditors
at least $15 billion, including $7.5 billion due to
foreigners this year, and may be as much as $30 billion in
debt, although the exact number is anybody's guess. Citi's
Russian Country Officer Zdenek Turek and HSBC Russia CEO
Stuart Lawson told us that nobody knows how much Deripaska
owes, including Deripaska himself. According to our
contacts, foreign investors are watching the Deripaska case
closely, viewing it as a test case for how the GOR will
respond to other major Russian enterprises. Alfa Bank Chief
Economist Natalia Orlova told us that the Rusal case would be
a key indicator of how willing the GOR is to be a good
business partner because of its close ties to the private
company. She said only 10-15 percent of investors understand
the firm is bankrupt, and that many foreign banks demanding
that they be repaid are probably doing so in vain. If Rusal
defaults on large chunks of this debt, according to Orlova,
its creditors would probably reduce lending to Russian firms
for years, even if global credit markets open soon.


8. (SBU) Recognizing the gravity of Rusal's situation, First
Deputy Prime Minister Shuvalov in late March publicly said
the GOR might allow Deripaska to pay foreign creditors of
Rusal with shares of the company. This would mark a major
shift for the government, which has made keeping major
Russian assets in Russian hands a primary goal of the GOR's
anti-crisis efforts to date. The GOR, for instance, loaned
Deripaska $4.5 billion last fall (due to be repaid later this
year) to pay a consortium of foreign banks who were
threatening to seize a large part of his Rusal stake, which
he had pledged for a large purchase of Norilsk Nickel.
Shuvalov's admission that the GOR is open to greater foreign
ownership of Rusal, and other recent comments from Shuvalov
that the GOR "overpaid" Deripaska late last year are further
indications of the GOR's policy change.

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Fridman in Trouble?
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9. (SBU) Rumors are also rife that Alfa, controlled by
Mikhail Fridman, is in trouble. As we recently reported (Ref
A),the core bank appears to be deeply concerned about a
rising percentage of non-performing loans (NPLs). Alfa's
CEO, Petr Aven, went so far as to suggest in early April in
an interview with Russian business daily Vedomosti that the
bank would be willing to sell almost 50 percent of its shares
to the state in return for recapitalization funds. In
addition, Alfa Bank's parent, Alfa Group, borrowed more than
$2 billion late last year from the GOR to ensure Alfa's stake
in Vimpelcom--Russia's second largest telecom provider--did
not fall into foreign hands because Fridman had pledged a
large stake of the company as collateral for a foreign loan.
Then earlier this month, Alfa became the only major Rusal
creditor to refuse the so-called standstill agreement with
Deripaska. Fridman later backed off his hard-line position
toward Deripaska, issuing a statement that the two were

seeking a "mutually acceptable" solution, but questions about
Alfa's financial health remain.


10. (C) Merrill Lynch Chief Economist Julia Tsepliaeva told
us that Alfa could be a "big domino going down," and its
collapse could reverberate through the entire economy. She
said that the parent company and Fridman were highly
leveraged, citing Fridman's recent closing of his
London-based hedge fund and Alfa's large exposure to Ukraine.
Alexey Moiseev, Renaissance Capital's fixed income research
director, echoed this view, saying that a moratorium on
corporate debt payments is likely in Ukraine, which would
have a major negative impact on Alfa. If foreign creditors
find themselves in restructuring talks with Fridman and Alfa,
they may look back on the Deripaska negotiations
nostalgically -- Fridman's track record on TNK-BP (Ref E) and
Norwegian telecom company Telenor (Ref B) speak for
themselves.

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"London Rules" in Moscow?
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11. (C) Russia HSBC CEO Stuart Lawson at a banking conference
in late March called for the creation of a commission that
would help firms like FLC, Rusal, and Alfa restructure debts.
Lawson said the commission would be modeled on the "London
Rules" (aka London Approach) for debt restructuring (N.B. The
London Rules are a set of non-binding principles designed by
the Bank of England in the 1970s -- updated in the 1990s --
to guide large-scale debt restructuring, ensuring that viable
companies survive and minimizing losses to financial
institutions). Lawson said a "Moscow Rules" commission would
help define creditors' rights and make use of lessons learned
from past restructurings to ensure an orderly process.
Grishin confirmed to us that talks on such a commission were
under way but said no agreement was imminent.


12. (C) Lawson told us privately that he sits on a bank
coordinating committee working with Deripaska on the Rusal
debt. The committee includes the western banks with
significant exposure (in the $200-400 million range for each
bank) to Rusal debt, including Royal Bank of Scotland,
Societe Generale, Citibank, Ceylon, and BNK Paribas. Lawson
said Shuvalov and First Deputy Prime Minister Sechin had both
spoken to the Western institutions, emphasized the GOR's new
policy, and made clear that they would need to agree to the
standstill agreement or deal with the consequences.


13. (C) Lawson added that he personally favored the
standstill agreement, without which the foreign banks would
have been frozen out of the restructuring process. That
might have resulted in a situation like that of the Yukos
affair, where the foreign banks had been required to abrogate
their claims in order to get anything back on their loans.
With the standstill agreement and the possibility of a more
orderly restructuring, the foreign banks at least had a
chance at acquiring a portion of Rusal's underlying assets,
rather than see them slide back to the state or political
insiders, with "dirty hands" all over the deal.

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Comment
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14. (C) The GOR's change in policy comes at a time when
would-be creditors have already negatively re-evaluated their
risk appetite for emerging markets and for Russia in
particular. In the short term, the GOR's decision not to
provide bailout support probably has little effect on
sentiment. Lenders are already demanding much higher risk
premiums to lure them away from quality, and prospective
sources of financing for Russian firms will probably wait out
the crisis regardless. Capital inflows to Russia are
therefore expected to be virtually non-existent until the
economy begins to recover. However, longer term, the outcome
of the restructuring negotiations taking place this year and
expected to continue into 2010 could affect lender sentiment
toward Russia leading to still further increases in the risk
premiums on Russian debt. This in turn could slow Russia's
economic recovery when it does occur, given the economy's
continuing dependence on foreign capital. End comment.
BEYRLE