Russian Default Gives Investors the Jitters

By JOANNA SLATER in New York and ANDREW OSBORN in Moscow A tiny default by a Russian aircraft-leasing company is sending ripples through the much larger market for the country's debt. The default by Finance Leasing Co. on $250 million of bonds is the first by a Russian state-owned company on foreign debt since the country's 1998 financial meltdown. That is rattling foreign investors, who worry that Russia could allow many more companies to renege on billions of dollars of debt while it grapples with an economic and financial crisis. "It's clear that the capacity and willingness of the government to...provide support to a large number of entities is declining," says Ed Parker, head of emerging Europe sovereigns at Fitch Ratings. View Full Image Itar-Tass/ Getty Images A Russian Tupolev 204, one of the types of planes leased by Finance Leasing Co., at the Berlin Air Show in 2006. The Russian state-owned company defaulted on $250 million of bonds. After suffering a currency crash and a default on its sovereign debt a little more than a decade ago, Russia began to recover thanks to soaring energy prices. That drew back foreign investors. And when times were good, Russian companies borrowed heavily in international debt markets, to the tune of more than $215 billion since 2006, according to Dealogic. Now they are facing an environment where it is impossible to get funding from abroad and the local banking system is under huge strain. The ruble has also tumbled, making it more onerous to repay debts denominated in dollars or euros. J.P. Morgan Chase & Co. estimates that Russian firms need to refinance or pay off at least $40 billion in foreign-currency borrowing this year alone. To do that, many will need help from the Russian government. FLC's default has raised the ire of investors, a number of whom said they participated in the issue only because of the company's ties to the government. "It was the first Russian bond I bought in 10 years, and I regret it," says Michel Lahaie, head of Axiom Investment Management, a Hong Kong money manager who invested funds both personally and on behalf of clients. "Frankly, we're all stupid for lending money to Russia." The government has made it clear that it can't help the entire corporate sector with its foreign-currency debt. Earlier this year, it scrapped a $50 billion fund aimed at helping companies with such borrowing. In addition, Russia has depleted its considerable foreign-exchange reserves, spending more than one-third of what was once a $600 billion stockpile since last August. Some analysts believe FLC will prove to be an isolated case, since it seems to involve specific issues of mismanagement. However, others note that by allowing FLC to default, the message from the government appears to be "we'll take care of the big guys, but after that, you've been warned," says Jonathan Schiffer, lead sovereign analyst for Russia at Moody's Investors Service in New York. Investors shouldn't assume that "just because a company is directly or indirectly owned by the state that that provides some sort of comfort for bondholders," he says. FLC is a subsidiary of United Aircraft Corp., a large Russian state-owned conglomerate that includes the makers of the famed MiG fighter planes and Sukhoi jets. The state directly owns a 29% stake in FLC and a further 52% indirectly through United Aircraft, itself 90% state-owned. In December, FLC defaulted on $250 million in debt held by investors including major American, British and European banks, institutional investors, and hedge funds, as well as Russian banks. On one part of that borrowing, it failed to make its first interest payment. The $150 million five-year bond was issued last June with a coupon of 10%. Moody's rated the debt two notches below investment grade. It said the company enjoyed a "medium" level of government support and noted that "a default on the part of the company could cause embarrassment, as it would imply government mismanagement in an area of great economic importance." FLC declined requests for comment. Maxim Sysoev, a spokesman for United Aircraft Corp., FLC's parent company, said the situation was "complex" and the company was monitoring the situation to see if FLC "can cope on [its] own." Some investors remain convinced that Russian authorities will step in. "They really are wise enough to know that this is a crucial issue and a crucial industry," says Francois Nordhof, an asset manager at Banque de Commerce et de Placements, a Swiss private bank that is one of the bondholders. If you need foreign investors in the future, he says, "you need not to disappoint them, even in the current turmoil." Write to Joanna Slater at joanna.slater@wsj.com and Andrew Osborn at andrew.osborn@wsj.com