If Bank of America’s (NYSE:BAC) eye popping 10.5% Brazilian real bond caught your attention, then JP Morgan’s (NYSE:JPM) 11% Russian ruble won’t lose it. As mentioned previously, it is fairly common for large multinational financial institutions, which certainly includes JP Morgan Chase, to issue debt (bonds) denominated in the local currency of countries where they conduct business. And like Bank of America, it is to JP Morgan’s advantage to borrow, leverage, and lend in a local currency because it removes any “currency exchange risk” from their most basic and fundamental business of borrowing, leveraging, and lending.
This time, we have identified certain of JP Morgan Chase’s debt, denominated in the Russian ruble, which currently has a yield over 11.0% for 69 months. The extremely high yield and medium length maturity of this Russian bond, when considered with its solid Aa3/A+ rating and good cash position, compares extremely favorably with other high yielding instruments in our Foreign and World Fixed Income holdings, and we view the most recent weakness in the ruble as an opportune time for adding it to our basket of foreign fixed income holdings. We believe the dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power, and we view the recent European debt concerns to have unduly weakened the Russian Ruble. The resulting strength of the dollar appears to have presented a great opportunity to diversify into the Russian economy, which continues to show remarkably good growth potential in spite of the recent financial turmoil.
Russia has undergone significant changes since the collapse of the Soviet Union, moving from a globally-isolated, centrally-planned economy to a more market-based and globally-integrated economy. Economic reforms in the 1990s privatized most industries, with notable exceptions in the energy and defense-related sectors. The Russian export industry consists primarily of natural gas to the eurozone, is the world’s second largest exporter of oil, and is the third largest exporter of steel and primary aluminum. This reliance on commodity exports makes Russia vulnerable to boom and bust cycles following the highly volatile swings in global commodity prices, and provides reason for the higher correlation of its currency to oil prices.
The economy had averaged 7% growth since the 1998 Russian financial crisis, resulting in a doubling of real disposable incomes and the emergence of a middle class. The Russian economy, however, was one of the hardest hit by the 2008-09 global economic crisis as oil prices plummeted and the foreign credits that Russian banks and firms relied on dried up. The economic decline bottomed out in mid-2009 and the economy began to grow in the first quarter of 2010. Growth for 2010 was 4%, and unemployment in Jun declined to 6.1 %. Capital markets are relatively small but growing and are dominated by energy companies. 2011 estimates for GDP growth were recently reduced to 4.2%.
Russia’s competitive flat income tax rate and low corporate tax rates support innovation, although private enterprises also must cope with “informal taxes” such as bureaucratic hassling and corruption. Other taxes include a value-added tax (VAT) and a regional property tax. In the most recent year, overall tax revenue as a percentage of GDP was 34.1 percent. In the most recent year, total government expenditures, including consumption and transfer payments, increased slightly to 34.1 percent of GDP. The state maintains a strong presence in such key sectors as energy and mining. Public debt is at 11 percent of GDP ($1.465 trillion in 2010), while inflation slowed to 9%.
|Country||Debt to GDP||2010 GDP growth||Unemployment Rate|
|Russia||11.0 %||4.0 %||6.1%|
|United States||92.7 %||2.8 %||9.2 %|
About JP Morgan Chase
JPMorgan Chase & Co. is one of the oldest financial institutions in the United States, with a history dating back over 200 years, and is built on the foundation of more than 1200 predecessor institutions. The firm is a leader in investment banking, financial services for consumers, small-business and commercial banking, financial transaction processing, asset management and private equity. It operates in more than 60 countries with over 200,000 employees, and its assets total $2.2 trillion.
Last month, JP Morgan reported second-quarter 2011 net income of $5.4 billion, compared with net income of $4.8 billion in the second quarter of 2010. Earnings per share were $1.27, compared with $1.09 in the second quarter of 2010.
Commenting on the firm's balance sheet, CEO James Dimon said: "We maintained our fortress balance sheet, ending the second quarter with a Basel I Tier 1 Common ratio of 10.1%. Our strong and growing capital base enabled us to buy back $3.5 billion of stock during the second quarter, and we will continue to buy back stock opportunistically. We estimate that our Basel III Tier 1 Common ratio was approximately 7.6% at the end of the second quarter. This level is well in excess of what is required today under existing rules and is greater than the level we expect will be required under the proposed rules for up to five years, including the additional buffer for global systemically important financial institutions. Our strong capital position and significant earnings power will allow us to actively grow our business and rapidly meet any proposed Basel III requirements as they are phased in. We intend to keep our capital ratios approximately where they are as we do not see a need to manage to higher ratios ahead of time."
In concluding, Dimon stated that they continue to see substantial opportunities for the company building up their international presence, with more bankers, branches and products to serve our multinational clients where they want to be served. JP Morgan Chase’s senior unsecured debt is rated Aa3 by Moody’s, A+ by S&P, and AA- by Fitch.
|J P Morgan bonds||Interest Rate||Ratings||Maturity|
|Russia Linked||11.00+ %||Aa3/A+/AA-||June of 2017|
|United States||3.80 %||Aa3/A+/AA-||July of 2017|
|U.S. Treasury||1.49 %||Aaa/AA+/AAA||August of 2021|
These JP Morgan bonds, linked to the Russian ruble, have an over 7.0% higher yield than their very comparable U.S. obligation. The Russian linked bond spread is over 9 % measured against the longer 10 year bench mark U.S. Treasury bond, indicating a better than 500 % yield improvement with a 4 year shorter bond.
The default risk is JP Morgan’s ability to perform. Considering JP Morgan’s highly experienced and outstanding management team (led by James Dimon), its proven leadership role throughout the 2008 financial crisis that set them above many of their peers, and it’s quality Aa3/A+/AA- credit ratings, it is our opinion that the default risk is very minimal relative to the currency risk of the Russian ruble.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Russia’s economy.
Russia's long-term challenges include a shrinking workforce, a high level of corruption, difficulty in accessing capital for smaller, non-energy companies, and poor infrastructure in need of large investments. The Russian economic decline bottomed out in mid-2009 and the economy began to grow in the first quarter of 2010. However, a severe drought and fires in central Russia reduced agricultural output, prompting a ban on grain exports for part of the year, and slowed growth in other sectors such as manufacturing and retail trade. Higher oil prices, which buoyed Russian growth in the first quarter of 2011, could help Russia reduce the budget deficit inherited from the lean years of 2008-09.
Accessibility and Liquidity
JP Morgan Chase currently maintains over $700 billion of outstanding debt, mainly denominated in U.S. dollars. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual JP Morgan Chase’s Russian ruble denominated bonds. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and advisor's assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as $ 10,000 U.S. dollars.
While acknowledging that every investment vehicle involves varying elements of risk, we believe that this recent strengthening of the U.S. dollar relative to the Russian ruble represents an extremely attractive opportunity for initiating a moderately longer term exposure to the Russian economy with a well respected issuer, at a very attractive yield. A continued demand for Russia’s abundant supply of oil and natural gas will likely result in a continued strengthening and expansion of their economy, which in turn is likely to result in the strengthening of the ruble currency, which we believe is one of the currencies more highly correlated to the price of oil. Therefore, we view the ruble currency risk of this prominent emerging market as an unusual and significant opportunity that we have highly recommended our clients take in their continued effort to diversify away from overweighted U.S. dollar-based assets, and it is why we have added it to our Foreign and World Fixed Income holdings.