Fixed Income - If CBR Turns Even More Hawkish, Local Corporate Bids for Payer Swaps Could Pick Up

As banks have considerably expanded their floating-rate loan books in recent months, hedging from local corporates has begun having a somewhat larger effect on swap rates. However, CBR data suggests that local corporates have so far hedged only a sliver of their loans. Hence, their demand for paying fixed rates could rise if the current hiking cycle turns out quicker than expected. Swaps price in at least 130 bps of additional hikes by the CBR over the next year, but we ask: What if the CBR is even more hawkish at upcoming meetings? If bids from local corporates re-emerge soon, we think that could provide an additional tailwind for bear-flattening in ruble rate curves.> Last week, the CBR published interesting data on floating-rate loans in Russia's bank sector. The share of these loans to nonfinancial entities rose from 31.9% at the start of 2020 to 37.9% at end-1Q21. Most floating-rate loans (73.4%) are benchmarked to the key rate. > This came amid a rise in the volume of outstanding fixed-for-floating interest rate swaps, which grew from R3.3 trln at the start of 2020 to R6.9 trln at end-1Q21. Over that period, local banks (excluding subsidiaries of foreign banks), which are the most active participants in the domestic swap market, more than doubled (a 2.3-fold increase) their net fixed-rate paying position, to around R1 trln. Subsidiaries of foreign banks and nonresidents are their key counterparties in swaps - they held a net receiving position of R830 bln as of April 1. Local corporates, similar to local banks, are also net payers in interest rate swaps, with Russia's systemically important banks representing 94% of the counterparties for such swaps. Thus, Russian corporates effectively pass on some of their interest rate risk to SIFIs, which in turn pass that risk on to internationals. > Local corporates were expanding their net paying position during 2020-1Q21, from R126 bln as of the beginning of 2020 to R221 bln at end-1Q21. Notably, despite such rapid growth, as of end-1Q21, local corporates had still hedged only a tiny share of their floating-rate loans. The share of hedged key rate-linked loans has remained almost flat over that time frame at around 2.0-2.5%.> However, we think that corporates likely increased that share in April-May due to a hawkish turn in the CBR's rhetoric. But given the low base, there is plenty of room for them to build up their position as payers of fixed rates, especially if inflation remains elevated and the CBR keeps surprising the consensus on the hawkish side. Recall that the CBR delivered bigger than expected rate hikes in March and April (we were among the few houses that predicted both correctly - see our decision reviews for the March and April meetings). The current levels of the swap curves already look conservative - the market has priced in at least 130 bps of further rate hikes over the next year, on our estimates. However, we think there is a risk that front-loaded hikes by the CBR could temporarily push rates even wider from here (historically, the market has often overshot the actual scope of rate hikes - for instance, that was the case in late 2018). If such a risk does materialize, their demand to pay fixed rates will likely pick up due to the recent expansion of their floating-rate loans and the still-low share of already hedged floating-rate loans. Thus, the question is: In which tenors will we see the highest demand? We think it quite reasonable to assume that demand will mirror the maturity structure of their floating-rate loans. The CBR data suggests that corporate exposure to floating-rate loans is skewed toward short and medium tenors. For large corporates, 52% of all floating-rate loans have a maturity of less than 3y and 70% of less than 5y. Hence, the corporate bid, should it be reignited by more hawkish CBR rhetoric, may be an additional driver for bear-flattening in ruble swap curves (bear-flattening is our base case - see our note "How To Play a Front-loaded Rate Hike Cycle").