Finance Leasing investors gear to fight Russian government over unpaid interest

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Less than one year ago, Finance Leasing Company (FLC) marketed a USD 150m bond as quasi-sovereign risk, touting close ties to the Russian government through its owner, United Aircraft Corporation. The company recently pulled an about-face when it stressed its independence from state-owned UAC and said it did not expect support from the corporation at a meeting to discuss restructuring with bond holders, a buyside source told Debtwire.

The shareholder structure shows a clear connection between the two companies and bondholders are drawing battle lines in a dispute with UAC and the Russian government, according to several sources close to the situation. Frustrated by a lack of progress in the workout, investors are ready to seek full and immediate repayment through legal action but it remains uncertain how enforceable any court ruling might be in Russia, said a bondholder and a legal source.

The amounts involved are relatively small – FLC owes USD 12m of interest on two bonds worth USD 250m – but the stakes are high, said one of the sources. “If FLC does not resolve this default quickly, all state-owned Russian companies will be viewed differently by local and foreign investors,” the source said.

FLC sold its bonds bolstered by letters of comfort issued by United Aircraft Corporation (UAC) and Russia’s transport ministry. Other issuers in Russia benefiting from letters of comfort include TransCredit Bank, BTA bank and various regional banks.

A banking source involved in the workout talks with FLC said the investor community’s confidence in the Russian government has been shaken by recent events: “The situation is not going anywhere. [In fact] it is getting worse and worse – like gangrene.”

The letter of the law

FLC’s problems came to a head on 20 December when it missed a coupon payment on a USD 100m 9.25% bond due in 2011, and just over a week later failed to make an interest payment on a USD 150m issue that matures in 2013. Noteholders maintain that letters of comfort mean the Russian government is liable for the payments.

A 51.8% stake in FLC is held by UAC, which is 90%-owned by the Russian government. The Russian government also has direct ownership of a 28.69% stake in the leasing company. Several creditors claim FLC’s failure to pay interest on its two bonds constitutes the first default on a foreign-currency obligation by a state-owned Russian company since the sovereign default of 1998.

The letters of comfort were signed by UAC’s chairman, Alexei Fedorov. One was sent to Moody’s in February 2008 and the other was addressed to export credit agencies and financial institutions in September 2008. In the second letter, UAC confirmed its intention “to provide the company [FLC] with support and assistance, which can be required for guaranteeing the sufficiency of capital and liquidity for the purposes of the timely fulfilment of financial obligations.”

Sources close to UAC and FLC say the letters do not constitute a guarantee and support from UAC will not be forthcoming. FLC has hired PricewaterhouseCoopers as financial adviser and has spoken this week with holders of both its bonds, as reported.

Nicolas Genechesi, a senior analyst at FLC bond holder Forum Asset Management, said FLC has so far been unable to answer questions about the likelihood of a restructuring proposal. He described a conference call with FLC and PwC this week as a step forward but not much more: “There is no indication that UAC or the Russian government have any intention of participating in FLC’s restructuring.”

Forum is one of 40-50 local and international financial institutions owed money by FLC, Genechesi said. Holders of the leasing company’s USD 150m bond arranged by BCP Securities have formed a 12-strong committee representing around 80% of the notes and are likely to hire financial and legal advisers of their own.

“The committee has waited patiently and made several attempts to meet with government officials to solve this situation, but, so far, to no avail,” Genechesi added.

Fight or flight

FLC derives most of its leasing income – 85% in 2007 – from the aviation sector by leasing commercial passenger aircraft and aircraft manufacturing equipment to Russian airlines. It made a profit of USD 7m in 2006 and USD 6.72m in 2007, according to information circulated to investors.

The company’s USD 150m issue is governed by English law and noteholders appear to have a strong case against UAC and the Russian government, according to Dmitry Sobolev, a senior associate from Moscow-based law firm Avakian, Tuktarov and Partners. “A comfort letter containing representation from the sponsor’s shareholder with respect to the credit quality of the bonds has serious weight,” he said. “It is more than likely that a UK court will award damages to the bondholders if the information in a comfort letter can be proved to be misrepresentation.”

But enforcing such a judgment could be difficult, he added. “It becomes more complicated to deal with such documents in Russia because the country lacks tort law for misrepresentation,” said Sobolev. “And the political context could cause some difficulties because the company is a strategic enterprise with the government as a shareholder.”

The state’s shareholdings in the Russian aircraft industry were consolidated by the Russian government in 2006 through United Aircraft Corporation, and in presentations to investors FLC stressed its “close links” with the Russian government and UAC. It has received USD 250m of capital injections from the Russian government since 2002.

FLC’s bonds were rated, marketed and purchased on the assumption that they were quasi-sovereign issues, said the banking source. Moody’s initially assigned the company a ‘Ba3’ rating, which it has subsequently cut to ‘Caa3’. The rating agency attributing FLC’s two defaults to “inadequate” liability management and a significant deterioration in asset quality.

The leasing company hopes to receive additional funding from state-owned Russian bank VTB, as reported, but in the meantime, holders of FLC’s USD 150m bond have decided to accelerate the notes. That process is likely to be finalised by the end of next week via trustee Bank of New York, said the banking source.

Bond holders are embroiled in a bureaucratic procedure, said one London-based fund manager with experience of Russian bond defaults in 1998. “This won’t be a standard commercial negotiation and a debt-for-equity swap is clearly out of the question,” he said. “The Russian government is unlikely to ignore the company, it just has other priorities at the moment.”

This sentiment was echoed by Andrey Markov, a credit analyst at Renaissance Capital in Moscow. “The company [FLC] was never a core business for its current majority shareholder and in the past UAC has demonstrated its own discontent with FLC’s management and its actions,” he said.

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