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This Sector Could Hinder Russia ETFs

Thanks in large part to what have been, until recently, strong oil prices, Russian stocks and the related exchange traded funds are performing well this year.

The VanEck Vectors Russia ETF (NYSE: RSX) is up 15.41 percent year-to-date, putting the largest ETF well ahead of the MSCI Emerging Markets Index. Plus, RSX gained 1.55 percent in May while the MSCI benchmark lost 6.63 percent.

What Happened

The $1.3 billion RSX reflects the energy-intensive nature of Russian financial markets as the fund devotes 40.70 percent of its weight to that sector. However, another sector could potentially become thorny for Russian markets and RSX.

That sector is financial services, 12.50 percent of RSX's weight, making the group the fourth-largest sector allocation in the benchmark Russia fund. The source of the potential problems for Russian banks is that those institutions are showing increasingly willingness to lend to households that are already highly leveraged.

“On May 30, the Central Bank of Russia (CBR) reported that the share of new cash loans granted to individuals with a payment-to-income (PTI) ratio above 50% exceeded 40% in fourth-quarter 2018, compared with approximately 36% in the previous quarter,” said Moody's Investors Service in a recent note. “This increase indicates higher credit risk in the unsecured consumer loan segment (approximately 50% of total retail loans outstanding),a credit negative for banks' asset quality.”

Why It's Important

Like their counterparts in developed markets, Russian banks undoubtedly see opportunity in lending at higher rates to already indebted households, but as has been the case in other countries, the strategy can backfire.

If the economy there suddenly deteriorates, consumers may become delinquent on their debt, particularly the bills with the highest interest rates and data indicate some Russian lenders have been boosting rates.

“The trend reported by the CBR is partially attributable to banks having started to raise their interest rates on retail loans since the fourth quarter of 2018,” said Moody's. “We regard the increase in new borrowers' leverage as an early warning sign, which leads us to expect deteriorating performance of unsecured consumer loans towards the end of 2019, as cash loans granted in Q4 2018 season.”

What's Next

Alone Sberbank Of Russia is RSX's largest holding at a weight of 8.74 percent. Fortunately for investors, that bank is not among those Moody's views as most vulnerable to the trend of lending to already heavily indebted consumer.

“Importantly, the overall debt-servicing capacity of Russian borrowers, based on all the outstanding retail loans of different types, has continued to improve in recent months. On 29 May, Russia's National Bureau of Credit Histories reported that the nationwide PTI ratio,the share of households' monthly income spent on debt payments, declined to 22.99% as of 1 April 2019 from 23.55% six months earlier,” according to Moody's.

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