Kazakhstans banks have suffered more than most in the summers global credit rout. What is the outlook for the countrys most prolific borrowers and can they regain the confidence of investors, asks Joanne OConnor?
With spreads widening, a swathe of ratings downgrades and deals being postponed or abandoned, the fortunes of Kazakhstans banks the countrys most prolific borrowers in the Eurobond market took a sharp turn for the worse this year.
At the end of 2006, Kazakh banks had $33bn of outstanding foreign borrowing, but by June this year, the figure had leapt to more than $40bn. In the first two months alone, six banks Bank TuranAlem, Bank CenterCredit, Alliance Bank, TsesnaBank, Kazkommertsbank and ATF had printed Eurobonds worth the equivalent of almost $5bn.
A surging domestic credit market over the past three years has seen average credit growth of 75% annually in Kazakhstan, and many of the countrys banks are growing at an even faster pace. In the first half of 2007, lending expanded by almost 40%.
This lending boom has been principally funded by external borrowing, which grew from 38% of total liabilities in 2004 to 52% at the end of 2006. And despite attempts by the regulator to control spiralling foreign borrowings, Kazakh banks continued to take advantage of abundant global liquidity at attractive terms.
Bumper start to the year
When in January Bank TuranAlem opened the market, the prevailing theme was one of investors flush with cash, chasing supply.
In a single blow, BTAs cleanly executed dual tranche deal took out half of its ambitious borrowing programme for the year. Comprising a short dated $250m two year floater and a $750m 30 year non-call 10, the deal met with a rapturous response from investors who lavished the deal with orders the short dated floater attracted $850m of orders while the 30 year paper garnered a $1.95bn book.
Bookrunners Credit Suisse and JP Morgan structured the deal to target demand for short-dated floaters amid the prevailing interest rate uncertainty while also appealing to real money accounts looking to tap the longer end of the curve. Most away from the deal agreed with its pricing rationale the 30 year non-call 10 came with a 5bp-10bp new issue premium while the two year floater was priced with a 5bp premium to the curve.
Bank CenterCredit, one of the countrys less frequent borrowers, followed with a $500m seven year transaction, pricing at the tight end of guidance that was already revised from 9% to 8.85%-8.9%. Some 188 investors showered the deal with demand, placing $1.84bn of orders for the bonds.
Seeing the flood of dollar issuance from BTA and BCC, Ba2 rated Alliance Bank opted for euros and in late January, it brought its debut for 2007, a Eu750m five year through HSBC and UBS. Even for a Kazakh bank, the deal was ambitious the largest ever out of Kazakhstan and the largest euro print out of the CIS. Yet despite its size and the promise of more issuance from Kazakhstans banks, the wall of liquidity ensured the deal was greeted with a phenomenal Eu2.3bn of demand from more than 240 accounts. The deal tapped the pool of euro assets in Asias private banking sector and as demand flooded in, the leads tightened guidance from 400bp over mid-swaps to 385bp-390bp over, before the deal priced at the tight end.
As with the BCC deal, bankers on the print were amazed by the sheer volume of demand.
Also in January, B1/B- rated TsesnaBank, the countrys 14th largest bank, and the only one to be headquartered in Astana, gave investors a much wanted opportunity to play in a higher yielding Kazakh banking name. Its $125m three year was priced 10.125%. Again, the sheer number of investors that participated surprised even the leads more than 50 accounts were allocated bonds, 32% of whom were UK names and 55% European accounts on the hunt for yield.
Having gorged themselves in the dollar market, Kazakhstans banks have increasingly sought to diversify their investor base and thus attain the tightest possible pricing, by sampling new currencies, maturities and structures.
In 2006, they delved into euros and sterling for the first time and priced smaller opportunistic deals in Polish zlotys and Singapore dollars too.
This year, the trend continued, and buoyed by the success of Bank TuranAlems sterling debut in November 2007, Kazkommertsbank plunged into the sterling market with a £350m five year, priced at 220bp over Gilts. The deal came as part of a dual tranche issue featuring a Eu750m 10 year, matching the ambitious euro print from Alliance Bank just a fortnight earlier.
The deal came ahead of new central bank regulations aimed at putting the brakes on foreign borrowings by the countrys banks and was thus seen by some accounts as their last opportunity to participate in a large, liquid transaction from the country. While the borrower was happy with a Eu500m transaction, it became clear on the roadshow that sterling accounts were sniffing out higher yielding instruments, so the borrower opted for an opportunistic print.
The sterling book reached £850m with 90 accounts participating, while the euro piece garnered a whopping Eu3bn book with 250 accounts placing orders. While the pricing was 5bp-10bp back of the dollar curve for the euro trade and 10bp back of dollars for the sterling, most away from the deal agreed it was not overly wide.
The value of scarcity is amply demonstrated by the success of Baa1/BB+/BB+ rated Halyk Banks largest ever issue. The $700m 10 year deal was met with a stampede of orders and priced at a super-tight 220bp over mid-swaps. The appearance of Halyks dynamic CEO Grigori Marchenko gave the deal an added boost as investors took the opportunity to quiz the formal central bank governor on the state of the market generally. For the first time the bank priced inside of Kazkommertsbank.
"Our general approach is to rely on our so-called fan club of investors," said Marchenko. "This consists of 30-35 accounts who we meet regularly and who know Halyk and Kazakhstan well. Our general policy is to distribute 70%-75% of our deals to this loyal fan club but with this deal we were also happy to see over 30% of the bonds go to new investors."
Victims of their own succcess
The sell-off in the credit markets has hit Kazakh banks the most prolific borrowers in the emerging markets particularly hard and spreads have widened by as much as 200bp for some borrowers.
Kazkommertsbank was forced to cancel its bond exchange deal and a swathe of other banks have postponed roadshows in the hope markets will improve.
The last Kazakh borrower to tap the Eurobond market was Bank TuranAlem, which priced a $250m tap of its 2037 notes through Deutsche Bank. Yet, as borrowers wait for direction in the markets, few believe spreads will return to the record tights of earlier this year any time soon.
"I dont see a significant call-back in spreads in the near-term," says Stefan Weiler, vice president of emerging market bond origination at JP Morgan in London. "In my view, the market will probably stabilise at wider levels. For most issuers, this will mean looking at the international capital markets as a source of more expensive funding than they would have had a few months ago."
Even before the malaise hit the credit markets in July, there were growing signs that investors, having gorged on Kazakh risk, were tiring of the seemingly endless stream of issuance from the countrys banks.
"During 2006, a number of investors were upset when banks print far bigger deals than they talked about during roadshows," says Ray Harte, head of emerging market origination at Dresdner Kleinwort in London.
Sterling investors in particular have turned away from Kazakhstan, with spreads on sterling issues widening sharply. "Earlier this year when the sterling market was hungry for yield, some Kazakh banks took advantage and managed to place paper with this investor base. This was the first time sterling investors looked at such paper," says Harte.
Says another banker, who declined to be named,"Kazakh borrowers like Alliance brought deals on the back of the sterling market being very strong. But when the market weakens, these sorts of bonds are just the thing sterling investors will lose first, so it widens dramatically."
The widening of spreads on Kazakh bonds highlights the double-edged sword of investor diversification. On the one hand, borrowers can attain price tension through engaging new investors but on the other, more experienced names are less easily scared when markets turn sour.
"Banks who need to utilise the international debt capital markets for the long term need to be careful about allocations and really must include people who are familiar with their name and their market," says Harte but admitting "of course, the only way to improve pricing is to engage new investors."
Nonetheless, while the sterling market would appear firmly shut, Harte is optimistic Kazakh borrowers will again tap the currency. "I do think the sterling market will open again, its just a matter of time."
Rating agency highlights concerns
In August, in light of the global credit squeeze, Standard & Poors issued a report highlighting the vulnerability of Kazakhstans banks to the global credit turmoil, but concluding that while foreign borrowing remains a concern, Kazakh banks are capable of weathering the storm.
"Their fundamentals are still relatively good in terms of business prospects, asset quality, earnings, and capitalisation. The main impact is expected to be the curtailing of growth trends and earning margins in the short to medium term. Banks are passing the higher cost of funding on to customers, which is already dampening credit demand," said the report.
Adel Kambar, CEO Renaissance Group Kazakhstan & Central Asia at Renaissance Capital in Almaty agrees the banks can weather the turmoil. "I'm always a believer in fundamentals and fundamentally, the macro picture in Kazakhstan is strong," he says.
Indeed, the summers credit market turbulence could be the trigger that normalises credit growth levels in Kazakhstan and if this leads to lower profitability, the effect in the longer term may be for the better.
But, S&P believes that things will get worse before they improve. "Such a slowdown would reveal the true extent of asset quality problems. High growth in recent years hid problem loans, as most credits were unseasoned and loans, even problematic ones, could easily be refinanced in a buoyant environment."
Regulator clamps down sort of
Kazakh bank balance sheets remain heavily dollar-oriented and foreign borrowing comprises between 50% and 70% of liabilities. The extent of banks foreign borrowing has caused some alarm among international rating agencies and multilaterals. In its global financial stability report, released in April, the IMF, expressed concern about how much Kazakh banks were borrowing.
"A reduction in external creditors appetite for Kazakhstan exposure, or a sharp decline in the quality of loan portfolios were the credit cycle to turn, could disrupt banking activity and carry consequences for the real economy," it said.
The national bank of Kazakhstan moved to deal with the problem in April 2007, when it increased the amount of capital that banks have to set aside to cover external borrowing. In August, it announced that it would raise the minimum reserve requirement on banks foreign liabilities to 10% from 8%, effective August 29. It also said it would cut the reserve requirement on domestic liabilities to 5% from 6%.
While some in the market think the moves unnecessary, others dont think the central banks reforms go far enough.
"International borrowing has become more expensive, in part on the back of the recent regulatory changes," says JP Morgan's Weiler. "But I don't believe these regulations will have an impact on the banks appetite for international borrowings. As high double digit balance sheet growth rates are again targeted, the banks would need to borrow in the sort of volumes that only the public international markets can absorb."
But although Weiler believes that market conditions will force many banks to adjust growth and funding targets downwards this year, he concludes "With retail and consumer lending rates frequently reaching more than30%, banks can still make a very decent return on their funding even if the international markets are more expensive."