Having established themselves in the international bond markets, Russian and CIS issuers are now exploring what they can do there. In 2005 the banking sector made the most headway, with the arrival of lower tier two capital in Russia and tier one in Kazakhstan. Duncan Kerr charts these achievements and examines the prospects for 2006.
In a simple but telling summation of just how far Eurobond issuance from Russia and the wider CIS region has evolved, one head of emerging market debt syndicate said the type of capital raisings inconceivable just a few years ago were realised with ease in 2005.
State-owned Vneshtorgbank opened Russia's subordinated debt market in January and in September Promsvyazbank became the first single-B rated Russian bank to launch a five year Eurobond. But then, not to be outplayed, Kazakhstan's Kazkommertsbank broke new ground in October when it sold the CIS region's first tier one capital deal as part of a dual tranche financing through ING, JP Morgan and UBS.
The sheer number of firsts in bond issues from Russia, Kazakhstan (see box) and Ukraine last year was remarkable, so much so that it set a tough benchmark for borrowers and syndicate bankers to better in 2006.
But the mood remains stubbornly bullish that this year, the scope and breadth of capital raising could well match if not surpass 2005. However, there is one caveat — US interest rates.
"While I don't think the Federal Reserve will raise the Fed Funds rate as aggressively as it has, benchmark rates will certainly rise further and US Treasury yields will continue to move higher," says Petri Kivinen, head of debt capital markets origination for central and eastern Europe, the Middle East and Africa at Dresdner Kleinwort Wasserstein in London. "It has been a one way market for emerging debt for so long and I think that will start to change this year, although I've got to remain bullish."
The minutes from the Federal Open Market Committee meeting in November showed that the Federal Reserve has entered what it expects to be the final phase of the interest rate tightening cycle that began in June 2004.
The interest rate setting committee thought that, at 4%, rates remained accommodative and that "a continued measured pace of policy firming" remained likely.
Most analysts expected another two or three rate hikes from the Fed, and the first of these came in December. Assuming one more in January, with no Fed meeting in February, it will be Ben Bernanke who will have to take the decision whether to go on to 4.75% — or call a halt at 4.5% — in his first meeting as Fed chairman in March 2006.
There are, of course, several arguments why Russian debt should be protected from the volatility it suffered in previous emerging market sell-offs. For one thing, Russia's economic fundamentals are impressive, unlike in 1997-1998 when the Asian crisis was followed by a Russian domestic debt default and soaring yields.
However, the greater correlation between global markets' performance is one argument against Russia evading a protracted wider sell-off.
"Markets are far more interlinked than they have been historically — disruption in one area leads to repercussions elsewhere," says George Niedringhaus, global head of emerging market debt syndicate at ABN Amro in London. "Treasury volatility has now become a focal point, but the economic fundamentals of commodity-driven emerging markets such as Russia are very strong. This should enable them to weather market downturns like we have seen in the past."
Russian issuers will have to hope that investors remain willing to give them the benefit of their positive rating outlooks.
"We remain optimistic that although the market is now entering a rising interest rate environment, emerging markets will continue to draw investor interest, given the combination of their strong fundamentals and the prospects that emerging market issuers will continue to benefit from GDP growth," says Kivinen.
Difficult days after early promise
New debt issuance from Russia, as from emerging markets in general, started with a bang in the first few months of 2005. But dealflow petered out in the second quarter as emerging market spreads widened in the face of US rate rises.
Spreads on the Russian portion of the JP Morgan EMBI+ index widened 16bp to 197bp over Treasuries during the week of March 21 alone.
"There were two unknown factors at that time that influenced issuance during the remainder of 2005 — and that was whether the market remained supportive, and how much international financing Russian corporates would require. Many are outperforming due to high commodity prices, so their financing requirements are lower," says Niedringhaus at ABN.
Corporate Eurobond issuance, restricted in the first quarter to a tap by diamond monopoly Alrosa and new deals from mobile phone operators Mobile TeleSystems (MTS) and Vimpelcom, did not rise in line with expectations in the remainder of the year, though the pipeline is fuller for 2006.
In the last third of the year, a spate of debut borrowers — such as car maker Avtovaz, food logistics firm JFC Group, real estate company Open Investments and food producer Nutritek — established their credentials in the capital markets with credit linked note issues, a record they will hope to play on with full-blown Eurobonds this year.
But apart from the $750m 8.5% 10 year deal from steel company Evraz through ING and UBS in early November — which buckled in secondary trading soon after launch but has since firmed up — it was left to Gazprom to crown corporate issuance from Russia in 2005.
The gas company launched two emphatically placed Eu1bn benchmark deals — a 10 year in May and a seven year in December, both led by ABN Amro and Credit Suisse First Boston. But Gazprom's most innovative transaction was in July.
The company launched a novel $1.87bn double tranche loan participation note (LPN) to refinance two existing secured loans for the Blue Stream Pipeline Project. A $1.222bn tranche, maturing in July 2013, is supported by a financial guarantee from Italian export credit agency Servizi Assicurativi del Commercio Estero (Sace), becoming the first Russian deal to be structured with a foreign wrap. The transaction is also notable as Sace normally supports loans rather than bonds or LPNs. Deutsche Bank and MCC Capitalia were lead managers, with Depfa and Dexia as co-leads.
The second tranche, an amortising eight year LPN with an average life of 3.8 years, totaled $646m. Demand for this segment, which Deutsche led on its own, was enormous, reaching around Eu4bn.
Banks at the cutting edge
While Russian banks have continued to issue senior bonds, they have also been exploiting the cash available at the short end of the market through syndicated loans. But the emergence of subordinated capital securities in Russia and the CIS was perhaps the single most important development of 2005.
The phenomenal growth in the loan portfolios of Russia's banks has left many with reduced capital adequacy ratios. In October, the average capital ratio of Russian banks — a measure of the bank's financial strength, expressed as a ratio of its capital to the risk of its assets — had dropped to just 16%, according to central bank data. To account for the volatility of the Russian economy, the central bank has set the lower ratio limit for Russian lenders at 10% — two points higher than international standards set by the Basel Committee.
Delivering Russia's first lower tier two capital bond in late January, Vneshtorgbank's aim was to improve its capital ratio. Its capital had been depleted by the impressive growth of its balance sheet and its run of private bank acquisitions such as the purchase of Moscow-based Guta Bank — now rebranded VTB 24 — and the 25% stake it bought in St Petersburg's Industry & Construction Bank.
As well as making acquisitions, Vneshtorgbank has been aggressively increasing its loan book, which grew by 60% in 2003 and over 100% in 2004. As a result, the bank's capital ratio fell from 25% in 2000 to around 14.5% by the end of 2004.
"As institutions like Vneshtorgbank continue being acquisitive, that will have a bigger impact on their capital requirements, which means that assuming the Russian central bank agrees to follow the general frameworks of many other countries, there will be more bank capital issuance in 2006," says Richard Luddington, head of CEEMEA debt capital markets at UBS in London.
Vneshtorgbank's $750m 10 year non-call five deal via Barclays Capital, Deutsche Bank, HSBC and JP Morgan came in the same week as Standard & Poor's awarded the Russian sovereign investment grade status, giving the country a full house of triple-B ratings.
The leads capitalised on this, and brought the deal at "just less than 50bp over Vneshtorgbank's senior curve," according to Andrew Dell, head of emerging market debt finance and syndicate at HSBC in London. "The bank has strong management, strong ownership and is showing strong growth, giving it a fairly unique combination of attributes. This is combined with up-to-the-minute balance sheet management, which makes Vneshtorgbank stand out, and was well appreciated by investors."
The leads were able to reduce price guidance from 235bp over mid-swaps to 225bp over, which equated to around 263bp over Treasuries. The bond was priced at par with a 6.135% coupon, giving a spread of 260bp over Treasuries. It has a call option at five years, after which the coupon steps up to 7.185%.
Not to be outdone, and only four days after Vneshtorgbank broke the ice, fellow state owned bank Sberbank launched its own lower tier two 10 year non-call five year deal to the tune of $850m through UBS. Sberbank returned three days later to tap it for a further $150m.
In September Industry & Construction Bank also joined the lower tier two party, as did Bank of Moscow in November and privately owned Alfa Bank and Russian Standard Bank in December. Alfa's deal was groundbreaking as it was the first subordinated bond for a wholly private company. Bank of Moscow is controlled by the City of Moscow.
For Martin Hibbert, head of emerging market syndicate at Deutsche Bank in London, the performance of the subordinated deals from Vneshtorgbank and Sberbank, and more particularly Industry & Construction Bank, encapsulated the acceptance of the sub debt product.
"Sberbank and Vneshtorgbank were investment grade on one side, owing to being state owned," Hibbert says. "Though those transactions opened up the market for subordinated debt for Russian financials, Industry & Construction Bank's deal — despite Vneshtorgbank's 25% stake — was fully sub-investment grade and actually did symbolise a real acceptance of the credit," he says.
For Luddington at UBS, the next step for Russia would be to explore upper tier two and perhaps even hybrid tier one transactions. "Nothing is clear yet or defined by the central bank but they are monitoring it very closely," says Luddington.
Western investment banks are known to have approached the top financial institutions — Sberbank, Vneshtorgbank, Gazprombank and Bank of Moscow — with proposals for the first tier one transaction from a Russian financial institution.
Discussions are at a preliminary stage, although a deal may come by the first half of 2006. The lack of central bank clarity on what constitutes tier one capital remains an obstacle, but if this is resolved, Vneshtorgbank would be favourite to inaugurate the asset class, given its impressive record of innovation.
|Innovations prosper as Kazakhstan brings tier one|
| 2005 was a year for debut issuers from Kazakhstan, with banks outside the big three of Kazkommertsbank, Bank TuranAlem and Halyk Bank finally getting access to the international debt markets.
Names such as CenterCredit, Alliance Bank, Nurbank, Bank Caspian and ATF Bank all opened their accounts with international investors in a year when global demand for emerging market debt was at all-time highs.
"I've never seen global appetite for risk at the levels it is at now," says Glen Finegan, chief emerging market strategist at First State Investments in Moscow.
Among the better known issuers, Development Bank of Kazakhstan issued the first 15 year Kazakh Eurobond in June. "The Development Bank of Kazakhstan deal went exceptionally well," says Tijen Taraf, director of capital markets at UBS. "It has become something of a proxy for the sovereign, in the absence of new sovereign issuance. The deal came when the market was very strong."
UBS priced the $100m deal at a coupon of 6.5%, with a yield of 6.75%. And while Kazkommertsbank (KKB) was notably quieter for most of 2005, apart from its $150m 7% November 2009 deal in the first quarter, it returned to investors' screens with style in late October.
Underlining its innovative credentials, KKB issued the CIS's first tier one Eurobond as part of a two tranche financing through joint bookrunners ING, JP Morgan and UBS. Alongside a Baa2/BB/BB rated $500m 10 year senior bond, the leads priced a $100m perpetual non-call 10 year tier one deal, rated Baa3/B/B+, at par to pay 462.7bp over Treasuries with a yield of 9.2%. The coupon resets to 619.05bp over three month dollar Libor if the bond is not called at 10 years.
If that was not enough, KKB returned in December with a $200m seven year wrapped diversified payment rights securitisation through JP Morgan and WestLB. The deal is backed by electronic payment orders received by the bank, the first deal of its type from the CIS.
Not to be outdone, Bank TuranAlem proved its own ability to innovate when it printed the first floating rate note from Kazakhstan in November through lead manager Credit Suisse First Boston.
|Banks ride Ukrainian success story|
|A little over a year after Ukraine's Orange revolution of December 2004, the country is making important political and economic progress.
In December, the European Commission awarded the country "market economy status". The decision recognises Ukraine's reform programme and will doubtless improve its trade relations with member countries and support its ambitions to accede to the World Trade Organisation in mid-2006.
Investors clearly see value in the country — whether through the stockmarket, which posted new highs in August, or in the potential consumer market that Ukraine's population of 48m provides.
Vienna-based Raiffeisen International signed a landmark deal worth just over $1bn in September to acquire a 93.5% stake in Ukraine's second largest bank by assets, Bank Aval.
BNP Paribas followed suit in December, announcing it would buy a 51% stake that is thought to be worth $600m-$800m in Ukrsibbank, the country's fourth largest bank.
But the genesis of a new era is never easy and the government is having to face up to a misfiring economy.
GDP growth is down from 12% in 2004 to between 5% and 6% last year. Annual inflation reached 14.8% year on year in July, up from 12.3% in 2004, 8.2% at the end of 2003 and price stability in late 2002.
In the first week of October, Ukraine sold Eu600m of 10 year bonds through Citigroup, Deutsche Bank and UBS. But it was no easy sell, coming as it did in the middle of the year's fiercest sell-off in emerging market bonds.
Similarly choppy market conditions made a harder sell of the City of Kiev's $250m 10 year bond via Citigroup and Credit Suisse First Boston and the $100m three year debut from Nadra Bank through Dresdner Kleinwort Wasserstein and UBS.
Banks dominated issuance from Ukraine last year, with Ukreximbank, the import-export agency, raising $390m in three deals, while Ukrsotsbank and Ukrsibbank tapped the market, both raising three year funds with their $100m and $125m Eurobonds in June and July respectively.
Ukraine's leading mobile phone company, Kyivstar, and chemical company, Stirol, provided the only exceptions to the bank supply.
Kyivstar printed a $175m seven year bond via Citigroup and DrKW that was priced at an eye-catching 7.75% — down from the 10.375% yield the same leads achieved on Kyivstar's debut $265m five year Eurobond in July 2004.
Stirol successfully raised $125m of three year funds through ING. The Dutch bank will also lead manage one of 2006's first corporate bonds, having been mandated to print a five year dollar deal for iron and steel company Azovstal.