The surge in bank capital issuance from CEEMEA issuers in the past 12 months has demonstrated the product's ability to meet the need of issuers and the demand of investors. Should banks convince their regulators to keep moving towards international standards, the market looks set to boom.
Before 2005 one could have been forgiven for considering the idea of central and eastern European, Middle Eastern and African (CEEMEA) bank capital an oxymoron, given the rarity with which the two terms appeared together.
The first significant issue only appeared in April 2004, a $100m 10 year non-call five lower tier two transaction for Kazkommertsbank (KKB) of Kazakhstan. By the end of the year only Turkey's Finansbank had followed suit, launching a $200m lower tier two transaction with a political risk insurance wrap.
But a little over one year later, CEEMEA bank capital has become an asset class that is impossible to ignore.
Six Russian banks, from the state-owned Vneshtorgbank to privately-owned Alfa Bank, launched public subordinated bonds in 2005, with Sberbank alone selling $1bn of lower tier two paper.
Also last year the first public subordinated debt issues hit the market in Hungary, Slovenia and Ukraine, and Gulf International Bank launched the first lower tier two issue from the United Arab Emirates.
Having opened the CEEMEA bank capital market in 2004, KKB added a new layer to it in October, issuing the first hybrid tier one deal, a $100m perpetual non-call 10 year security. And, just as its previous landmark paved the way for banks in other countries to take advantage of new capital tools, the deal holds out the promise of further progress in the coming year.
"This was a breakthrough transaction," says Igor Hordiyevych, director, CEMEA debt capital markets at UBS in London. "Not only did it come at a good spread and attract strong demand, but it shows other countries in that region that adopting a framework in line with Basel Committee regulations has its benefits, and is not the preserve of western European banks."
Too attractive to ignore
That the CEEMEA bank capital market truly opened for business last year did not come as a complete surprise to emerging market observers, many of whom view it as a natural progression.
"When banks start tapping the international market, they typically start with syndicated loans, then issue senior unsecured debt and only then do they come to subordinated debt," says Joel Bismuth, a senior analyst in Moody's financial institutions group in Limassol. "Russian banks, for example, only started tapping the Eurobond market significantly a couple of years ago, so it was only normal that we saw the first one come to the sub debt market early last year."
At the same time as CEEMEA banks were building up their track records in the international debt markets, they were also building up assets.
"What has been driving this has been the speed at which the banking systems have been growing," says Jan Mutsaers, head of EMEA debt origination at ING in London. "The Kazakhs, for example, have a compounded growth rate well into the 40s."
This, in turn, has led to banks taking a closer look at the way they manage their capital requirements and structures.
"As a result of their rapid growth, banks will have greater interest in using the international capital markets," says UBS's Hordiyevych, "not just for senior funding, but also to raise capital. A lot of banks in the region are looking to means other than simple equity to raise new capital and optimise their existing capital structures.
"They are seeking to improve their return on equity and are becoming much more conscious of the capital management techniques used by their western European counterparts."
And subordinated debt and hybrid tier one securities are an attractive option for banks in countries such as Russia.
"Russian banks have a few options to support their capitalisation," says Polina Kurdyavko, emerging markets corporate analyst at BlueBay Asset Management in London. "Banks' shareholders can either inject equity into the bank, attract a strategic investor, raise the money through an IPO, or issue subordinated debt. So far, foreign strategic investors have been more active in acquiring banks in neighbouring EMEA countries, i.e. Turkey and Ukraine, rather than Russia."
This, says Kurdyavko, is because taking over one of Russia's leading banks would involve an outlay, and hence risk, greater than most Western banks are willing to take, given the weak regulatory framework in the Russian banking sector, its lack of disclosure and transparency, and affiliation of select banks with financial-industrial groups.
"An IPO is definitely an option," she adds, "and from what some bankers are saying there could be as many as 14 in 2006, so clearly the banks are looking at this possibility.
"But in the meantime, with growth rates at 30%-50%, these banks need some immediate ways to support their capitalisation, and subordinated bond issues are the most logical solution for that."
Pushing down the capital structure
CEEMEA banks have so far mostly been issuing lower tier two debt. The main reason for this is that very few regulatory frameworks allow for hybrid tier one capital.
However, a push into upper tier two and hybrid tier one issuance across the region is expected this year.
"I would not be surprised to see much more supply in 2006," says one emerging markets DCM banker in London, "and some tier one deals in particular. If you look at some of the Russian banks' core capital, for example, some of them are at quite a low level.
"They are not yet breaching central bank requirements, but they would definitely benefit from issuing hybrid tier one."
While regulatory hurdles to upper tier two and tier one issuance remain in many jurisdictions, market participants hope that, by recognising the benefits of the instruments, regulators will move towards capital frameworks based on Basel Committee guidelines.
"It is a key part of what regulators in Russia and elsewhere need to do to improve the overall quality and sophistication of their banking sectors," says Rachel Hatfield, a partner at White & Case in London.
Progress also depends on demand for the products remaining as buoyant as it has been so far. And with yields remaining at historically low levels and the outlook for emerging markets again bullish, investors are expected to continue their move down the capital structure of CEEMEA banks.