Potential Russian Eurobond issuers have been faced with a dilemma this autumn. Should they push ahead with deals, knowing that they will have to pay more than they would have had to earlier in the year, or hold off in the hope that markets will improve but risk having to pay even higher premiums in the future?
This is the question that has been occupying Russian corporates and financial institutions during the third quarter, in the face of volatile markets and the threat of war in the Middle East.
After a quieter than usual summer lull, Gazprombank became the first Russian issuer to rise to the challenge, via its subsidiary Gazinvest Finance. But not even the lure of the first Russian retail bond since April could prove enough to make the deal a blowout. Lead manager Deutsche Bank was forced to cut the book back to Eu100m from a planned Eu200m and reduce the tenor to three from five years.
This allowed Gazprombank to stick within its yield target of below 10%. The issue was sold at a price of 99.85, implying a yield to maturity of 9.81% and a spread of 646bp over Bunds.
"Despite being cautious, investors have built up a large amount of cash and are willing to commit some to the right deal," says Stuart Young, head of syndicate at Deutsche Bank in London. "Market conditions have been very volatile during the summer. We had been getting the message from investors that they would be far more willing to take three rather than five year paper."
Italian retail was the mainstay of demand for the deal, buying about 30% of the issue at launch, and wading into the secondary market to up the level to more than 40% in the following weeks. "Since the introduction of the euro, Italian investors have been big emerging market buyers. The attractive yield on the bond meant that it was a prime deal for the Italian retail base," says Young.
UK investors took another 25% of the transaction, with 15% going to eastern Europe, 10% to Switzerland, 10% to Austria, 5% to Germany and 5% to other countries. Retail investors bought half of the offering, with 30% going to banks and 20% to fund managers.
According to Young, investors now have a better understanding of the relationship between Gazprombank and its parent company. "Gazprombank's first issue in December 2001 went very well and was increased to Eu200m from Eu150m. Investors are now familiar with Gazprombank's name and have a better understanding of its relationship with Gazprom."
Although some bankers away from the deal were less complimentary, most agreed that getting any issue away in the volatile September markets was a success in itself. "The deal did not go particularly well," says one banker "and I would not be surprised if it made other issuers, and especially Russian banks, take a good look at the market and decide to hold off from issuing."
But the bond was well enough received to allow the
borrower to tap it for an extra Eu50m in the following week,
driven by excess demand in Germany, Italy and Switzerland.
"Following the launch there was continued buying interest
from the retail investor base," says Young. "This enabled us
to increase the deal by Eu50m, at a higher re-offer price of
99.95, to satisfy the extra demand."
|Russian non-state Eurobonds issued in 2001-2002|
|Issuer||Date of Issue||Volume||Maturity||Coupon||Yield at issue date||Spread at issue date, bp|
|City of Moscow||Oct 01||$350m||25 Oct 2004||10 1/4||10.25%||100-130|
|City of Moscow||Nov 01||$400m||28 Apr 2006||10.95||10.95%||200|
|Rosneft||Nov 01||$150m||20 Nov 2006||12 3/4||13.00%||250-300|
|Gazprombank||Dec 01||$150m||22 Dec 2003||9 3/4||9.67%||200|
|MTS||Dec 01||$300m||21 Dec 2004||10.95||11.25%||250|
|MMK||Jan 02||$100m||18 Feb 2005||10||10.10%||230|
|Sibneft||Jan 02||$375m||13 Feb 2007||11 1/2||11.50%||200|
|Gazprom||Apr 02||$500m||25 Apr 2007||9 1/8||9.125%||95|
|Vimpelcom||Apr 02||$250m||26 Apr 2005||10.45||10.45%||340|
|Gazprombank||Sep 02||$100m||4 Oct 2005||9 3/4||9.81%||284|
|Gazprom||Oct 02||$500m||21 Oct 2009||10.5||10.5%||250|
|Source: Renaissance Capital|
Just over two weeks later, Gazprom placed the first out of two planned Eurobonds. Its $500m seven year Reg S deal via CSFB and Citigroup/SSSB has a 10.5% semi-annual coupon, and carries a three year put option, allowing bondholders to sell the bond back to the company at par in 2005. Fund managers often believe the inclusion of put options to be a sign of either weakened investor interest, or volatile markets. But the option may not necessarily be exercised. According to UFG's fixed income analyst Dmitry Dmitriev, yields may be lower in three years' time, while Gazprom's prospects should become clearer, meaning that investors may be happier to hold on to the issue.
In a report Dmitriev highlights three reasons why Russian issuers have started to return to the Eurobond market, even though they may have to borrow at a relatively higher cost. Firstly, he believes that a further improvement in Russian external debt market conditions will only come relatively slowly, so there is little point in delaying.
Secondly, he says: "Even at current levels, financing via Eurobonds may be quite attractive for some issuers given other available sources of financing." Lastly, 2003 may see greater competition among potential issuers and there is no guarantee that levels of demand will be as high.
This will be especially true if Gazprom successfully places its planned $750m 10 year 144A issue in early 2003. Gazprom is in turn understood to be working closely with government officials to make sure that the timetable for its planned issues does not conflict with any plans that the sovereign might have.
The Gazprom transaction brings the number of Eurobonds issued by Russian entities to 11 since 1998. The last two issues out of Russia to be completed before the summer were a $500m five year bond from Gazprom and a $250m three year offering from mobile phone company Vimpelcom. Both were completed under far less volatile market conditions. Gazprom's Reg S Eurobond in April was sold at a yield of 9.125%, giving a spread of 95bp over Russian sovereign Eurobonds and attracted $2bn of orders. But by mid-September the trading spread on the bond had widened to 231bp over the sovereign with the yield increasing to 10.2%, indicating how greater volatility has led to increased risk aversion.
Vimpelcom's bond was launched at 10.45%, at the tight end of price talk, and attracted a book of $850m. "This demand reflected both strong investor sentiment for Russia and the credibility of the management team," says Mike Elliff, head of emerging market origination at UBS Warburg in London, which lead managed the issue alongside Jp Morgan. The transaction was also helped because many investors already knew the management team and their story from the company's convertible issue in 2000.
Concerns over the elections in Brazil and US corporate scandals have been responsible for both the bottleneck in Russian issuance and the spread widening on existing bonds. While Russian markets have shown signs of decoupling from Brazil, events in the US are becoming increasingly relevant. Indications that the economic slowdown is ending would lead to a gradual increase in yields on Treasuries, which would have a positive knock-on effect on emerging market debt.
The scarcity of new issues since April means that there is a large volume of potential issues to come before the end of the year, should market conditions pick up. But this can lead to its own problems. Although talking the market up in public, some syndicate heads are privately worried that several large or badly timed deals could close the pipeline for the rest of the year.
"There is only a finite amount of demand," says one head of emerging market debt syndicate in London. "If there are two or three big deals from well known names, then that could easily soak up liquidity."
Some issuers fear the same situation. Once Alfa Bank decides to go ahead with its planned $150m-$200m issue, it is understood to want to issue before any other financial institutions are able to soak up precious liquidity. "Deals will get done selectively," says the banker. "Investors are cautious but will respond to the right names."
Sovereign plans still unclear
The sovereign has continued to confuse investors during the summer over the timing of its first Eurobond since August 1998, following various announcements by officials that it may issue a $1bn-$1.5bn Eurobond later this year.
According to one official, the money would be used to build up a special reserve account, which has been set up in response to Russia's heavy foreign debt repayments which are estimated to reach more than $14bn next year.
But bankers remain sceptical about the chances of a Russian Federation issue before 2003. "It is highly unlikely," said one. "They do not need to issue while market conditions are so volatile."
The government has repeatedly made conflicting statements over its Eurobond intentions. Deputy finance minister Sergei Kolotukhin has also been quoted as saying that Russia would probably abandon plans to issue a $2bn Eurobond later this year.
There is a risk that the market will experience the same phenomenon as in the fourth quarter of 2001 - oversupply. Late last year, after a three year drought, investors were suddenly treated to three deals within two months of each other. And while the City of Moscow's Eu300m three year deal via UBS Warburg and ING benefited both from being the first Russian Eurobond for more than three years, and being from the country's financial powerhouse, a subsequent offering from oil major Rosneft failed to garner anything like the same interest. Lead managers ABN Amro and Dresdner Kleinwort Wasserstein were forced to slash the planned issue size to $150m from $300m, and Russia's eighth largest oil company had to pay a 12.75% coupon even on that small volume. This then persuaded fellow oil producer Sibneft to postpone its own plans, even though Sibneft was a much better regarded credit than the old fashioned state owned Rosneft.
A further issue then came from the City of Moscow, which brought a Eu400m 4-1/2 year deal via BNP Paribas, Dresdner Kleinwort Wasserstein, JP Morgan and Merrill Lynch. This deal was driven more by necessity than opportunistic borrowing - Moscow is constrained by legislation that only allows it to refinance external debt obligations in the year in which they mature. Moscow then tapped its 2004 deal for a further Eu50m.
The list of corporates carefully eyeing market conditions is long. Unsurprisingly, most of these come from the oil and gas sector - Slavneft, Sibneft, TNK and Transneft among others, as well as the world's second largest diamond producer Alrosa.
But a number of financial institutions are also on the lookout. UBS Warburg and Merrill Lynch hold the mandate for Alfa Bank's issue, while MDM Bank has mandated CSFB for a $150m-$200m three to five year transaction.
Bank Zenit is the latest to undergo the rating process necessary as a prelude to issuing Eurobonds, having recently been assigned a B2 long term foreign currency by Moody's. Russia's second largest bank, Vneshtorgbank, also plans to issue a $500m five to seven year bond in 2003, according to chairman Andrei Kostin.
Finally, on the sub-federal level, the City of St Petersburg has mandated Deutsche Bank for a dollar denominated bond of up to $120m, which must be launched before the end of the year to comply with the federal legislation that restricts sub-federal entities to refinancing existing debt in the year that each issue falls due. The City of Moscow's head of funding Sergei Pakhomov has said that Moscow is working hard to get this legislation changed so that it can issue next year.
Other corporates expected to issue include mobile phone company MTS, which is on the acquisition trail domestically and within the CIS. Although it is has not reached a decision on plans for a second Eurobond, it is extremely underleveraged and would likely consider an issue to finance any significant acquisitions.
But the continuing volatility has proved too much for some. Russian Aluminium's chief operating officer announced in early October that the company has postponed plans to issue Eurobonds either later this year or early in 2003.
"The reason for the change of plans is the worsened situation on the world's financial markets and the necessity to optimise the structure of the Russian Aluminium group," said Alexander Bulygine. *