Russia has long promised to provide the fullest list of
opportunities in central and eastern Europe's emerging bond
markets. The Russian Federation, the country's two leading cities
and selected banks and corporates all successfully ventured into
international markets during 1997.
But the after-effects of the Asian crisis, worries about the
country's fiscal situation and lingering political uncertainty
combined to push Russian spreads out to unprecedently wide
Of all central and eastern European bond markets, none suffered as
much as Russia during late 1997 and early 1998.
But since then the country has successfully negotiated impending
political crisis to return to the lira and the Deutschmark sectors.
Participants believe that, handled sensitively, many of the issuers
in the looming queue of Russian credits may be accommodated. But
first, Russia needs to prove itself in the dollar market.
WHILE THE PACE OF ECONOMIC REFORM IN Russia may be every bit as
lumbering as the country's national mascot, the bear, there is
clear evidence of the reform process gaining ground over the past
As a result, an increasing range of Russian bank, corporate, municipal and credits are positioning themselves for an assault on the international bond markets in 1998, which promises to rival that of 1997.
As Standard & Poor's commented in a credit report: "The Russian debt issuance market is potentially the largest, and therefore the most interesting and challenging in emerging Europe."
Prices on Russian Eurobonds may have borne the brunt of investor bearishness during the Asian crisis - with the spread on the Russian Federation's 2007 benchmark soaring from 334bp to 900bp in a matter of days - but in the course of 1998 they have retraced much of the lost ground, with the 2007 issue trading at 490bp by late April.
Despite political upheaval which at times has threatened to undo all the hard-won gains of the past year, investors are slowly but surely regaining confidence in the economic prospects for Russia.
Last year marked the end of Russia's transition recession. Although GDP growth in 1997 is estimated to have been a modest 0.5%, last year may in retrospect have marked a turning point in the country's move from a centrally planned to a free market economy. Consensus forecasts for 1998 are for GDP growth of 2%-3%.
As Jochen Wermuth, director and head of CIS debt origination for Deutsche Morgan Grenfell, observes: "The political resolve to press ahead with economic reforms has been strengthened by the Asian crisis."
Problems do remain, most notably in the shape of Russia's poor tax collection record, which needs to be improved in order to reduce the pressure on stretched government finances.
But, overall, the mood among analysts is one of cautious optimism. Stuart Parkinson, emerging market economist at Deutsche Morgan Grenfell in London, comments: "This is the year that things could really click into place for Russia. We could see positive growth, improving tax revenues, falling inflation and a closing of the fiscal gap."
Certainly, the international bond markets seem to have taken the weakening of Russia's credit ratings in their stride. Despite Moody's decision to downgrade the country's Ba2 rating to Ba3, and the move by Standard & Poor's to revise the outlook for its BB- rating to negative from stable, investors seem to have taken heart from Fitch IBCA's reaffirmation of Russia's BB+ rating.
With investors seemingly willing to look to Russia's future economic potential, rather than the country's chequered financial past, the Russian Federation has already been able to source $1.1bn in Eurobond funding so far this year.
Although the sovereign has yet to brave the dollar market, it has been able to leverage on its position as the most strategically important economy in central and eastern Europe to increase its investment profile in the European currency bond sectors.
The process began in late March with the launch of a DM1.25bn 9.375% seven year issue via Deutsche Morgan Grenfell and SBC Warburg Dillon Read.
The deal sorely tested the deal management skills of the lead managers, which had to contend with political turmoil in the run-up to launch after Russian president Boris Yeltsin sacked his entire government in frustration at a lack of progress on economic reforms.
However, by launching the issue for a relatively modest DM1bn, and at a launch spread of 475bp - towards the upper end of the 460bp-480bp indicative pricing range - the leads were able to attract a heavy oversubscription, which allowed them to increase the deal by DM250m within a matter of hours.
Strong institutional demand from Europe - and the US, where investors were marketed under a 144A option - was the key driver behind the success of the deal, which was notable for attracting widespread participation by mainstream investment managers, pension funds, insurance companies and corporate treasuries (many of them buying emerging market debt for the first time).
This was in stark contrast to the Russian Federation's Euro-DM debut - the CSFB and Deutsche-led DM2bn 10% March 2004 issue - launched in March 1997, which was largely bought by retail accounts.
Syndicate members said that the fact that the latest DM issue had got done at all, given the political backdrop, paid testimony to investors' confidence in the sustainability of the economic reform process in Russia and the market sensitive approach adapted by the borrower and the leads.
One London-based syndicate head observed at the time: "It speaks volumes for Russia, that it could bring a deal under such circumstances."
The Russian Federation also shrugged off political concerns when it returned to the Euromarkets at the end of April with a debut offering in the Eurolira sector.
The deal was launched shortly before the Russian parliament was due to vote for a third and final time on president Yeltsin's nomination of Sergei Kiriyenko for prime minister. A third rejection of Kiriyenko's candidature on the Friday after launch would have forced the Russian president to dissolve parliament and call fresh parliamentary elections, plunging the country into a potential policy vacuum.
However, thanks again to prudent deal management by the lead managers Credito Italiano and JP Morgan, the five year issue was able to be increased from an initial launch size of Lit500bn to Lit750bn - the maximum amount permitted for emerging market borrowers by the Italian central bank.
With a 9% coupon, the issue was priced to yield 435bp over the five year lira swap rate on a fixed re-offer price of 98.71 at launch - at the bottom end of the 435bp-440bp indicative pricing range and roughly flat to Russia's interpolated yield curve in Deutschmarks. This was trimmed to 434bp over on the increase.
JP Morgan and Credito Italiano - which distributed 90% of the deal - said the transaction was driven by institutional demand in the initial stages while the increase is reported to have been prompted by follow through retail buying.
Credito Italiano said that 90% of its bonds went to Italy and 10% elsewhere in Europe, while JP Morgan claimed 70% Italian distribution and 30% non-Italian, including sales into Hong Kong.
Banks, insurance companies, investment and pension funds all participated in the deal, which a Credito Italiano spokesman described as a "fantastic achievement for the Russians".
Fortunately for the leads and the borrower, the Russian parliament finally approved Kiriyenko's nomination and the country can now look forward to the formation of a new government. Meanwhile, with the establishment of a broad based institutional bid in core Europe, the Russian Federation is now well placed to press on with plans for a debut issue in the future single European currency sector, where DM and lira investors have been key buyers of euro product.
Also on Russia's issuance agenda is a potential debut Yankee transaction in the US bond markets. This deal, however, is only likely to emerge if the Russian Federation can truly convince US investors of the merits of its credit story.
Compared to European investors, US investors have so far this year proved immune to Russian issuers' charms. There was nevertheless US interest in a largely European-targeted $150m three year issue for Moskovskaya Gorodskaya Telefonnaya SET (Moscow City Telephone Network or MGTS), which in early March was the first Russian issuer to brave the public Eurobond markets since the Russian Federation increased its benchmark 10 year dollar bond last October.
Credit Suisse First Boston and Salomon Smith Barney were joint leads on the transaction, which had originally been scheduled for launch in the fourth quarter, but which was postponed due to the sell-off in the emerging markets debt sector in the wake of the Asian financial crisis.
MGTS' debut issue featured a 12.5% coupon to yield 690bp over US Treasuries on a spread basis at the fixed re-offer price of par. This represented an attractive 240bp pick-up over the Russian Federation's $1bn 9.25% November 2001 issue which was trading at 450bp and a 160bp premium over the City of Moscow's $500m 9.5% May 2000 transaction at 530bp over.
Both issuers are major shareholders in MGTS, which is the largest of Russia's 86 regional telecom companies, and the monopoly provider of fixed line telephony services in Moscow and the surrounding region.
In addition to institutional and retail demand from the Benelux, France, Germany, Switzerland and the UK, there was demand from offshore US fund managers keen to gain first time fixed income exposure to the fast expanding Russian telecoms market.
US investors also proved keen on a $100m 12.25% one year issue for the Yamal Nenets Autonomous Okrug via Lehman Brothers at the end of March and a $100m six month issue for the Republic of Tatarstan via ING Barings.
But, with the credit-linked offerings for two of Russia's regional borrowers paying launch spreads of 640bp and 875bp over Libor respectively, the message from US investors would seem to be that, while they are once again willing to buy Russian risk, they expect to be rewarded handsomely for their participation.
For the foreseeable future, the European currency sectors are likely to form the most receptive market for Russian debt.
The City of Moscow is set to follow in the footsteps of the Russian Federation, with a maiden Lit750bn three year issue. The Russian capital has already successfully tapped the Euro-DM sector this year with a Credit Suisse First Boston led DM500m three year offering, which kicked off its $1.5bn Eurobond funding programme for 1998 in late April.
Moscow's debut Euro-DM featured a 9.125% coupon transaction and was priced to yield 490bp over the Bobl 118 at a fixed re-offer price of 99.83 - widely seen as fair value relative to the 490bp trading spread on the Russian Federation's DM1.25bn 9.375% five year issue launched a week earlier, and the 490bp trading margin on Moscow's $500m 9.5% three year transaction launched in May 1997.
Following the lira transaction, the next leg of the city's funding programme will involve a probable $500m five to 10 year dollar issue in May via CSFB and ING Barings.
Russia's second city, St Petersburg, which last June launched a well received $300m 9.5% five year issue via Salomon Smith Barney, is also expected to return to the Euromarkets this year to raise funds for improving infrastructure in the city, which is fast establishing itself as the centre for Russia's flourishing tourist trade.
Another well received debut in the Euro-DM sector this year came from electric utility Irkutskenergo, which in April launched a DM125m three year deal via SBC Warburg Dillon Read. The issue featured an optically attractive 12.5% coupon to yield 825bp over Bunds at the issue/fixed re-offer price of 99.75.
Syndicate members welcomed the pick-up the issue offered over outstanding Russian Eurobonds: at launch, the B1/B+ rated Irkutskenergo deal offered a 320bp premium over the Ba3/BB- rated DM500m 9.125% three year issue by the City of Moscow, trading at 505bp over Bunds, and an even larger margin over the Ba3/BB- rated Russian Federation's DM2bn 9.0% March 2004 and DM1.25bn 9.375% March 2005 Euro-DM offerings, which was trading at 444bp and 468bp respectively.
On a sectoral basis, the issue was seen as offering good value over the $200m 8.375% five year transaction for Moscow's BB-/BB+ rated electric utility Mosenergo. This issue, lead managed by Salomon Smith Barney in October 1997, was trading at 630bp over Treasuries at the time.
The message from the Euromarkets so far is that Russian corporate and utility issuers that can offer either a commodity or a monopoly driven credit story will be welcomed provided they offer a sufficient premium over the sovereign.
Firmly in the former category are oil companies Sibneft and Tatneft, which made their debut international debt financings during 1997.
Sibneft's $150m three year FRN via Salomon Smith Barney in August - the first public international floating rate note from a Russian corporate - and Tatneft's $300m five year transaction via Dresdner Kleinwort Benson in October - the first public international fixed rate issue from a Russian corporate - both offered investors exposure to Russia's massive oil industry.
The country's hydrocarbon sector is also likely to be the first in the country
to embrace securitisation, with companies launching issues backed by export receivables.
Russia's regions also offer investors an interesting investment alternative to the sovereign. Whether an economic reform play such as the Oblast of Nizhniy Novgorod - which launched a $100m three year via ING Barings in September 1997 - or resource plays such as gas-rich Yamal Nenets or oil-rich Tatarstan - which have issued credit-linked issues via Lehman and ING Barings respectively - the country's regional credits offer diversification and credit plays.
Bankers caution, however, that an uncontrolled flood of regional Russian Eurobonds is the last thing the Russian debt sector needs.
A London-based syndicate head explains: "It is important for the Russian authorities to maintain the integrity of the Russian yield curve and enforce an orderly procession to market.
"Issues by Russian regional issuers require a lot of credit research, and it is important that requirement is properly met so as not to run the risk of endangering Russia's image in the international markets."
Russian banks are also looking to make a return to the Euromarkets. Inkombank is poised to establish a $75m one year US commercial paper programme at the end of April via Chase Manhattan, and the bank has also announced revised plans for the launch of its first Eurobond.
The issue, mandated to Goldman Sachs and West Merchant Bank last year but postponed due to Asian-inspired volatility in the emerging market debt sector, is now likely to surface towards the end of June for $100m-$150m over a three year tenor.
Separately, Tori Bank is expected to launch the first issuance of its RZB-arranged $50m Euro-commercial paper programme at the beginning of June.
However, the experiences of the Russian banks that have tapped the Euromarkets, have not altogether been pleasant ones.
Alfa Bank, SBS-Agro, Rossisky Kredit and Unexim all launched three year Eurobonds last year. Although all four issues were increased from their original launch sizes and were priced in an average spread range of 410bp-450bp over Treasuries, in the wake of the Asian-inspired emerging market sell-off at the end of October, the spreads on those issues soared to over 1,500bp - and, in the case of Rossisky Kredit, an alarming 2,700bp.
By the end of April, the transactions had recovered some of that lost ground, with Alfa, SBS and Unexim all trading in a 900bp-950bp range, and Rossisky Kredit at around 1,500bp.
The problem for the Russian banks more than any other Russian credits was that the principal theme of the Asian crisis was financial sector meltdown.
Sophisticated as some of the leading Russian banks may be, the country's banking sector remains one of the most underdeveloped in central and eastern Europe.
Once investors saw bankruptcies in supposedly mature banking sectors in Indonesia, Korea and Thailand, Russian bank Eurobonds were the among the first - and ultimately the hardest hit - victims of the emerging market sell-off which followed.
With the bank reporting season for fiscal year 1997 having just begun, analysts are scouring Russian banks' balance sheets to determine which banks have emerged best from the challenge of the liquidity crunch that the sector suffered at the end of the year.
Only those banks with state ownership or those private sector banks which have best managed their exposure to Russia's currency, bond and equity markets are likely to be able to launch Eurobonds this year.
The poor quality of information from Russia also provides a major challenge to potential Eurobond issuers, as diamond producer Almazy Rossii-Sakha (Alrosa) found to its cost earlier this year.
The company had hoped to launch a $150m three year Euro/144A bond via Salomon Smith Barney and SBC Warburg Dillon Read in February but the issue was postponed after reports in the Russian press that Alrosa was in default on some of its veksel issuance - short term rouble denominated securities issued for cashflow management purposes.
Although it transpired that the problems simply centred around delays in sending out payment transfer notices - an everyday occurrence in the veksel market - international investors, who at the time needed no excuses not to buy Russian debt, demurred from confirming firm orders.
The lead managers hope to resurrect the transaction by the end of the first half, having issued a revised red herring prospectus with an in-depth detail of the workings of the veksel market
But with both local and international banks devoting ever greater resources to Russian research, participants hope that investors will be better informed about the potential risks - and rewards - of Russian debt issuance.
While most bankers believe that spreads on Russian issues are unlikely to return to the levels of last October - when the Russian Federation was able to secure 10 year funding at 334bp over Treasuries with a $400m add-on to its benchmark $2bn 10% June 2007 transaction - they nevertheless report that increasing numbers of investors are once more seeking out Russian Eurobond risk.
Deutsche Morgan Grenfell's head of CIS origination, Jochen Wermuth, remarks: "I may be biased, but for me the biggest potential star performer in eastern Europe this year is Russia, which has a lot of scope to improve its spreads." EW