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Emerging Markets

Chop and change

The financial crisis has radically reordered business for capital markets bankers operating in central and eastern Europe. Deal volumes have plummeted and teams slashed. But for those with staying power, a resurgent bond market offers some comfort

In the eight months since Lehman went bust, some of the Euromarket’s best-known faces have disappeared as banks are forced to slash costs in a desperate response to plummeting deal volumes and revenues.

Central and eastern European loan volumes for the first four months of this year crumpled to $6.236 billion from $41.45 billion in the same period last year or compared to the $68.293 billion in the first four months of 2007, according to data provider Dealogic.

The bond market has fared slightly better, registering just over $19 billion in the months through April this year, against $24 billion in the same period last year. But even these numbers pale when contrasted with the first four months of 2007, when $41 billion was issued by central and eastern European (CEE) borrowers.

“It’s the same as elsewhere in the markets: there is not enough dealflow to go around, and banks are under huge pressure to reduce their cost bases,” says the head of syndicated loans at a European bank in London.

Shapes and sizes

Teams were built on models that assumed a regular dealflow. But “that dealflow has fallen off a cliff but we are still left with these teams which start to become incredibly expensive with no revenues coming in through the door,” he says. “It’s bloody and unfortunate but we have to adapt to the new era.”

The question is how this “new era” will shape central and eastern European debt capital markets operations.

Senior bankers have had little choice but to act. “When we were reviewing our strategy for 2009 we were obviously looking at where we should cut costs,” says the head of debt capital markets (DCM) at a prominent global bank in London.

He says that Russia and central Europe took the brunt of the chop, since deal volumes had fallen sharply and are expected to remain low. “Along with many others we were over-staffed and over-exposed,” he says, although he notes that his firm held back from cutting headcount in the Middle East. “The encouraging flow of bond deals so far this year from [that region] indicates we made the right decision.”

And while central and eastern Europe remain a key market for many banks, most bankers do not expect to grow their region teams. “We are committed to the region, and we will certainly maintain our corporate and investment banking teams, for example in Moscow,” says the head of DCM. “But on the DCM side we are not expecting to enlarge our team over the next two years. We do not expect the dealflow to pick up enough to grow that team.”

Teams are likely to be cut back permanently relative to the boom years of 2006–07, even though most firms will continue to operate in the region and have staff on the ground in places such as Moscow as well as dedicated EM specialists in their headquarters.

“While central and eastern European capital markets is not becoming an after-thought for western banks, in many cases it is becoming less important,” says one senior capital markets banker.

“Teams covering the region really don’t have to be that big any more. Even the banks that want to dominate the business don’t need more than six or eight people in the DCM team. And those smaller houses really don’t need more than two to three people on the origination side. As for syndicate – well, an EM syndicate specialist is really becoming a bit of a luxury.”

Changing of the guard

The emerging market bond syndicate community in London has been especially hard hit. Deutsche Bank, Citi, UBS and Merrill Lynch in recent months have all begun ditching their EM syndicate specialists. Other houses such as Credit Suisse and JP Morgan have persuaded their EM syndicate bankers to switch their focus to the European corporate sector. This is partly a reaction to the dearth of dealflow in central and eastern Europe but also a way to bolster their western European investment grade corporate businesses which are having record-breaking years.

Others, who have seen their EM syndicate specialists leave voluntarily, have chosen not to replace the position, instead sharing the workload around the syndicate team. CEE loans bankers are also falling in number.

The big bet

For the banks that have stuck with the region, Russia – with its enormous financing needs spread across banking, oil and gas, telecoms, metals and mining and retail sectors – remains the main focus, despite the turmoil that has beset its markets and economy since September. In contrast, Kazakhstan and Ukraine, having fallen foul of the credit crisis, are not expected to concern primary market bond and loan bankers in the medium term.

“Russia is fundamentally important: natural resources and size make it a must for most financial institutions,” says Christopher Marks, head of debt capital markets, EMEA (Europe, Middle East and Africa), at BNP Paribas.

“There are of course obstacles but this is the country where we can expect a large volume of business to come – there are a lot of names to work with. We think the top tier of banks should be in a position to issue successful bonds. Oil and gas companies will get a decent reception.”

The international loan market in Russia remains largely frozen, despite signs recently of a tentative thaw for some bigger borrowers. Lukoil is planning a $750 million syndicated loan, reduced from $1 billion; TNK BP is looking for $315 million pre-export financing; and MTS, the telecom company, is planning to refinance $630 million of a multi-maturity $1.3 billion loan that its 13 bookrunners hope to launch into general syndication later this year, in what would be the first retail phase in Russia since the Lehman collapse last September.

But most observers say this cluster of activity does not represent the beginnings of a concerted recovery for the market, despite the fact that loan facilities pay much higher margins and fees than two years ago.

Cementing bonds

Instead, central and eastern Europe is likely to see bonds replacing syndicated loans as the key funding tool for companies, a trend seen in western Europe this year. “We may well be seeing a permanent shift in the way companies are looking to raise their money,” says Mike Elliff, managing director and head of CEEMEA (Central Eastern European, Middle East and Africa) debt origination in London.

Indeed, for Russia, many are placing their faith in the bonds – whether new financings or liability management.

Loans had long been the first choice of product for most borrowers, given the liquidity available in the bank market. But since loan market capacity plummeted, many borrowers are increasingly looking to diversify their funding more into the bond market. “Bonds might be more expensive than loans were in the boom years, but the bond market has liquidity, and there are signs that treasurers are now prepared to pay up for it,” says Elliff.

He says it won’t be long before the market sees the return of Russian corporates. “There are now signs that it is beginning to settle down.”

Although spreads are still wide relative to pre-crisis levels, they have fallen substantially from the highs reached last year. Investors are willing to look at new deals again. “If other blue-chip corporates, particularly from the energy sector, wanted to do deals, they probably could – although most don’t want to pay the price that their current CDS [credit default swap] and cash secondary levels indicate,” says Elliff.

“Most potential issuers feel that spreads will have to come down further still before they are tempted to issue again, although with the potential remaining for a significant further sell-off later this year, this is obviously a risky view to have.”

Central Europe: capital markets wasteland?

While Russia is providing some hope, the crisis has taken a heavy toll on banker confidence in central Europe. “Rightly or wrongly, the market has a strong sense that the central European region is on a challenging road to prompt rehabilitation,” says Marks at BNP Paribas. He notes the fact that the region has seen four IMF packages – for Hungary, Latvia, Romania and Poland.

“While these are only positive for confidence, there is lots of negative noise and misinformation coming out of the region. This has helped to create the impression that the region is structurally complicated, with little differentiation across countries, making it is a much tougher place for capital markets teams to operate in,” he says.

Another problem for many capital markets teams focused on central Europe is that it lacks a critical mass of regular borrowers to justify dedicated coverage.

Many of the countries have small consumer-driven economies – compared to Russia and western European countries, no big commodity businesses to speak of. Moreover, the issuers that tap the capital markets – with the possible exceptions of Czech energy firm, Cez and the Hungarian gas company, Mol – do so irregularly, which means that cherry picking mandates has become a popular strategy for many of the big investment banks.

Nevertheless, several sovereign bond mandates from central Europe are likely on their way as governments look to shore up their balance sheets. Croatia is expected first and Serbia, Montenegro, Macedonia and Bosnia are understood to be considering issuing bonds.

“The investor community has decided to look at risk again, including sovereign credits from central and eastern Europe,” says Marks. “Sovereign bonds are the first sign of recovery for the region, at least as far as the markets are

concerned. Their funding requirements are obvious. The next step after the sovereigns will be the top corporates – utilities probably – who will be able to launch deals but at a generous spread.”

But while the bond market is showing signs of a resurgence, the central European loan market is expected to remain quiet for the foreseeable future – balance sheets will remain tight not only because banks are trying to defend and improve their capital but also because there is a lack of ancillary business on offer.

Whereas in Russia the big corporates might be able to offer three or four separate product lines on the back of a syndicated loan, bankers say many companies in central Europe cannot offer much else apart from fees and the margin on the loan.

Staying committed

Patrick Butler, RZB board member responsible for investment banking, treasury and global markets, says the negative sentiment on central and eastern Europe is ill-deserved.

“The picture is not nearly as black as people are painting it. The main problem is not irresponsible borrowers or over-stretched lenders but the level of short-dated indebtedness that the region has coming up. It’s a refinancing issue,“ he says.

He makes the point that the loan market – while much reduced – remains open. “Every bank is more cautious than they were – this is true all over the world. But what is not true is that there has been a complete shut down of the credit markets for central and eastern Europe.”

Those whose central and eastern European businesses were something of an add-on are reviewing their options, and some are exiting the business completely. But those banks still in a position to lend will still do so, he says, adding, “For banks like us, central Europe is in our genetic code and we will remain committed to the market.”

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