Russia dominated the bonds and equities scenes last year but this year there are likely to be opportunities for small corporates and second-tier banks in other CEE countries to join the fray, writes Michael Marray.
The search for yield pick-up on the part of global fixed income investors is proving to be highly beneficial for central and eastern European (CEE) bond issuers. Top-class names are getting extremely fine pricing and the market is also receptive to first-time issuers. European and US accounts are hungry for paper and the private banking bid from Asia is exceptionally strong for B or BB-rated borrowers.
The result is a funding opportunity for new issuers, such as small corporates and second tier banks, which might not have been approached by underwriters even two years ago; and a new set of debut offerings is expected this year.
Dominant force
Last year, Russia dominated the picture but new issuers from countries such as Bulgaria and Ukraine also tapped the international markets for the first time. In November, Bulgarian fuel retailer Petrol AD closed a five-year €100m Eurobond offering, with ING as sole bookrunner. Strong demand from both emerging market and high yield investors for the B minus-rated paper, priced at 8.375%, resulted in the deal being four times oversubscribed.
The same month, Ukranian poultry company Myronivsky Hliboproduct (MHP) launched its debut bond offering in the Reg S/144A market, with a five-year deal managed by ABN AMRO and Morgan Stanley. The
B-rated issue was priced at 10.25%, 568.5 basis points (bp) over US treasuries. Europe took 55% of the deal, US investors 40%, and Asia 5%.
“With limited corporate supply out of Ukraine, we had to draw comparisons with similar companies in the US as well as in emerging markets, such as Brazil. MHP had a great growth story that was presented in a sophisticated fashion during roadshows in Singapore, London, Zurich, Geneva, New York, Boston and Los Angeles,” says George Niedringhaus, head of emerging markets bond origination at ABN AMRO.
“With books nearly three times oversubscribed, we placed 60% of the $250m deal with traditional emerging markets asset managers, while hedge funds took another 16% and banks 11%,” says Mr Niedringhaus. “The bonds have since traded well and, from the investor perspective, this type of positive introduction to Ukrainian corporate product should pave the way for more first-time issuers from the country in 2007.”
Bank issuance
Heavy investor demand was also in evidence for the steady pipeline of deals out of Russia that came in the fourth quarter, after the market took a few months to settle down following the volatility seen during May. Two Russian banks were big issuers during 2006. In November,Bank of Saint Petersburg did its debut Eurobond offering, led by Dresdner Kleinwort and ABN AMRO, selling $125m-worth of three-year loan participation notes priced at 9.5%. And in early December, Bank Petrocommerce launched an upsized $300m Eurobond that was lead managed by Merrill Lynch and ING, pricing its three-year bonds at 8.75%.
“In spite of the large number of Russian bond offerings during the fourth quarter, the Eurobond deal we brought for Bank Petrocommerce in early December still had a big order book, illustrating the strong investor demand for Russian bank issuers,” says Alex von Sponeck, head of CEEMEA debt capital markets at Merrill Lynch in London.
Russian investors took 20% of the bonds, with 25% placed in Asia, 19% in the UK and 16% in Switzerland.
“For this type of senior unsecured offering, a sizeable amount of distribution in Asia is quite typical,” says Mr von Sponeck. “The private banking demand is strong out of Asia for both bank and corporate issuers where there is a high yielding coupon, whereas for the lower yielding Russian securitisation deals, there is generally not much distribution in Asia.”
Funding diversity
One of the best known Russian issuers is Alfa Bank, which has been taking advantage of the high level of liquidity on the international capital markets as well as in the bank market to diversify its funding sources. Like many Russian banks, growth is rapid and there are heavy funding requirements.
In October, Alfa did a $400m Eurobond out of its MTN programme, issuing three-year bonds at 7.875%. It has also been in the syndicated loan markets ($438m in May and $340m in December) and club loan markets ($220m in September).
“We target a broad investor base and so will cover all areas of the globe,” says Andrew Baxter, CFO at Alfa Bank in Moscow. “Spreads on Eurobond issuance have come in by more than 100bp since 2005 and we have seen a similar effect in our syndications.
“There appears to be more appetite for longer tenors,” says Mr Baxter. “Syndicated loans are cheaper than bonds, given that they are relationship driven, but tenors are shorter and the covenants are different.”
Structured finance
One of the most important capital markets trends during 2006 was the use of structured finance by Russian issuers, giving them access to an additional set of investment grade investors separate from their senior unsecured offerings.
Typically, structured paper can be one notch higher than the senior unsecured bank issuer rating, so the Moody’s Ba2 rating for the top private sector banks can get them to investment grade in the structured market. Ratings from Standard & Poor’s (S&P) are generally one or two notches lower, which means that the same banks cannot get to investment grade.
Last March, Alfa Bank did the first ever diversified payments rights (DPR) deal out of Russia, raising $350m in an offering of Baa3-rated notes, lead managed by Dresdner Kleinwort and Merrill Lynch. The deal was also the first 144A offering by Alfa targeting US investors. The bank subsequently came back with a second DPR offering in December.
Trail blazer
The other Russian institution that is blazing a trail in securitisation is MDM Bank, which last year did an international bond offering backed by car loans, in addition to a DPR deal. The DPR offering, which was also lead managed by Dresdner Kleinwort and Merrill Lynch, featured a €225m tranche and a $200m tranche.
“The DPR programme is a substantial enhancement of our funding toolkit that we will continue to employ successfully for profitable and above-market growth in corporate, small and medium-sized enterprise, and retail segments,” says Andrey Ilyin, chief financial officer at MDM Bank in Moscow.
At the time of the offering, MDM had a Ba2 rating from Moody’s and, with the help of structuring, the notes were rated two notches higher at Baa3.
In December, the bank changed its shareholding structure, with 50% owner Sergey Popov increasing his stake to 90%. According to Mr Ilyin, the change in shareholding structure should not have any negative rating implications, and the outlook for MDM’s credit ratings remains a positive one. The bank is currently rated Ba2 by Moody’s, BB minus with positive outlook by Fitch Ratings, and BB minus by S&P (the latter was raised from B-plus, on the day following the announcement of the change to shareholder structure).
“Shareholder support is practically not factored into our current credit ratings and, from our preliminary discussions with the rating agencies, our understanding is that this event alone is neutral; they will not be changing their ratings just on the strength of this announcement,” says Mr Ilyin.
More upgrades are likely in the next couple of years. One of the attractions for investors in Russian bonds is the steadily improving ratings story, for both state-owned companies and the private sector, and issuers anxiously await news of each one-notch upgrade. For the state-owned companies, their arrival at A-rated status will mean even tighter pricing this year. For example, in late December Gazprom had its senior unsecured rating raised from Baa1 to A3 by Moody’s.
Gazprom has been one of the favourite names for bond investors and is a regular issuer in the Eurobond market. In October, it did a €780m offering lead managed by Citigroup, Dresdner Kleinwort, Goldman Sachs and Morgan Stanley. The issue met with an enthusiastic response from asset managers, banks, insurance companies and pension funds. The bonds were sold with a 5.03% coupon, which represented a spread of 102bp over mid-swaps.
Euro offerings
“Most Russian borrowers are focused on dollar issues, but in 2006 we lead managed euro-denominated offerings for both Gazprom and the City of Moscow,” says William Weaver, co-head of EEMEA debt capital markets at Citigroup. “This transaction came shortly after an upgrade from S&P, so it was the first deal in which Gazprom had three investment-grade ratings. We saw orders from investors you would not normally see in emerging markets deals, helping to bring the order book to around €7bn.
“Gazprom has been able to achieve steadily better pricing on its debt, with its bonds tightening in by about 100bp during 2005 and another 20bp to 30bp in 2006,” says Mr Weaver. “While spread compression slowed down for top names during 2006, there was a lot of spread compression for lower rated Russian corporates. Many investors have shifted down the credit curve to BB or single-B names in the search for yield, so we expect to see new corporate names doing their first deals in 2007, as well as more offerings from well-established borrowers such as Gazprom.”
It is this steadily improving credit environment, on the back of a buoyant economy powered by high oil and gas prices, that has underpinned the investor appetite for Russian bonds over the past two years. This appetite also extends to equity offerings.
Last year was dominated by the giant $10.4bn flotation of oil company Rosneft in July, with the state selling a 14.8% stake. Joint global co-ordinators were ABN AMRO Rothschild, Dresdner Kleinwort, JPMorgan and Morgan Stanley.
There were a number of other initial public offerings (IPOs) out of Russia. Among them was steel company TMK, which is Russia’s largest pipe manufacturer. Its IPO was lead managed by Dresdner Kleinwort, Credit Suisse and Renaissance Capital.
“The $1.1bn IPO that we led for TMK was 19 times oversubscribed. But some other IPOs struggled around that time, which shows that equity investors are selective and are looking for top-quality companies with a good story to tell,” says Ken Robins, head of Russian and emerging markets equity capital markets at Dresdner Kleinwort.
“Equity investors are seeking out Russian companies with excellent growth prospects, either because of their access to natural resources, such as Rosneft, or a first-class customer base, such as TMK,” he says. “These companies are not just viewed as emerging markets companies that appeal to emerging markets investors, but are bought by the same sectoral investors who buy into western European IPOs.”
The number of Russian IPOs is likely to be higher in 2007, even if volume may struggle to beat 2006 because of the size of the Rosneft flotation. In general, CEE companies look set to continue to get a good reception from equity investors.
In addition to equity and bond offerings, banks and corporates are also getting access to extremely fine pricing in the syndicated loan market, and there should be a continuation of the trend for second-tier borrowers to come to the loan market this year.
In countries such as the Czech Republic, Hungary and Poland, many issuers tend to favour the syndicated loan market over the bond market. Also, many banks in those countries have been taken over by western European banks and so do not need to access the capital markets in the way that independent Russian institutions do.
Bond issuance out of these new EU accession countries is quite low compared with those out of Russia, although there are some regular issuers, such as Czech electric utility CEZ. CEZ has completed four Eurobonds to date, most recently coming to market in October with a €500m offering that was lead managed by Deutsche Bank and Société Générale.
With regard to Russia, there are likely to be more mortgage-backed offerings and structured deals backed by auto loans and DPRs this year. Bankers expect total international bond issuance volume to be considerably higher than last year’s figure of $20bn.
Hybrid moves
Hybrid capital deals are likely to be a feature of the market in the coming year. Alfa Bank did the first subordinated debt deal out of Russia at the end of 2005, lead managed by UBS Investment Bank and Barclays Capital. For various regulatory reasons, last year was fairly quiet but a number of banks are working on transactions.
“We are likely to see a number of Tier 1 or Tier 2 hybrid capital deals from Russian banks during 2007, including offerings from banks wanting to beef up their capital ahead of planned IPOs,” says Richard Luddington, head of CEEMEA debt capital markets at UBS.
“On the corporate side, a number of private sector names are looking at getting credit ratings and will subsequently do bond offerings, so we will see some new Russian corporate issuers coming to the market during 2007,” says Mr Luddington. “We will also see corporate bond issues from well-known names in the energy, metals and telco sectors, predominantly driven by refinancing needs and increased mergers and acquisitions activity.”
