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Asia-PacificJune 3 2013

Government backs Kazakh capital markets revival

Led by innovative deals from development banks, Kazakh bond markets are enjoying a dynamic spell, but pension reform casts uncertainty over the equity markets.
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Government backs Kazakh capital markets revival

Kazakhstan was one of the worst-hit victims of the 2008 credit crisis, with two of the country’s largest banks, BTA and Alliance, defaulting on their substantial debts in 2009. However, the past year has given plenty of cause to believe that the central Asian country’s reputation, among bond investors at least, has been impressively rehabilitated.

The Development Bank of Kazakhstan (DBK) and the Almaty-headquartered multilateral Eurasian Development Bank (EDB), in which the Russian and Kazakh governments are the largest shareholders, have been at the cutting edge of this revival. DBK took Kazakh international issuance into new territory with the first sukuk (sharia-compliant notes) from any country in the former Soviet Union in June 2012, denominated in Malaysian ringgit to target the largest single pool of Islamic finance investors.

Sukuk deal

Malaysia is by far the deepest sukuk market, accounting for about 60% of outstanding issues, of which 40% are sukuk al-murabaha (commodity sale-and-repurchase), the structure that DBK wanted to use, says Zhaslan Madiyev, the bank’s deputy chairman and chief financial officer. The twin aims of the issue were to present Kazakh issuers to a new international investor base, but also to bring new techniques to the local market. Kazakh investors bought about 38% of the RM240m ($79.9m), five-year deal, which was listed on the Kazakhstan Stock Exchange (KASE) but issued under Malaysian legal and sharia norms.

“On the roadshow, we found that Malaysian investors knew very little about Kazakhstan, and we were also teaching Kazakh investors how to do the accounting for a new type of deal structure. Only by practical example could we find the shortcomings in existing legislation – you do not get the same benefits from just doing a theoretical exercise,” says Mr Madiyev.

The yield on the sukuk was 5.5%, with an all-in cost of 4.95% once the ringgit were swapped into dollars. By contrast, Kazakh sovereign yields were more than 12% at the height of the 2008 crisis, a good indicator of how far sentiment has recovered. While glad to have opened a new market for Kazakhstan, Mr Madiyev is unsure that there will be an immediate rush from the sovereign, other quasi-sovereigns or corporates to bring sukuk to market. Conventional yields are sufficiently low that such deals might not be the most economic way to fund.

But he points out that the bond market buoyancy induced by massive liquidity injections from the world’s leading central banks cannot last forever. When conditions change, investor diversification will be especially valuable for Kazakhstan, and Mr Madiyev says he is ready to look at further sukuk issues targeting the other large sharia-compliant investor base, in the Gulf countries.

Eurobond stars

Kazakh issuers used the strength of the conventional bond market for ground-breaking liability management exercises in the closing months of 2012. Privately owned hydrocarbons producer Zhaikmunai launched a cash tender offer in November 2012 for its 2015 bonds, buying back about 77% of the old issue for $348m while issuing $560m of 2019 debut benchmark bonds. The 2019 bond carried a coupon of 7.125%, compared with 10.5% on the issue that it refinanced.

“A sovereign connection has been a preferred feature among international investors, and most issues out of Kazakhstan in the past four years have been quasi-sovereign. But the landmark Zhaikmunai deal enjoyed strong demand, showing that the sovereign link is not a must, and there is a good market for independent issuers with a robust credit standing,” says Arnat Abzhanov, member of the management board at Kazakh investment bank Halyk Finance, which was a co-lead manager on the tender and new issue.

A month after Zhaikmunai had introduced the liability management concept to the Kazakh market, DBK went a step further with a deal that used the world’s first intermediated exchange process involving a dollar-denominated bond. The intermediated exchange is designed to provide certainty of execution for the issuer and allowed the loss to the issuer from buying back bonds above par to be amortised over the life of the 10-year new issue. The $1bn deal received $3.43bn of orders from 170 accounts, allowing a coupon of just 4.125%.

“We paid a small premium to investors on the old bonds, but the all-in cost was very efficient, with a historic low yield for a corporate anywhere in the CIS [Commonwealth of Independent States] and it showed this technique is viable in favourable market conditions,” says Mr Madiyev.

The deal was followed with a $425m tap in February 2013, making the 2022 bond the largest outstanding single maturity in Kazakhstan at that time. Mr Madiyev says this leaves the DBK with excess liquidity to fund the growth of its portfolio, and the bank has no immediate plans for further issues, although it will watch market opportunities.

The pace of Kazakh issuance accelerated into 2013, reaching $3.53bn in the first four months, compared with $3.16bn in the whole of 2012 and just $1.24bn in 2011. This surge culminated in the $3bn raised by state-owned oil and gas producer KazMunaiGaz in $1bn 10-year and $2bn 30-year tranches in April 2013. Global yields are plumbing fresh lows and US swap rates are very helpful for all-in funding costs, but Mr Abzhanov says this is still quite a remarkable performance for Kazakhstan in general, and for KazMunaiGaz in particular, as the company has fully achieved its funding objectives and successfully extended its debt maturity profile.

“At least half of each Eurobond issue is taken up by the usual suspects – emerging market fund managers – so Kazakh issuers are competing for attention with all the other emerging markets including the CIS region. So far, we have been able to capture the focus of investors,” says Mr Abzhanov.

Going local

If the Eurobond market is maturing fast, the market for Kazakh tenge bonds is still in its infancy. The EDB has a mandate to help develop tenge markets, and it needs to raise long-term tenge funding for its project finance and other loan commitments in Kazakhstan. While some of this lending can be funded through dollar issues, tenge swap markets have little capacity beyond one-year maturities, so the bank needs tenge issuance to avoid generating excessive currency mismatches between its assets and liabilities.

The EDB debuted a Tg20bn ($135m) tenge bond in April 2009, in Eurobond format, and settled through global settlement system Euroclear. In December 2012, it launched a Tg10bn five-year bond that was much more significant for the local market, because the prospectus was under Kazakh law, with a KASE listing, sold purely to Kazakh investors. This was the first bond issued in the local market by a foreign or multilateral issuer, and was followed with a further Tg15bn five-year bond in April 2013.

Dmitry Krasilnikov, a member of the EDB managing board in charge of corporate finance, says the issues were marketed to local pension funds and banks, and companies in the sovereign holding group Samruk. These are sizable yet naturally conservative investors, but the April deal was eventually three times oversubscribed, allowing a 6% yield.

“The chronic problem in the tenge market is a shortage of high-quality non-sovereign issuers. The EDB represented a very good opportunity, as it is a strong credit rating proxy for the sovereign with a premium. The five-year maturity was well suited to most pension funds that have long liabilities, although there were also some commercial banks looking for gains in the secondary markets,” says Mr Krasilnikov.

He says the EDB’s portfolio is expected to grow about 25% to 30% per year, of which more than one-third is denominated in local currencies, a proportion that could rise in Kazakhstan. This implies growing tenge bond issuance if there is a receptive audience.

Pension fund uncertainty

The nature of that audience is uncertain at present, following government announcements of a planned pension reform. This could see the money saved in the country’s 10 private pension funds transferred into a single state fund during 2013. It is not clear how this fund would then operate, for example if it would allocate the money back to the 10 existing funds as asset managers. The situation is forcing those dependent on tenge bond markets to make contingency plans.

“It is still uncertain at this point of time how the consolidated pension fund would work with local banks, and what cumulative exposure limits it might have. However, given that our bank does not borrow much in the bond markets, we should not suffer from establishment of one pension fund,” says Samat Balkenov, deputy chief executive of one of the country's top 10 banks, Tsesna Bank.

In practice, deposits account for about 90% of Tsesna’s liabilities, and banks that are better able to fund themselves through savings are likely to be at an advantage while the uncertainty over local pension funds remains. Tsesna has been able to grow its loan market share 1.4% in 2009 to 4.8% today.

Eurobond investors are not yet ready to welcome back the banking sector, with BTA restructuring its debt a second time as recently as 2012. Maxat Kabashev, chief executive of the other restructured bank, Alliance, says there is no opportunity to access the Eurobond market at present. Halyk Bank, the country’s second largest with a substantial share of household deposits, raised $500m in 2011, but an attempt by the more highly leveraged Kakommertsbank to raise up to $750m a few months later was undersubscribed, resulting in an issue of just $300m.

People's IPO

The effects of the pension reform may be even more profound for the government’s plans to launch initial public offerings (IPOs) of companies held by Samruk, which were dubbed the 'People’s IPO' programme. The proposed method is to list the stakes exclusively on the KASE, open only to domestic retail and institutional investors.

Oil distributor KazTransOil became the first company to list a stake under this programme, with a $186m offering for 10% of its capital in December 2012. A single pension fund, if created, would change the rules of the game for the People’s IPO programme, says Georgy Egorov, who is head of emerging Europe equity capital markets at UBS. The Swiss bank, one of the few global banks with staff on the ground in Kazakhstan, is a financial advisor on the whole People’s IPO programme.

Potentially, a single state pension fund could lead to less diversified portfolio allocation and also reduced turnover on the KASE if the new fund generally performs a buy-and-hold strategy. In any case, the KazTransOil deal was small compared with some of those planned for the future, such as railway operator Kazakh Temir Zholy. Larger companies may still need to tap international investors for at least some of the equity raised, says Mr Egorov.

“Just two years ago, daily equity trading volume on the KASE was less than $2m, which really kept it off the radar for international investors and made companies such as [mining group] Kazakhmys look to London for their listing. That is why the government decided to do something to take it further, to develop local markets and give the population access to the wealth created by these state companies,” says Mr Egorov.

IPO prospects

While the focus of the People’s IPO programme is likely to remain on domestic investors, recent evidence suggests that international investors are now comfortable investing in KASE-listed stocks, via global depository receipts (GDRs) if necessary. KCell, the Kazakh mobile subsidiary of Scandinavian telecom giant TeliaSonera, successfully raised $525m through a listing of KASE shares and London GDRs in December 2012, despite the proximity to year-end fund reporting and the much larger IPO of Russian mobile operator Megafon. UBS was a bookrunner on the KCell deal, which garnered almost 30% of orders from domestic investors.

“There had been no IPO from Kazakhstan for five years, yet the deal pulled in 120 accounts, which is outstanding for a market categorised as frontier by [share index compiler] MSCI,” says Mr Egorov.

He is unsure about the prospects for further IPOs from privately owned companies, as the private economy is relatively concentrated on a few holding companies. Corporate governance disputes at London-listed mining company Eurasian Natural Resources, which have resulted in the resignation of several board members and the launch of an investigation by the UK Serious Fraud Office in April 2013, could also dampen investor sentiment. This means the People’s IPO programme is likely to remain the major source of equity capital markets activity. The Kazakh Electricity Grid Operating Company is scheduled to begin an IPO in June 2013, with power generator Samruk-Energo to follow in the fourth quarter.

By contrast, the rescued banks BTA, Alliance and Temir (a retail bank spun out of BTA) seem likely to be sold to strategic buyers rather than through the KASE. Most recently, the government has mooted selling BTA to Halyk, or possibly merging Alliance and Temir prior to a sale. Alliance has now returned to profit and a positive (although insufficient) capital position. Temir has a healthier capital position, while BTA is still in negative equity.

“The extra capital at Temir would result in a stronger capital position for a merged bank, and the combination would be good strategically as it would have a 20% share of the retail market. There would be good potential to optimise operating expenditures, infrastructure and IT. But Samruk is still deciding whether to sell the banks together or separately, we expect a clearer answer during the second half of 2013,” says Mr Kabashev of Alliance Bank.

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