Project finance is still in its infancy and the number of true project financed deals can be counted on one hand. Beneath the surface, though, banks and companies are preparing the ground for what could turn into an explosion of project-financed deals within a few years.
The political turmoil caused by the so-called Yukos affair – what was seen as a politically motivated attack on oil company Yukos – undermined investment sentiment and seriously impaired domestic fixed investment activity. Before the Yukos fracas, companies typically relied on their own cash flow for half their investment needs, but that proportion rose to 70% last year.
Confidence is returning but, with a booming stock market and buoyant bond market, Russian companies are still shying away from the legally tricky project financing deals to raise investment funds.
High valuations
“We have been talking to the International Finance Corporation about project finances for years, but chose to issue a convertible bond last year and don’t need more money at the moment,” says Peter Hambro, chairman of the goldmine of the same name. “At the moment, companies are making the most of the high stock market valuations. However, they will soon want to limit dilution of their stock and will turn to project finance.”
Project finance turns on a company’s ability to set up a special purpose vehicle (SPV), a legal box that separates the parent company from the assets that are the target of a project financing deal. The idea is to take an asset and legally separate it from any risks associated with the instigating company – an increasingly attractive prospect in the post-Yukos affair Russia.
Although only a few companies have taken that path, banks are rolling out an increasing number of structured financed securities that are preparing the ground, because they use the same legal tools as project-financed deals and so are ironing out the kinks in the law.
Soyuz Bank debuted in the capital markets in July with Russia’s first asset-backed security (ABS) based on cash flows generated in Russia. The bank floated a $49.8m Eurobond in London backed by receipts from a 4000-car loan portfolio worth $60m-$80m. The car loans were transferred to Russian Auto Loan Finance V, a Netherlands-registered SPV, which then issued three tranches of bonds. JPMorgan will act as cash manager and Russian Standard Bank will act as the back-up servicer.
Investment grade
The bond’s legal packaging impressed the rating agencies so much that Moody’s granted it a high (by Russian standards) rating of Baa3, which is an investment grade rating. Soyuz’s own rate is sub-investment grade – Moody’s does not rate it but Standard & Poor’s gave it a CCC+ rating in August.
Investors bought the senior tranche that carries the least risk, which made up 88% of the total, paying 1.75% over Libor, a cost of capital that is significantly cheaper than the bank could raise for itself.
The deal is also significant because Soyuz Bank is a relative newcomer on the scene, having emerged from a series of restructurings to bank entities associated with insurance giant Ingosstrakh after 1998. The bank is now part of the Basic Element aluminium group, headed by oligarch Oleg Deripaska, and only entered the car loan business in 2004.
Soyuz’s ABS is not Russia’s first securitisation. Rosbank securitised external credit card payments from foreigners using their cards in Russia and Gazprom securitised gas export receipts last year, but both these bonds were awarded lower ratings of Ba3 and BBB- by Moody’s.
“The Soyuz issue was groundbreaking because it was the first to securitise cashflows inside Russia. It was doubly impressive because the structure received an extremely high rating,” says Alexey Boulgakov, a debt analyst at Aton Capital.
Soyuz deputy CEO Yekaterina Demygina told reporters shortly after the issue that the bank planned to increase its car loan portfolio to about $180m by the end of this year and issue more ABS to finance the loans.
Lack of distinction
The traditional problem for organising ABS in Russia has been the lack of a clear distinction between loans provided by a bank and those provided by a non-financial institution, or SPV. Previously, it has been impossible to transfer loans from one type of entity to the other. Nothing has changed materially in the rules but the judicial system has decided to accept the principle of assets transfer between banks and SPVs, although the legal concepts underpinning the issue are still fluffy and untested.
“Basically, the legal structure of the issue, the first of this kind, features a number of uncertainties, and it will be interesting to see how investors react. Acceptance by the market would probably signal the emergence of a large number of similar offerings,” says Mr Boulgakov.
Soyuz’s issue was a groundbreaker, but banks are making increasing use of SPVs in rapidly expanding credit note issuances. In the wake of Russia’s booming domestic corporate bond market, banks are rolling out a range of structured products. The credit-linked note (CLN) market, pioneered by Trust Bank, is growing fast and makes use of the same legal framework as project financing. Leading commercial bank Alfa Bank registered a $1bn medium term note (MTN) programme with its Cyprus-based SPV, Alfa MTN Issuance Limited, in June and its main rival, MDM Bank, has organised a raft of CLNs in the past year.
The Soyuz ABS has already generated a lot of interest from other banks that intend to copy its legal structure. Vneshtorgbank, Russia’s second largest bank, has said that it may float the first mortgage-backed bonds by the end of the year, aping the Soyuz legal structure.
The government is providing the biggest impetus to the use of SPVs in the raising of finance, though. Last year, the Kremlin set up the Rosneftegaz SPV as part of its effort to secure complete control over gas monopoly Gazprom. The problem was that the government owned just under 40% of the gas giant outright and wanted to transfer 10.7% of treasury stock off the company’s books to give itself a clear majority stake.
As Gazprom is a publicly-traded company, shareholders must be compensated for moving these shares off its balance sheet to the tune of $7.3bn. The whole issue turned into a saga of Kremlin infighting but after a plan to swap state-owned oil company Rosneft shares for the stake failed, the Kremlin decided to buy the shares with cash.
Biggest corporate loan
Rosneftegaz was set up by the government as a SPV to handle the transaction last year but could not raise the money in time to meet the government’s self-imposed deadline and, ironically, had to take a short-term loan from Rosneft. However, by the end of August, the SPV had secured Russia’s biggest ever corporate loan, borrowing $7.3bn for a year at an interest rate of 1.5% over Libor.
Western banks were queuing up to lend money. Rosneftegaz will receive the loan in tranches of $1.4bn within three months and another $5.9bn by December.
Next year, the government plans to make use of another new financial fad that is sweeping the Russian market: to refinance the loans next year by floating part of Rosneftegaz on the stock market to pay back these loans.
Gazprom’s management has said on several occasions that it wants to make use of project financing to raise money for investment projects. With its debt now exceeding $16bn, project financing is becoming increasingly attractive because it is a way of raising money for an investment project that will not appear on Gazprom’s balance sheet.
