The effort that Russia’s leading banks have put into building up their names on the international capital markets, using a string of short-term and expensive bond issues, has paid off. Since the start of the year, the banks have issued a flood of Eurobonds with falling yields and lengthening maturities that have given them the resources to pull away from their smaller peers, which are still barred from the international markets.
Russian Eurobonds are back in fashion and this spring they overtook Mexican bonds – the favourite comparison – in their appeal to foreign investors. Russia’s most liquid Eurobonds, maturing in 2030, earn investors about 5.6%.
Russian banks have also overtaken their native companies in the first quarter of this year, upping their share in total Eurobond issues to 38%, while corporate fell to 31% of the total.
“The top 30 banks have strong credit portfolios and their increasing access to international capital markets has opened a source of cheap, long-term financing. It has begun a natural process of divergence between winners and losers,” says Mikhail Galkin, a credit analyst at Trust investment bank.
Banks connected to the state, such as Sberbank, Vneshtorgbank (VTB) and Gazprom, are commanding low yields of 7%-8% on their Eurobonds. However, small Russian banks are forced to borrow on the domestic market at rates of 13%-15% on the interbank market, where volumes are low and only a handful of banks can issue rouble bonds at all.
“Domestic banks have been more or less shut out of the domestic bond market,” says Mr Galkin. “Without a working pension industry or other institutional investors, banks remain the biggest holders of bonds and they are unwilling to increase their exposure to other banks by buying their bonds.
“They already take enough of this risk by lending on the interbank market. The one exception is VTB’s bonds, which are seen as sovereign bonds rather than a banking bond.”
VTB is planning a huge Rb30bn ($1bn), seven to 10-year rouble bond this autumn, issued in two tranches, which shows how deep the domestic market has become. Such large bond issues were not possible 12 months ago.
The state banks are dominating the Eurobond issues but commercial banks are close behind. By the end of 2004, Russian banks accounted for 31% – or $5.8bn – of total Eurobond issues but are now adding a few billion dollars in issues nearly every month.
June saw another $2.5bn-worth of Russian bank issues and, in July, Alfa Bank and Home Credit Finance Bank issued bonds of $200m and $275m respectively. Impexbank plans to issue a similar amount in the next few months and leading consumer credit specialist Russky Standart wants to increase its Eurobond issue from last year’s $150m to a whopping $1.5bn by the end of 2005. Analysts expect banks to issue a total of $8bn of Eurobonds by the end of the year, against the total of $11bn of Eurobonds – both bank and corporate – issued last year.
“Russian banks have the right credit ratings and the capital markets are accepting them as creditworthy. As soon as a bank gets a B- credit rating, it seems it wants to rush to the international capital market to raise money,” says Mr Galkin. “This is the only source of long-term capital that Russian banks have. The issue is not if the interest rates are acceptable but just if the banks have access at all.”
Russia is not alone in this – banks in Kazakhstan and Ukraine have also been active issuers as their retail banking sectors boom. Indeed, the acceleration of bank bond issues has the ratings agencies worried.
“The rapid credit growth, although coming from a low base, could not only be storing up problems for the future but also hiding the level of non-performing loans,” said Standard & Poor’s in a recent research report on bank bonds from the region.
RUSSIAN BANKING SECTOR REFORM
“The CBR is not trying to push reform so much as attempting to clean up the sector using deposit insurance as the brush,” says Mikhail Galkin, a credit analyst at Trust investment bank. “Banks are not being closed down, but the strong banks are getting stronger and the weak ones weaker.”
Russian bank reform has been progressing slowly and last summer’s mini-banking crisis showed how fragile confidence is. The opportunity for radical reform after the 1998 financial crisis was missed and bank reform has to progress slowly now as radical change could easily destabilise the system again.
The Central Bank of Russia (CBR)’s strategy has been to use the introduction of the deposit insurance scheme to clean up the ownership and capital structure of banks while beefing up inspection and the implementation of regulations.
Despite the botched closure of Sodbiznesbank last May, which sparked the crisis, the CBR has not completely ignored its duty when it comes to shutting down weak banks. Three hundred of the 1100 banks that applied for a new licence and membership of the deposit insurance scheme have been rejected.
The insurance scheme is unlikely to make a big difference to the retail sector for several years and the fund will be unable to bail out even a medium-sized bank for some time to come. Russians had an average deposit of $850 in the first quarter and 95% of total deposits are below the cut-off level of $3500, which enjoy a 100% guarantee, according to the new law.
At the start of May, the deposit insurance fund contained $300m, the bulk of which comprises state-owned assets such as buildings, while banks had contributed just $100m in cash. The fund is expected to double in size by the end of the year.
Political impetus for change
Despite the lack of headline-making changes, there is real political will to knock the financial sector into shape. “We are finally seeing good ideas at the CBR, the Duma Banking Committee and the other bodies that deal with the sector,” says Irina Penkina, who covers the Russian banking sector for Standard & Poor’s. “There are a raft of initiatives that we can approve of.”
Transparency is improving and the regulator has started regulating for the first time. Despite the Sodbiznesbank disaster, bankers are now taking the CBR’s orders seriously.
“The CBR now has influence over the sort of borrowers a bank caters to. It has put together better systems to measure risk and decide who to do business with,” says Richard Hainsworth, CEO of RusRatings, the leading Russian bank ratings agency.
New rules for Real term deposits
The Duma Banking Committee has got in on the act and proposed several draft laws, the most important of which tackles real term deposits. The Russian civil code gives citizens the right to withdraw all their money at any time, making a fiction of the few term deposits banks offer. The committee is proposing to introduce a new class of “non-callable deposit” – Russia’s first real term deposit – to dodge the civil code. Depositors will either be allowed to withdraw their money if they pay a penalty or they will have to agree to lock their money up for the full term.
However, even if the non-callable deposits become a reality, analysts say the premium banks will have to offer could make them uneconomic for banks.
Another initiative is to broaden the definition of what counts as collateral. The current definition is very narrow and banks are forced to use their physical property – buildings and equipment – as collateral if they want to borrow money at home.
“It’s a nightmare for banks,” says Mr Hainsworth. “At the moment they raise credits collateralised by loan receipts – the main banking asset – which makes it hard for them to raise money to fund their lending activities.”
Regulating bank mergers
New rules to make bank mergers easier are due later this year and could accelerate the consolidation of the banking sector. There has been a spate of acquisitions over the past year and more are in the pipeline, but none of the banks involved has completed a merger because they are awaiting the new rules.
“The problem is the bank merger laws are based on the joint stock company rules,” says Ms Penkina. “This means that you have to inform all your customers of the merger, which, in a bank’s case, can be millions of people. And they all have the right to withdraw their business during the process. It makes mergers potential lethal for the business.”
