At less than $100 per head of personal indebtedness, Russia boasts one of the most under-leveraged societies in Europe. And thanks to income levels that are expected to jump by as much as 50% over the next three years, the consumerism trend shows no sign of abating. More than one million consumers now possess at least one credit card, and banks are forecasting that the triple-digit percentage growth in volumes – to more than $1bn in 2004 – seen over the last three years will be repeated again this year. “Anyone with cash and distribution is getting into consumer finance,” says Guerman Aliev, a Rosbank board member. “It’s the juiciest piece of business.”
With margins of as much as 35% on durable goods and 20% on autos, it is easy to see why banks are so enamoured. Pioneered by specialists like Russian Standard Bank and Delta Bank – both of which have since been acquisition targets of Western majors – the four-year old sector offers almost immediate profit potential.
Non-card consumer debt – mostly generated by time payment schemes for brown and white goods purchases – produces good returns and, as well, bankers see consumer financing as a platform from which to cross-sell other financial products, such as mortgages, investment funds and insurance, to cardholders and consumer-lending clients.
The segment also is proving to be a source of heightened competition and not only among Russian banks. Citibank has drawn faint praise for its street-level marketing campaign. Meanwhile, GE Capital in August invested a reported $100m for Delta Bank and its stable of more than 100,000 customer accounts. Even banks that lack a retail franchise are moving in. Renaissance Capital, an investment bank, has established a subsidiary that offers white-label credit programmes to retailers. “Financial opportunities at this moment are just incredible right across the board,” says Roland Nash, a managing director and co-head of equity group product at Renaissance Capital.
Pricing and partnership
In corporate and trade finance, as well as their investment banking activities, mid-sized Russian banks are facing many of the same challenges that they do on the retail side of the business. Concerns about capital cost and balance sheet structure are paramount. Competition for customers is keen, as is the desire for exposure to Russian credits among an array of banks and investors. All of this depresses fee schedules and terms for origination and execution of all manner of deals and contracts. Fortunately, deal flow in many of those businesses is running high, begging questions about how best to deploy capital for maximum return.
“In dealing with blue chips, banks find that they can’t make big margins, so many of them are moving down the credit curve to work with medium-sized companies,” says Alex Ganyushkin, a vice-president and senior manager in the international banking and financial institutions division at Alfa Bank in Moscow.
“What is helping is that the mentality is changing in those companies. They realise that it is worth it to them to work closely with a large bank. Corporations are migrating and we have seen a wave of new clients.”
Longer tenors
In the area of trade finance, increasing client demand and lengthening borrowing histories mean that banks are being called upon to attract capital at longer tenors – up to five years – that they then can pass on to borrowers.
Often this requires the participation of foreign banks, many of whom are eager to gain exposure to Russian credits. Mr Ganyushkin cited Alfa Bank’s $120m, one-year facility, which drew heavy interest from the 20 banks that took part, as indicative of the interest and the pricing the bank can achieve. The deal, paying 200 basis points over LIBOR, capped $200m in issuance by the bank last year.
In corporate finance, a booming bond market for mid-sized corporate debt and the tendency of small companies to self-finance through returned capital has kept loan levels low. Just 5% of fixed investment is paid for by bank loans in Russia, thanks in part to banks’ unwillingness to scale down the credit curve for issues of size and credit quality.
With competition keen and origination fees low, some banks are developing specialised debt programmes to increase fees.
“Fees are dropping fast even as the market is booming,” says one Moscow fixed-income specialist. “That is because many banks look at leading plain vanilla issuance as a way that they can generate value in other areas.”
Outsourced functions
Meanwhile, capital markets specialists from large banks are awaiting the culling effects of sector reform. Having invested to build capacity, large banks say that they will offer to outsource trading and settlement functions for the smaller banks that remain in the market. Sergei V Rodionov, the managing director and head of Alfa Bank’s capital markets division, says: “We have dedicated infrastructure and the ability to offer risk management and back office functions in addition to executing trades. It will make commercial sense for these banks to seek solutions from larger providers.” On the equity side, the government’s slow march to pension reform is giving impetus to the rapid development of a local asset management industry as competitors – especially deposit-taking retail banks seeking to cross-sell products. And that, in turn, is creating a demand for securities among a growing coterie of local institutional investors. To meet this demand, some banks are developing new techniques for getting companies launched on their way to exchange listing.
Competitors arrive
Developments in the capital markets will gain pace as reforms make their way through the financial system. More competition is promised with the arrival of UBS, via its purchase of the remaining shares in local brokerage Brunswick, and Deutsche’s acquisition of investment bank UFG. Bankers say that it is incumbent on them to protect their franchises. “The growth in domestic sectors like financial services and the consumer spending boom are indicative of the strength of the underlying economy,” notes Artem Konstandian, head of the international financing department at Promsvyazbank. “It is up to banks to create a range of new products and across business lines that capture some of that growth.”
CREDIT-LINKED NOTES: INCUBATION AND INNOVATION
Russia’s corporate bond market boom has led some homegrown investment banks to employ credit-linked structures as vehicles both for boosting client profiles and for bettering their own bottom line.
Credit-linked securities have long been a feature of Russian corporate finance. Utilising the expertise and distribution capabilities of Western investment banks, blue-chip companies with hard currency receivables have found that by securitising those assets, they can turn future payments into ready sources of capital.
In light of the increasing investor appetite for Russian corporate risk, enterprising local investment banks have taken the technique a step further. By offering unsecured credit-linked funding options to second-tier companies – the country’s so-called ‘emerging blue-chips’ – these banks have found that they can help their clients and themselves. The securities provide companies looking to build a foundation for forays into international capital markets with fast and easy funding options. However, they also enable the banks underwriting them to generate higher fees than those on offer in the booming market for domestic corporate bond origination.
“Many companies possess solid fundamentals, but they lack the track record or need to place a full fledged Eurobond,” says Kieran Donnelly, managing director for International Fixed Income Sales at Moscow-based MDM Bank. “Credit-linked notes are a means for putting them on the road to the Eurobond market.”
Typically short in tenor – running from six months to two years – and small in size (from $30m-$200m), credit-linked notes (CLNs) so far have been undertaken by about a dozen emerging Russian bluechips. MDM Bank, a subsidiary of the MDM Financial Group, along with Moscow-based TRUST Investment Bank (working with ING on larger deals) have pioneered the technique among second-tier corporates. They have collected average commissions of between 0.75% and 1.25% (depending on credit quality and size) – significantly higher than the low-fee/no-fee schedules for guiding corporate issuers to the domestic bond market.
The deals are structured as issues from a Western bank’s note program which are linked to an underlying loan from the same bank. The structure – aided by a combination of investor appetite for paper yielding 200-450 basis points over Russian corporate Eurobond returns – allows issuers to expand their sources of funding and build profile with investors. Price is determined by credit quality, the issuer’s financials and proposed use of funds, as well as sector and country risk considerations.
“These are all the same factors that affect pricing in the Eurobond market,” says Konstantin Mokhnachev, managing director for debt capital markets at TRUST Investment Bank. “The benefits to the issuer are that CLNs can be brought to market faster and more cheaply than Eurobonds because these securities do not require the same level of disclosure.”
Among the largest issuers thus far are auto industry giant Avtovaz, which cut a $150m, one-year deal paying an 11.75% coupon via TRUST Investment Bank and Raiffeisen Bank. Meanwhile, independent gas producer NovaTEK has tapped the market twice in TRUST Investment Bank/ING-led issues that raised $300m and saw the company achieve finer pricing and extended maturities. MDM has brought a range of CLNs, offering investors exposure to supermarkets, energy and gaming.
In total, about $1bn worth of CLNs have come to market and more deals in the pipeline, over and above potential refinancings for programme-minded issuers, will add to those volumes, bankers say. MDM’s Mr Donnelly says that other Russian banks have taken notice and he expects that they will be preparing similar issues for their clients. He adds that steps need to be taken among the issuers to support each other’s issues in a bid to increase much-needed liquidity.
TRUST Investment Bank’s Mr Mokhnachev predicts: “In the coming year, I believe we will see issue sizes grow and maturities lengthen. And as that takes place, investors that like this product – mostly hedge funds and private banking clients – will increase their activity in the secondary market because there will be more securities to trade.”
EQUITY FINANCE: PRIVATE PLACEMENT PIONEER
By discreetly placing shares ahead of bringing companies to market, one Russian investment bank is quietly stealing a march on the competition.
Three dozen or so Lucite boilerplates adorn a conference room display case at the central Moscow office of Troika Dialog. Ranging in shape from traditional rectangles to beer kegs, juice boxes and refrigerators, they are an eye-catching testament to the bank’s lengthy track record in Russia’s competitive market for advisory services.
Yet of late, bankers say they are finding a modicum of success by taking a decidedly lower-profile approach. By bringing together investors eager for ground-floor exposure to emerging Russian corporates and companies keen to test the market for their shares ahead of seeking an exchange listing, Troika Dialog has pioneered a hybrid technique that it hopes will become a staple feature of equity finance in the local market.
“We call it ‘pre-IPO’ financing,” explains Richard Ogdon, a managing director and co-head of investment banking at Troika Dialog. ”It is more than a private placement, but less than a full-blown IPO. Essentially, what we are offering is a way for companies that aren’t quite ready or can’t wait to seek a listing but that are willing to go further to get access to investment capital, so that when they do decide to pursue a listing, they will have a better idea of the value of their shares and a smoother trip to the market.”
Over the last 13 months, Troika Dialog has raised more than $230m for three companies from institutional and private investors both inside and outside Russia. The pioneering programme calls for the bank to provide a full range of research and secondary market support, ensuring that investors have a liquid security whether or not the issuer presses ahead with an exchange listing.
Verkhnaya Salda Metallurgical Production Association (VSMPO) provided the debut issue, releasing 12% of its shares and raising $90m in February ahead of its listing on Russia’s RTS equity exchange. Such was the positive response from the group of 50 investors who took up the placement that the world’s largest producer of titanium was able to boost the price of the offering by more than 20% at launch. Investors, too, have been rewarded as VSMPO shares have outperformed the RTS index, and were among the exchange’s biggest advancers in 2004.
“Because the commitment to liquidity is at the bank, it absolves investors of the risk that the shares will not trade,” Mr Ogdon says. “It’s not quite private equity as much as a halfway house option that matches portfolio investors with attractive companies that fit their appetite for risk.”
Indeed, one company, Dutch-based Amtel Holding Holland NV, that has issued securities through the programme remains privately held. One of the largest tyre producers in Russia and the CIS, Amtel was able to raise $34m from 20 investors through the sale of depositary receipts equivalent to 10% of its share capital.
In the latest deal, Troika Dialog helped independent Russian gas producer OJSC NovaTEK to sell off 3% of its shares in a deal that coincided with its listing on the RTS exchange. More than 80 investors participated in the January two-tranche placement, which raised $100m for NovaTEK.
“The fact that we’ve been able to generate the level of investor interest that we have is proof of the recognition among them of the value of this product,” says Mr Ogdon, noting that Troika Dialog is expecting more deals to come through the pipeline in 2005 and in a range of companies and sectors. “This is an innovation in this market.”
