Barcap strengthens reputation with pioneering VTB deal

Until autumn 2003, Barclays Capital (Barcap) had never lead-managed a bond market transaction for a Russian bank. Last year it enjoyed that role in one-fifth of all Russian bank issuance. Now it has forcefully confirmed its presence in this market with Russia’s first ever public issue of subordinated debt, on behalf of Vneshtorgbank (VTB).

VTB is Russia’s second-largest bank and its leading foreign trade financing institution. In February, it successfully raised $750m of lower Tier 2 capital in the form of 10-year non-call 5 (10NC5) notes at 222 basis points (bp) over mid-swaps. Joint bookrunners were Barcap, Deutsche Bank, HSBC and JPMorgan.

Setting the deal apart from the common herd was the fact that the structure had never been used in Russia before and, at the outset, it was not clear whether central bank regulations would even allow it.

Capital ratio concerns

“This was a regulatory-driven transaction, not merely a funding exercise,” explains Barcap’s team leader and Russian investment banking head Sergei Stankovski. A number of Russian banks have been growing their assets aggressively in recent times, he says, with an inevitable shrinking effect on their capital ratios.

VTB’s capital ratio, like that of its larger competitor, Sberbank, had been comfortably high – well above 20% against the Russian regulatory minimum of 10%. But as the assets got piled on, both found their ratios thinning down to the mid-teens.

“VTB’s aggregate ratio still looked okay,” says Mr Stankovski, who joined Barcap in 2003 from Goldman Sachs, where he marketed fixed income, commodity and derivative products to Russian and central European clients. “But on exposure to certain large single borrowers, it was beginning to approach the limits. And in a year or two, it would have been closer to the line even on an aggregate level.”

Limited funding options

Certainly, VTB projected that its asset growth would continue, in which case an early injection of capital seemed to be the prudent course of action. But not all funding options were open to the bank. “Access to equity capital was limited by the nature of VTB’s ownership – it is 99.9% owned by the state,” points out Don Drew, a director in Barcap’s financial institutions group (FIG) and a 25-year veteran of the international FIG business.

So it was decided that the best way to address the situation would be to raise lower Tier 2 capital via an appropriate bond issue, taking advantage of market conditions.

“VTB was already an established borrower in the international capital markets,” says Dmitry Gladkov, head of debt capital markets for Russia and Ukraine and, like Mr Stankovski, a Goldman Sachs alumnus. “A large core group of investors are familiar with the VTB credit, both by geography and investor type. We felt that would allow them to buy into this first subordinated debt issue, which involves going down the subordination ladder.”

This was all very well but, as a first-ever transaction, there were what Mr Drew calls a number of “structural uncertainties” in the early phases. “At the time, the Bank of Russia (CBR) guidelines were written such that there was no clear guidance on whether a 10NC5 structure would be permitted,” he recalls.

Central bank worry

One opinion was that the phrasing of the relevant instruction expressly forbade 10NC5. “The instruction does not allow a borrower or lender to prepay debt and, of course, 10NC5 gives the option to prepay,” says Mr Stankovski.

That was something of a problem because this structure was the most efficient way of raising regulatory capital. “If the CBR didn’t accept 10NC5, VTB would have had to commence amortisation of the capital benefits almost immediately, so it was important to clarify the central bank’s instruction,” Mr Drew says. “Any alternative structure would have been more expensive and less palatable.”

So began a period of concentrated consultation with the CBR, which had made it clear that it would not grant any exemptions to existing regulation but that any change or clarification should be a permanent precedent for other borrowers.

The process was helped considerably by the CBR’s positive attitude. “The central bank had stated from the beginning that it would bring regulations in line with those stipulated by the Basel agreement. This was the first test, the catalysing deal,” says Mr Stankovski.

“They took a positive view and wanted to be persuaded,” says Mr Drew. “They looked at the transaction with a view to permitting it, in line with international standards, as long as they could see all the arguments and convince themselves.”

Mr Gladkov makes the point that 10NC5 is so widely accepted in Europe that it was “only logical” that the first Russian subordinated borrower should use it. “It was a matter of bringing best practice on to Russian soil, adopting it for Russian borrowers and clarifying the regulations at the same time,” he says.

Nonetheless, the central bank wanted reassurance that the deal was not going to differ in any material respect from European standards and that VTB’s depositors would not be put at risk by the structure. Its ultimately positive response was aided, no doubt, by the fact that Sberbank and its advisers were conducting an identical, parallel but separate negotiation with the CBR at the same time.

Good communications

The green light came through at the end of last December. “The whole process was able to be speeded up through extremely good communication between VTB, the CBR and Barclays Capital,” says Irina Lomteva, an investment banker who works with Mr Stankovski on the VTB and other Russian accounts.

At that point, the team moved quickly into operational mode. There was a pleasant surprise from Moody’s. “Moody’s gave the deal the same rating as the bank’s senior debt,” says Marco Baldini, a debt syndicate director who joined Barcap from SG Warburg in 1995. “Once that came out, it allowed us to drive the transaction forward. The roadshow began in Asia before moving to Europe, and lasted one working week.”

It was important to tee up the deal, Mr Baldini says. Although investors were familiar with the name, this was a new product for them. Some investors were well acquainted with the structure but needed to understand how it fitted into Russian regulation. Others, while comfortable with the regulatory backdrop, needed familiarisation with the structure.

Pricing challenge

Pricing was something of a challenge because VTB had nothing comparable to speak of. “Investors could look at other things, such as Korean banks, but there was nothing directly comparable in terms of size, regulatory environment or ownership,” says Mr Baldini. “So, by interpolating the VTB secondary curve, we came up with a synthetic five-year senior level for VTB.”

To that was added the spread for subordination, arrived at from a combination of investor and issuer feedback. The marketing level was eventually set at 235bp over mid-swaps and the book-building exercise began. On the morning of pricing, Standard & Poor’s finally joined its rating agency peers in upgrading Russian sovereign debt to investment grade – somewhat late in the day for VTB but not unhelpful. The spread was finally tightened to 222bp – a premium to the senior debt of less than 50bp.

Even though investors were being marketed a similar issue by Sberbank at the same time, the order book was so strong that the original issue size was raised successively from $300m to an eventual $750m. “With bids of $1.2bn we could have done more but we wanted to keep the right size and price balance,” say Mr Stankovski. “Even at $750m, VTB needs to generate sufficient assets to use the capital efficiently, and that takes time.”

The team now hopes to capitalise on Barcap’s new reputation as the most successful lead manager in this sector. “The difference in our approach is that we treat Russian banks like banks,” concludes Mr Stankovski. “Others treat them as if investors were buying Russia.”