Russia claws in another $3.75 billion

Issuer: Russian Federation
Amounts: $1.25 billion; $2.5 billion
Maturity: 5-year; 30-year (10-year put)
Launched: June 4; June 18
Bookrunners: Goldman Sachs; JP Morgan; Deutsche Bank

It's the last week in May. Russia's economy is in turmoil again. Wages need paying, and still not enough taxes are being raised. The rouble falls to its lowest level against the dollar, and overnight interest rates are trebled in response. The only thing left to come is another government crisis.

Three weeks later, and Russia has pulled it off again. The economy is still in trouble, the IMF appears to have suspended delivery of a $670 million loan (or was that a misinterpretation of a press release?), yet Russia's ministry of finance has managed to raise $3.75 billion on the international capital markets. And, if reports are true, a few hundred million more (secretly) through some US banks.

In mid-May, all seemed well. Mikhail Kasyanov, deputy finance minister, and Oleg Buchlemeshev, head of section, international capital markets, had been discussing a straightforward dollar deal, with a roadshow and a syndicate, but the crisis a week later killed that idea. And the government effectively closed itself off from raising money domestically.

"The domestic situation had worsened rapidly, and GKO [domestic government debt] yields had widened beyond what the government was prepared to pay," says Buchlemeshev. An international deal was preferable, for psychological and fiscal reasons: "We at the ministry wanted to prove that we could still access the international capital markets, and the government wanted to use it to arbitrage against the GKOs," he says. But "in such difficult conditions, it was not so much a question of choosing the best option as picking the least worst."

First up was Goldman Sachs. This was the US investment bank's first stab at being a bookrunner for a Russian government bond, and it chose to do it alone, no syndicate even. And there was very little time from announcement to launch.

"When we made our offer, we felt that we had to move quickly because of the volatility in the market," say Bim Hundal, executive director at Goldman Sachs. "We decided that the best way to distribute the securities was to control the deal, and not have a syndicate. We were out of the bonds within an hour, and went back to increase the deal by $250 million"

The five-year $1.25 billion Eurobond issue was launched at 650 basis points over US treasuries. With no similar reference bond in the Russian portfolio, the deal was priced off the 2001 and 2007 issues ­ the former was trading at 587bp over, the latter at 610bp over at the time of launch, so the Goldman deal was priced at roughly 45bp over the notional Russian curve. Initially, the deal traded in to 620bp, although as a result of some selling to take part in the new deal, the 2001 and 2007 bonds widened.

But within a week, the positive effect of the Goldman deal had been wiped out: the yen hit 140 to the dollar, its lowest level for nine years, and the fear of another Asian meltdown hit other emerging markets. Goldman's deal widened out to 725bp over, taking its reference 2001 and 2007 with it.

"We considered that the dollar-yen situation could well lead to a worsening situation in Asia and elsewhere, including Russia," says Buchlemeshev. "And with the start of the vacation period in late July, there would be no easy opening for us until after the summer." A structured product with an option to offer value through the crisis was needed. And it needed to be of sufficiently large size "to prove that we would have the money to repay our domestic debt at least until the end of the summer".

The US Federal Reserve intervened to prop up the yen, and Anatoly Chubais was appointed by Yeltsin to be Russia's chief negotiator in talks with the IMF.

His appointment, combined with the yen intervention, helped stabilize the markets. "The spread on the Russian benchmark stood at 725bp over US treasuries on Monday [June 15]," says Tony Best, managing director and head of emerging markets sales, trading and research at JP Morgan. "But they had tightened to 680bp over within 24 hours." On Wednesday, rumours of a big Russian deal were leaking out, and spreads tightened another 10bp.

JP Morgan and Deutsche Bank received the mandate the same day. "Russia needed to raise a substantial amount in a volatile market, so size, speed and timing were crucial," says Best.

The lead managers had already determined that there was enough demand, in the US at least, for long-dated paper, but without investors from Europe or elsewhere there was a danger that the US investors might play hardball and demand a wider spread during pricing - which could have been enough to kill the deal. The structure that won them the mandate was designed to attract both US and European investors, as well as introduce some price tension between: a 30-year bond with a put at 10 years.

The initial size of the deal was $1.5 billion when the leads opened the book late afternoon New York time on Wednesday the 17th, and orders came in quickly.

"I phoned New York when I got home at 11.30 that night," says Best in London. "And there was a substantial amount of interest." On Thursday, the book was kept open until 2pm London time, when it stood at $6 billion. The leads suggested, and the Russians agreed, that the deal be raised to $2.5 billion.

Then pricing and allocation began. The price had already been set at between 25bp and 50bp over Russia's $2 billion 2007, and over 200 accounts had taken tickets from the leads. There was a syndicate this time round, but it was a token gesture: the leads kept 90% of the deal, sharing the rest between the five co-leads. Even keeping that much control could not avoid what happened next.

Around 4pm, as the leads were getting close to launch, the IMF issued a statement: it was postponing the release of the latest loan, for $670 million. The markets began to panic, and some investors started to scale down or withdraw their tickets. Spreads on the 2007 widened suddenly from 698bp to 735bp.