Borrowers: Moscow moves in

Borrowers have become aware that high-profile issues offer more than just finance. They are also a good advertising medium. When the City of Moscow recently launched its debut Eurobond, the effect was as much to publicize Russia's ancient capital, celebrating its 850th anniversary this year, as to raise finance. Bond launches attract the kind of people politicians and local government want on their side.

The Russian delegation may have overdone it when likening the discovery of Russia's financial marketplace to the discovery of America. But ironically this city authority is more highly regarded by rating agencies and the markets, than is the US capital, the District of Columbia.

Although the larger-than-life mayor Yuri Luzhkov failed to turn up to the city's roadshow, his efforts in imposing business-style on Moscow's finances have played a key role in providing investor comfort for the bonds.

As an opportunity to strut its stuff, Moscow's 850th anniversary party was a huge success. Moscow is fast becoming eastern Europe's economic showpiece and investors who attended the roadshow in the second half of May were shown healthy figures.

Moscow is not desperate for money. Under Luzhkov it has built a financial empire of its own. Moscow is the heart of the Russian oil industry and since most oil earnings are in dollars, investors have little to fear about foreign currency payments. In January, president Boris Yeltsin signed over the controlling stake in Moscow Oil Refinery and oil distributor Mosnefteprodukt to the City of Moscow.

And the federal government depends on Moscow to supply the major part of its budget, 23% last year. Its nearest competitor, the Tumen region in western Siberia, which holds the bulk of Russia's mineral wealth, provided under 5%.

But following the creation in June last year of a municipal debt committee, the city has embarked on an extensive debt-financing programme. Under guidelines approved by the city duma last November, it plans to raise a total of $2 billion, $500 million of which will come from international bond markets.

The foreign portion of this was easily raised when Moscow came to market on May 27. "Based on the response from investors and the spread indicators during the bookbuilding, Moscow chose the upper limit amount," says Isabelle Terrillon, associate director of emerging markets for Nomura International which led the deal with Credit Suisse First Boston.

While Luzhkov failed to make the roadshow, other Moscow representatives were highly involved. "They were very involved in this deal, at every stage," says Terrillon. In fact, Mechislav Klimovitch, head of Moscow's debt committee, stood with Nomura's syndicate team on the trading floor at Nomura House as the deal was priced. Andrew Asbury, Nomura's head of debt syndicate, talked the issuer through each stage.

"It was a well prepared deal, so pricing was really just a formality," says a syndicate member. "The syndicate broke at about 3pm, half an hour after pricing and the bonds started trading immediately higher. It went to 303 basis points over treasuries then widened for a while to 307bp. The next morning they were at about 302bp, which is consistent with the tightening we have seen in Federation bonds."

Although bond analysts say it is possible that Moscow's Eurobond will trade through the sovereign, Terrillon sees no case for competition between the two credits: "We were really pleased to hear that buyers who passed over the sovereign launch were now coming straight into the market for Moscow. But this bodes well for the next federal launch."

Simon Meadows, co-head of the CSFB's debt syndicate, says: "It's a municipality which basically has limits on how much they can borrow. The rating for Moscow hits the sovereign ceiling, but it's a better credit." Rated BB minus/Ba2, the city of Moscow is on par with the Russian federation.

Analysts think it a better credit: "It's definitely a constrained credit" says Jane Eddy, director of S&P's markets division in New York. "The city's real rating is somewhat higher than BB minus, though it does share some economic troubles with the federation."

During the roadshow for the Eurobond the City of Moscow was also in the market with a syndicated loan which, along with the two Russian federation issues, helped the leads price the deal. "European lenders are now being joined by US and Asian lenders," says Matthew Previte, assistant director at West Merchant Bank. "When looking at the breakdown of the lenders we should not forget that provisioning requirements are still a significant deterrent to lenders from certain jurisdictions."

The City of Moscow loan, launched at 350bp over six-month Libor, was also a success. The syndicate closed with $200 million on its books, four times the target, proving there was an appetite outside Europe for Russian paper.

Why does Moscow need to raise cash on the international markets? After all, it has attracted a third of all foreign direct investment in the Russian federation, has enjoyed operating surpluses for the past six years, has a commercial property portfolio valued at $12 billion, and collects $200 million a year in rents.

One reason is that poor tax collection has led to a freeze on all development plans: Moscow can no longer fund its ambitious redevelopment with budgetary funds. All capital expenditure on development must come from outside the budget. Based on last year's 15% tax shortfall it could take some time before this changes. Privatization has also been slow, in part because Moscow wants a more generous valuation of its portfolio. In any case the city's current income is unlikely to match the scale of mayor Luzhkov's plans (which include a potential bid for the 2008 Olympic games). Rebuilding Russia's capital city has now reached fever pitch in the run-up to anniversary celebrations. In the next few years capital expenditure is set to outstrip current expenditure in a ratio of 3:1.

Nomura's Terrillon says that investors, satisfied with the health of the city's finances and clarification on tax issues, just wanted to know how the money was to be spent. The preliminary prospectus gives little away, saying only that net proceeds will be used for "general investment purposes". A series of non-budgetary funds have been set up to cover general investment and redevelopment programmes, though these are not legally distinct from the city's finances.