Russia is redefining all previous notions about what emerging market borrowers can hope to achieve in the Euromarkets.
Fewer than nine months after the first Russian Eurobond, there have already been more than 10 non-sovereign deals for a combined $1.8 billion. The Russian Federation itself has three times stretched the market to the limits – and succeeded each time.
Its latest deal was the most ambitious. In late June it raised 10-year debt for the first time, doubling the size of the issue to $2 billion – making it the largest ever fixed-rate Euro/144A issue for an emerging market borrower. “This is truly a landmark transaction which has established Russia as the pre-eminent borrower in central and eastern Europe,” says a spokesman for JP Morgan, joint lead manager with SBC Warburg.
The deal lifted the total raised by Russia in the international bond markets in 1997 to $3.2 billion, just short of the $3.4 billion budgeted for the year. “The yield curve we have established will help other Russian institutions to come to the market,” says Mikhail Kasyanov, Russia’s deputy finance minister, who hosted investor presentations for the issue. He points out that the deal was launched only 95 basis points wider than where the country’s $1 billion five-year debut issue, launched in November 1996, was trading at the time. “That shows Russia is improving its credit.”
The Federation’s success in the Eurobond market has encouraged the country’s leading cities, banks and corporates to follow its lead. Analysts are already looking at Russia’s capital requirements over the next 20 years, and confidently predicting the country will be seeking a large proportion of the $400 billion it needs from the international capital markets.
That says as much about investors’ preoccupations as it does of Russia’s future requirements. It is striking how, in a very short time, Russian risk has become a core investment for an increasing number and range of investors. Although analysts may be exaggerating the country’s future demand for capital, issues from Russia are likely to pose the greatest challenge to the international capital markets in the foreseeable future.
Last November’s debut Eurobond from the Russian Federation ranked as the most eagerly awaited new issue from central and eastern Europe since the fall of communism.
At $1 billion, the Euro/144A offering was the largest ever debut issue from an emerging market sovereign credit in the Eurodollar market. The market had been expecting an offering of between $300 million and $500 million, but demand for fixed-income exposure to Russia grew spectacularly during an exhaustive roadshow. Lead managers JP Morgan and SBC Warburg marketed the issue in Asia, Europe and the US, attracting more than 1,500 investors. “The quality of the order book we put together for this deal was incredible. It read like the ‘who’s who’ of the international investment community,” recalls an SBC Warburg spokesman.
“We not only succeeded in attracting the expected audience of emerging market and high-yield fund specialists from around the globe,” adds a spokesman for JP Morgan, “but also managed to convince more mainstream, institutional funds of the relative value merits and importance of the transaction.”
The Ba2/BB minus-rated deal had a 9.25% coupon and was sold at a fixed/re-offer price of 99.561 to yield 345 basis points over US Treasuries. Investment bankers regarded this as an extremely competitive level of funding for the Russian government, since earlier in the year the launch spread had been expected to be as high as 500bp. Even so, demand was so strong that the deal was hailed a success on the day of launch.
Its after-market performance was less impressive. The Russian government’s failure to meet tax collection targets set by the International Monetary Fund (IMF) and the ill-health of president Boris Yeltsin combined to stymie the spread performance of the deal. At one point it widened as far as 410bp over Treasuries, before recovering to trade inside the launch spread at the beginning of the second quarter of this year.
Not surprisingly, when the Russian Federation returned to the international bond markets in mid-March, investors’ attitudes towards the country had hardened. Worse still for Russia, there was speculation at the time that the Federal Reserve would lift US interest rates at the end of March, which prompted a flight to quality among international investors.
The launch of a Dm2 billion seven-year offering was therefore greeted with trepidation by central and eastern European specialists. Undaunted, Russian finance officials and joint leads CSFB and Deutsche Morgan Grenfell pushed ahead with the largest ever Euro-Deutschmark debut by an emerging market borrower.
The most important feature of the issue was its 9% coupon, which offered a spread of 370bp over the 6.25% March 2004 Treuhand. Investors thought this attractive compared to Republic of Argentina’s Dm1.5 billion 7% seven-year issue, trading at the time at 187bp over German government bonds, or the Russian Federation’s own five-year Eurodollar deal at 325bp over T-bills.
Bankers were deeply divided about whether Russia had gone too far by launching a larger issue than the Dm1.5 billion indicative size range, although the lead managers insisted that the size was central to its appeal.
“At Dm2 billion this is a benchmark issue for Russia in the core European currency,” says a CSFB spokesman. “Given the dearth of Euro-Deutschmark supply from central and eastern Europe borrowers, a smaller issue would have quickly become illiquid.”
Most of the issue was placed in Europe, with Germany, Switzerland and the UK the core centres of demand. There was also a strong bid from Asian accounts, many of which had not participated in Russia’s Eurodollar debut. Initial buying came from bank funds, global funds and emerging market funds as well as insurance companies and corporate treasuries; there was also good retail demand in the after-market.
“The Russians wanted to do a large, benchmark issue in Deutschmarks,” a CSFB spokesman recalls. “We believe it was a stunning deal in every sense, from the size of the transaction, the difficulty of the market conditions, through to the final placement and the spread tightening since launch.”
Impressive though it appeared at the time, the deal was outshone in June by the ground-breaking $2 billion 10-year offering.
The market was expecting only $1 billion, but the feedback from investors convinced the bookrunners and the borrower that they could double the size. The coupon was set at 10% and the issue was priced to yield 375bp over US Treasuries at the issue/fixed re-offer price of 99.164. That compared favourably with the 280bp spread on Russia’s five-year debut offering and was seen as proof that investors regard Russia as an improving credit.
Traders acknowledged that on a relative value basis the Russian deal compared favourably to 10-year issues for Mexico and Argentina, which were trading at 260bp and 270bp at the time.
On a blended basis, JP Morgan and SBC Warburg sold 53% of their bonds into the US, 24% into Asia and 23% into Europe, confounding expectations that the bulk would be placed in America. “Generically on a 10-year issue, one would expect the US to come in for at least three-quarters of a deal, but on this issue it was only a half, with a very good showing from both Europe and Asia,” says a spokesman from JP Morgan.
In terms of investor type, funds were dominant, accounting for 52% of the placement. Banks took 21%, insurance companies 17% and retail 10%.
More striking, perhaps, is that an estimated 40% of the deal was sold to investors buying Russian debt for the first time. The leads reported that the issue had attracted cross-over demand from a large number of investment-grade accounts keen to get hold of a benchmark issue from a country which is increasingly a core holding in a balanced fixed-income portfolio.
Given the improved tax collection in Russia it is thought likely this issue will be the sovereign’s last this year. The deal has since traded in to an average bid/offer spread of 360bp/357bp, having been as low as 335bp at one point.
Russia’s cities and banks have also been keen for their share of the limelight (see boxes). Their success in obtaining funds has not been lost on Russia’s corporates, which entered the market recently. In mid-July Russian oil giant Lukoil raised $125 million via a one-year private placement led by CSFB. Priced to yield 225bp over US Treasuries, the issue was viewed by market participants as attractively priced relative to the Russian Federation’s 2001 issue and the City of Moscow 2000 transaction. The Lukoil issue was taken up by between 20 and 25 investors, principally banks and funds in Asia, Europe and Latin America.
At the beginning of August AO Siberian Oil Company (Sibneft) became the first Russian corporate to tap the public international debt markets with the launch of a $125 million three-year floating-rate note issue via Salomon Brothers. The unrated transaction yielded 400bp over Libor, a level designed to offer investors an attractive pick-up over the Russian Federation’s 9.25% 2001 issue, then yielding 240bp over Libor.
“The aim was to establish a benchmark – not just for Sibneft itself but for future issuance by other Russian corporates as well,” says a Salomon Brothers spokesman. “Given the importance of the oil industry to the Russian economy, it is particularly appropriate that Sibneft should be the first corporate from the country to access the public international bond markets.”
Banks ride the Eurobond wave…
Eurobonds are starting to usurp syndicated loans as the main source of international finance for Russia’s top banks. Maturities on offer are lengthening while banks can issue Eurobonds in sizes simply not available in the loan market. The first Russian loan syndication was signed in 1995 when MosBusinessbank raised $20 million over six months at 5.5% spread over Libor. Two years on, the loan market still offers banks little more than expensive, short-term debt.
The first Eurobond for a Russian bank departed little from this template. In late 1996, Avtobank launched a $25 million six-month floating rate note FRN at a spread of 550 basis points over Libor. The deal was lead managed by HSBC Markets and Moscow Narodny Bank and offered an all-in spread of more than 600bp over Libor at the 99.75 issue price.
The spread far exceeded comparable instruments from other emerging market economies. Some 60% of the bonds were placed with banks and the balance was sold to emerging market funds and insurance companies. Geographical placement was skewed in favour of Europe and Asia, although there was also some demand from offshore US funds.
Avtobank returned to the bond market in May 1997 with another six-month FRN, but this deal was priced at 500bp, a 20% reduction in spread, and the issue was increased from an indicative size of $25 million to $35 million.
| Public fixed rate issues | |||||||
| Issuer | Launch date | Issue size | Maturity | Coupon | Launch Spread | Spread (over yield curve) at 1/9/97 | Bookrunner(s) |
| Russian Fed | Nov 21, 1996 | $1 bn | Nov 27, 2001 | 9.25% | 345bp | 252 | JP Morgan/SBC Warburg |
| Russian Fed | Mar 13, 1997 | Dm2 bn | Mar 25, 2004 | 9.0% | 370bp | 300 | CSFB/DMG |
| Russian Fed | Jun 19, 1997 | $2 bn | Jun 26, 2007 | 10% | 375bp | 328bp | JP Morgan/SBC Warburg |
| Moscow City | May 27, 1997 | $500 m | May 31, 2000 | 9.50% | 315bp over | 244bp | CSFB/Nomura |
| St Petersburg | Jun 5, 1997 | $300 m | Jun 18, 2002 | 9.50% | 312.5bp | 290bp | Salomon Brothers |
| SBS-Agro Bank | Jul 8, 1997 | $250 m | Jul 21, 2000 | 10.25% | 425bp | 418bp | JP Morgan |
| Alfa Bank | Jul 16, 1997 | $175 m | Jul 28, 2000 | 10.375% | 425bp | 420bp | Goldman Sachs |
| Uneximbank | Jul 17, 1997 | $200 m | Aug 1, 2000 | 9.875% | 400bp | 375bp | Merrill Lynch/MFK |
| Public FRNS | |||||||
| Avtobank | Dec 10, 1996 | $25m | Jun 9, 1997 | 5.50% over 6m Libor | HSBC Markets/Moscow Narodny | ||
| Avtobank | May 12, 1997 | $35m | Nov 7, 1997 | 5.0% over 6m Libor | HSBC Markets/Moscow Narodny | ||
| BashCreditBank | June 19, 1997 | $25m | Dec 19, 1997 | 4.50% over 6m Libor | HSBC Markets/Moscow Narodny | ||
| Sibneft | Aug 1, 1997 | $150m | Aug 15, 2000 | 4.0% over 3m Libor | Salomon Brothers | ||
But the full potential of the bond market became clear this January, when United Export Import Bank (Uneximbank), the third-largest Russian bank by assets, launched its Eurobond debut through a $50 million FRN private placement. The deal had a three-year maturity – one year longer than most syndicated loans for Russian banks – and carried a spread of only 300bp over Libor. The bulk of the Uneximbank issue was placed with European emerging market funds and banks wanting to gain exposure to one of Russia’s leading banks. The market gathered momentum in early July when SBS-Agro Bank, rated B1/B+, became the first Russian bank to launch a public fixed-rate Eurobond. Demand for the three-year issue was so strong that lead manager JP Morgan increased it twice from $150 million to its final size of $250 million.
This was also the first time that a Russian bank had raised fixed-rate funds in the international bond markets. The coupon was set at 10.25% and the issue yielded 425bp over US Treasuries at the issue/fixed re-offer price of 99.25.
The SBS-Agro issue offered an attractive pick-up compared to the Ba2/BB- rated Russian Federation’s 2001 and 2007 dollar issues at spreads of 233bp and 338bp respectively. Investors also regarded the deal as more attractive than bonds on offer from other emerging markets, such as a $250 million two-tranche bond from Banco Real of Brazil that was launched the same week. At B1, that bank has the same rating but its three and five-year tranches were priced at only 205bp and 190bp over Treasuries.
The Eurobond was also a good deal for SBS Agro. On an asset-swap basis, its cost of funds was 395bp over Libor, compared to the 450bp spread it paid on a $55 million one-year term loan earlier in the year. Geographical distribution of the issue was 64% Europe, 25% offshore US and 11% Asia. “Considering we didn’t roadshow the deal in the states and there wasn’t a Rule144A clause, the demand from the US was particularly surprising,” says a JP Morgan spokesman.
A week later, Alfa Bank and Uneximbank were able to ride the wave of investor interest and issue larger-than-expected debut international bonds. This was in spite of volatile trading conditions that prevailed due to currency turmoil in Asia.
Alfa Bank launched a three-year offering via Goldman Sachs that was the first issue off its $300 million Euro-MTN programme. The B1/B-rated issue was priced with a 10.375% coupon to yield 425bp over US Treasuries at the issue/fixed re-offer price of 99.625. Before roadshows in Asia and Europe, the deal was expected to total $100 million, but it was increased to $175 million because of the enthusiastic response from investors. Goldman, which kept 89% of the deal, reported that it was around two-and-a-half times oversubscribed at the $175 million launch size.
Uneximbank also returned with a fixed-rate issue and became the first Russian bank to raise funds with a coupon below 10%. Its $200 million three-year Euro/144A offering was lead managed by Merrill Lynch and had a 9.875% coupon to yield 400bp over Treasuries.
The Alfa Bank and Uneximbank offerings brought Russian banks into the mainstream of Euromarket funding. Debut issues are expected soon from Inkombank, Natsionalny Rezervny Bank and Sberbank.
Municipals go the way of Moscow
A string of Russian local governments is rushing to the Euromarkets in search of cheap funds. The city of Moscow was the first off the mark. In late May, it launched a $500 million three-year Eurobond, which helped reinvigorate demand for Russian risk and set a positive spread performance record for the country. The deal is also the largest Eurobond to date from an east European municipality.
The deal had a 9.5% coupon and yielded 315 basis points over US Treasuries at the issue/fixed re-offer price of 99.80. The three-year tenor chosen was perfectly attuned to investor preference for short-dated, high-yield emerging market risk, reflecting the increasing savoir-faire of issuers.
Other municipalities have been quick to follow Moscow’s lead. St Petersburg, Russia’s second city, launched a $300 million five-year Euro/144A offering via Salomon Brothers in early June.
Later this year, Ba2/BB- rated Nizhny Novgorod region intends to raise $100 million with a five-year Euro/144A issue that will be lead managed by ING Barings. Sverdlovsk region hopes to launch a similar issue via West Merchant Bank later in the year.
The St Petersburg deal was more than five times oversubscribed. Its five-year tenor helped avoid direct comparisons with the Moscow deal, which had a shorter maturity.
The pricing was another notable feature of the St Petersburg deal. It had a 9.5% coupon and at launch yielded 312.5bp over US Treasuries. This was the tightest launch spread yet achieved by a Russian issuer in the Euromarkets and below the 315bp-325bp expected by the market.
Nevertheless, investors felt the deal was attractive compared to the Russian Federation’s $1 billion 9.25% five-year issue and Moscow’s three-year transaction, which were both trading at 285bp on the bid side when the St Petersburg deal was priced.
Geographical distribution was split 15% Asia, 45% Europe and 40% US. The St Petersburg issue succeeded in its objective of attracting a strong, diversified bid from institutional investors. Buyers included emerging market specialist funds that have bought east European paper in the past and cross-over buyers. In addition to that, bonds were sold to more mainstream investment and pension funds, insurance companies and corporate treasuries.
Retail participation was limited but is expected to increase in after-market trading, not least as a result of St Petersburg’s growing role as a tourist destination.
Moscow and St Petersburg’s successes in the Eurobond market have convinced several other local institutions to follow their lead. The regions of Astrakhan, Chelyabinsk, Irkutsk, Moscow, Novosibirsk, Omsk, Oryol, Perm, Samara and Sakhalin are all investigating the international bond markets. Issues are also expected from the republics of Bashkortostan, Komi, Mary El, Sakha and Tatarstan.
