Bulgaria braves new ground
Borrower: Bulgaria
Deal type: Brady exchange
Deal amount: $2.2 billion
Advisers: JPMorgan, Citigroup
Sovereign debt exchanges can be politically controversial. So they are often only considered by a government that is either fairly secure in its power, or – like Argentina – is desperate. So some were surprised that Bulgaria’s government, after only a year in power, would want to take the risk of undertaking Europe’s first Brady exchange, particularly when both the finance minister and his deputy are former investment bankers and so perhaps easy targets for populist accusations of access capitalism.
Krassimer Katev, Bulgaria’s deputy finance minister and a former emerging-market trader at Paribas, Daiwa Europe and AIG Asset Management, says: “Obviously we took some calculated risks. It’s quite difficult politically to perform flexible debt restructuring, because all transactions related to the public debt have to be passed through government. So the opposition obviously attacked the measure, and tried to make short-term political gains out of it. They actually challenged the transaction in the constitutional court. The president got involved. It was high political drama.”
But ultimately finance minister Milen Velchev and Katev managed to bring Bulgarians round to the benefits of doing a swap. Observers attest to their intelligence, articulateness and obvious love of their country. This can, however, translate into an impatience with alternative views. Katev says: “The swap was a no-brainer. I knew we should do it from the very beginning. Anyone who doesn’t see the benefits is either too indecisive or too stupid.”
Katev has a point. The deal makes obvious sense. Bulgaria’s Brady debt was collateralized on US treasury slips, which were sitting unused. This was a sleeping asset, worth some $330 million, that Bulgaria could convert into cash if it exchanged the Bradys for pure Bulgarian debt.
This tallied well with the government objective of increasing the size of its fiscal reserve account, which Velchev wanted in order to give the government security against market vagaries such as less-than-expected revenues from privatizations or worsening global economic conditions.
From the point of view of the lead managers – liability management veterans JPMorgan and Citigroup, which have worked on debt swaps for Mexico, Argentina, Venezuela, Peru and others – the challenge was to get as many investors as possible on board.
As Jonathan Brown, managing director at JPMorgan, says: “A risk was that people were comfortable in their Brady debt. They’d only sell if they felt enough other people were selling, otherwise there’d be no liquidity in the new bonds.” It was something of a confidence game, as with all bond exchanges, involving persuading the investors to let go of the devil they know in favour of the devil they don’t.
Usually, at least in such crisis situations as Argentina’s 2001 debt swaps, investors are persuaded by an increase in interest rates. But the interest rates stayed stable on this deal, and what persuaded investors was partly the poor liquidity on the Brady debt, partly the lure of new benchmark bonds, partly the distant promise of EU accession, granting Bulgaria the protection previously supplied by the US government. The ability of JPMorgan and Citigroup to persuade big-fish investors such as Pimco and DWS to swim with the exchange also helped.
The minimum target for the exchange would have been $1 billion. In fact, Bulgaria ended up exchanging $2.2 billion in two deals, one in March and one in September, and in the first deal exchanged e835 million of the Brady debt into euro debt. The swap was thus not just the first public Brady exchange in Europe – it was also the first exchange to swap dollar for euro debt. The banks also structured the deal to give Bulgaria longer maturities than the Brady debt, and a better yield curve in dollars and euros. Bulgaria launched a 2015 dollar benchmark and a 2013 euro-denominated bond (which joined the existing 2007 euro benchmark, issued in November 2001 and also lead-managed by JPMorgan). All in all, in both swaps, it exchanged around 50% of the Brady debt for new debt.
Swapping into euros obviously made sense in the long term because of the country’s planned accession to the EU. But in the short term it also enabled some US investors, looking for yields more usual for emerging-market assets, to exit Bulgarian debt, and some special EU convergence funds, such as DWS and Deka, to buy it.
Bulgaria was thus enabled to sell the US treasury slips and increase its fiscal reserve account to more than e2 billion. This played a major part in the upgrade in outlook by both Standard &Poor’s and Fitch to positive, on the BB rating of Bulgaria. Fitch’s sovereign report of October 2002 said: “Brady bond exchanges have improved the currency, interest rate and maturity profile of the debt. Moreover, Bulgaria benefits from a fiscal reserve equal to around 1.7 times total 2003 public debt service, and strong external liquidity.” The report says these “significant improvements” make another upgrade likely in the next two years.
This – in addition to the other upgrades over the past year, means “investors holding Bulgarian debt have had a very good year”, as Brown at JPMorgan puts it. The banks haven’t done badly either, earning 0.55% fees on the first, $1.4 billion, deal and 0.325% on the second, $800 million, deal. That’s nearly $11 million in total.
And politically, the domestic press coverage was not too bad. The country is now in a good position financially for the foreseeable future. As Katev says: “The coming year will probably be very boring as a result of our prudent measures, as we can refrain from net borrowing, unless we achieve better ratings or can borrow at much better rates, though we do want to continue to aggressively reduce our public debt.”
Poland’s bond proves sterling
Borrower: Poland
Deal type: Sovereign issue
Deal amount: £400 million
Lead manager: UBS Warburg
Poland is one of eastern Europe’s most frequent and innovative borrowers, and its funding requirements mean it is likely to remain so in the next few years. In some ways, it is the Italy of the converging states – it needs to borrow regularly but has a strong treasury team who use innovative multi-currency deals and liability management programmes.
This deal was typical of Poland’s funding strategy – an eight-year £400 million ($625 million) bond launched on October 31, lead managed by UBS Warburg.
UBS Warburg was confident that demand existed for sovereign issues in sterling – the last was Italy’s in 2000, and the last from central and eastern Europe was Hungary’s in 1993. The deal was roadshowed to most quality UK investors – such as Aegon, Standard Life, Gartmore, M&G and Threadneedle – many of which had not looked at Polish debt before. UBS Warburg also says the three-day roadshow, in addition to its research, played “an instrumental role in communicating Poland’s story”.
UK investors liked the strong EU convergence story associated with Poland. As a syndicate member points out, if Poland joins the euro in 2007, it will be the fifth-biggest country in the EU, with the same voting rights as Spain. And the effect of convergence on bond spreads was clear – Poland had been trading at 80 basis points over swaps before convergence began, and is now trading at around 50bp over. The convergence bet is that it will continue on this route, down to the levels of Slovenia, at 20bp over Libor, and eventually to the levels of Greece and Italy.
The belief in this story helped UBS Warburg build a £700 million book, way up from the £250 million originally aimed for. The book was eventually closed at £400 million, at spreads of 80bp over swaps – at the tight end of the pre-price talk – which still offered a good pick-up over Poland’s euro issuance, of around 65bp over swaps: perhaps even slightly high from the issuer’s point of view.
However, Edward Basinski, head of foreign debt at the Polish finance ministry describes the deal as highly successful. “We have introduced a large number of new investors to the Republic of Poland and have further diversified our investor base into an important market,” he says.
Poland’s expectation is that the UK will also join the eurozone soon, so the issue will be in domestic debt. And if it doesn’t, the country is comfortable with having reserves in sterling. As Phillip Poole, head of emerging market research at ING Barings, says: “The issue was an interesting extension of Poland’s borrowing strategy, to tap as many pockets of demand as possible. The deal was definitely a success.”
Poland is likely to continue to be a frequent issuer in the next few years: its 2003 budget allows for between $1.3 billion and e1.5 billion in international issuance. It is considering doing a yen issue soon.
About two weeks after the issue took place, investors received a nice Christmas bonus when Moody’s upgraded eight EU accession states, including Poland – which was “an unprecedented event” according to one investor.
BRS gains liquidity from bond issue backed by vodka
Borrower: Bank Russky Standart
Deal type: Asset-backed bond
Amount: R500 million
Adviser: Renaissance Capital
At the beginning of 2002 Russian consumer finance bank Bank Russky Standart (BRS) was in a tough spot. Set up in 1998 by Russian alcohol distributor Roustam Tariko, who made his fortune importing such spirits brands as Smirnoff to Russia in the 1990s, it was doing well but needed more funding. The objective was to expand its business in order to capitalize on the growth of the consumer home appliance lending business in Russia.
BRS tried, in November 2001, to issue a R500 million ($15.7 million) bond 60% guaranteed by the International Finance Corporation. The deal should have worked, but perhaps because of poor marketing or investor indifference, it didn’t – and was soon trading at yields of 22%. BRS was unhappy about funding at such levels, so vice-president Nina Filimonova asked Renaissance Capital for help.
Renaissance concluded that BRS was going to find it difficult to access the market again when its earlier bond was performing badly. Pavel Mamai, Renaissance’s fixed-income researcher, did some analysis on the bond and worked out that the BRS debt, minus the IFC guarantee, was trading at interest rates of around 35%. “It was completely undervalued,” he says. Renaissance also started to make markets in the bond, and soon spreads had tightened significantly, to around 19% interest rates.
BRS had by the spring of 2002 improved its profile sufficiently to think about issuing again but Renaissance was still sceptical that the bank, rated at around CCC by local rating agencies, could do so without significant guarantees. And it wanted to structure the bond differently to the IFC debt, so it wasn’t in competition.
Renaissance’s director, Alexander Merzlenko, and its head of fixed income, Alexei Sizov, started to look at securitization. It wouldn’t be a pure securitization, because Russia doesn’t have legislation to allow for true sale transactions. But some sort of protection could be put in place.
The structure Renaissance used was a bond backed by BRS’s consumer loan portfolio, which had a 4% risk of defaulting as of Q2 2002, according to Renaissance. The collateral was 130% the size of the bonds. Although the loans could not be entirely ring-fenced, they were structured so that in the case of bankruptcy, investors would get priority over shareholders (though after BRS employees’ salaries), thereby protecting them from the shareholder asset raids that can afflict Russian bankruptcies. Renaissance also put in a guarantee from alcohol importer Roust Incorporated, BRS’s parent, and from BRS itself.
Renaissance then had to market the bond to investors, mainly Russian banks and insurance companies, almost all of which had no knowledge of asset-backed bonds. The deal was launched in July as a R500 million bond. It priced at 20.99%.
Mamai says: “We wanted to test whether structured deals could work in Russia.” And the answer? “We think it was undervalued. The market isn’t fully ready yet, but we’re trying to educate investors. We also hope the deal will have created more pressure for securitization legislation in Russia.”
For BRS, the deal was a success in that it secured funding when it looked as if it might be shut out of the market. Admittedly, it had been hoping for better pricing: 20.99% was right up against its 21% maximum pricing levels. Renaissance did manage to lower yields on the previous bond significantly.
Gazprom breaks new ground
Borrower: Gazprom
Deal type: domestic bond
Amount: R5 billion
Underwriter: Renaissance Capital
The Russian domestic bond market took a big step forward with Gazprom’s R5 billion ($1.6 billion) issue in November 2002, the biggest domestic bond deal yet seen from a Russian corporate.
It was an important step in what has been a long process for Russian corporates looking for domestic funding. Until 2001, that funding would have come from a few banks, which arranged bonds for corporates in which the debt would be held by themselves and one or two other banks, as in a syndicated loan. These quasi-bonds paid as much as 25% interest. As one banker puts it: “The banks arranging and holding the deals were totally conflicted.”
Gradually, throughout 2000 and picking up in 2001, some corporates tried issuing proper rouble bonds, with prospectuses and as wide distribution as possible. Uralsibank, for example, issued a $30 million bond in July 2001. The deal was small and had a three-month put option, because investors weren’t sufficiently confident about the liquidity to take a longer position, and the deal was only placed with 15 investors, but it did manage to break through the 20% interest rate mark.
Since then, several other names have come to the corporate bond market – 32 companies in the first nine months of 2002 according to Micex – but not many blue-chip issuers. Investors, says one banker, tended to go for yield regardless of credit quality. “We needed a default in the market to sharpen people up,” he says. That came in November 2001 when Sibur, a chemicals subsidiary of Gazprom, defaulted. That focused investors’ minds on credit quality.
This opened the way for quality issuers such as Gazprom, Alfa Bank and UES to maximize on increasing domestic demand. UES led the market with a R3 billion issue in July 2002 but Renaissance Capital was confident it could raise R5 billion for Gazprom. Richard Olphert, a partner at Renaissance, says: “We got a broad syndicate, with nine banks involved, including some of the quality names from abroad, such as CSFB or ABN Amro. We also did an extensive roadshow.”
The result of the entrance of a company such as Gazprom, combined with Renaissance Capital and St Petersburg Industrial Construction Bank’s marketing efforts, was that the bond broke through the 17% coupon level, pricing at 16.86%. The deal was two times oversubscribed and was placed with domestic pension funds and banks, as well as foreign banks with operations in Russia, many of which have substantial liquidity.
The deal came in at 600bp higher than Gazprom’s Eurobond levels but Gazprom wanted to diversify its investor base and help to mature an important source of funding. Boris Yurlov, deputy chairman of Gazprom, says: “The successful placement will serve as a benchmark for the development of the domestic bond market.” And, Olphert says, if the 6% devaluation of the rouble most people expect in the next year is taken into account that reduces the interest rate relative to a euro issue.
Gazprom also managed to extend the usual maturity for domestic debt to one year – from six months.
Parex arranges Latvia’s biggest syndicated loan
Borrower: Latvenergo
Deal type: Syndicated loan
Deal amount: Lats45 million
Arranger: Parex Bank
Latvia has a few regulatory issues to clear up before a corporate bond market can take off. At the moment, limited liability companies are prohibited from issuing public debt. The tax environment for bond issues is also not ideal.
This means it still makes sense for companies to raise finance through syndicated loans.
The amount that can be raised this way is getting bigger, as the Lats45 million ($76 million)syndicated loan for Latvian energy company Latvenergo in October showed.
The deal is the biggest loan ever put together by a local syndicate in Latvia. The previous largest deal was $12 million for oil transit company LNY in 1997. Valery Kargin, president of Parex Bank, which arranged the loan, says: “The loan is good news for the whole Latvian banking sector. It is appropriate it should be arranged between two of the country’s biggest companies.”
The loan was arranged by Parex Bank after a tough mandate bidding process. Martins Jaunarhas, the bank’s head of corporate sales, says: “The competition was very fierce, among all of the top six banks in Latvia.”
The five-year loan ended up being syndicated among three banks – Parex in Latvia, Parex in Lithuania and Suprema – and was priced at 100 basis points over Euribor, which compares favourably, for example, with the recent Eurobond issued by Estonian Energy, lead managed by Salomon Smith Barney, which came in at 120bp over and has now tightened to 100bp over.
Jaunarhas says Parex is comfortable taking this much exposure to the credit. “It’s the best credit in Latvia after the government,” he says. “If the company wants to increase the loan size, maybe we’ll look for other investors.” He says some foreign banks are interested in buying exposure to the name.
Latvenergo wants the money to reconstruct one of Riga’s largest power stations, enabling it to increase its power output and reduce Latvia’s reliance on other countries for its energy.
The deal structure gives the company some flexibility – it has already drawn Lats15 million of the loan and has the option to draw the remaining Lats30 million. It looks likely to do so.
