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Monday, 11 December 2017

Sanctions fail to stem access to finance for Russian corporates

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  • Annual issuance, US$ (billions)
  • Amount by sector, US$ (billions)
  • Russia

 People & Markets

Banks step in to replace lost access to global capital markets

US and European sanctions are inadvertently providing a boost to the same Russian companies they are supposed to punish, with some in Russia boasting the restrictions have triggered a reworking of the local financial system that has made access to funding cheaper and easier.

At the heart of the financial rewiring are domestic banks such as Sberbank and VTB. Despite being barred from global capital markets, both have seen a surge in corporate deposits as Russian companies fearful of an escalation in Western financial sanctions repatriate cash piles held abroad.

As well as providing sanctioned banks with a cheap source of hard currency, such inflows have ironically put the Russian banking system in a better position to help other companies shut out of global markets, either because they are directly subject to sanctions or because investor appetite for their debt has dried up.

“Now sanctions are in place, more and more corporates realise that there is a risk their name could appear on the list and we saw a highly accelerated withdrawal of foreign currency liquidity from foreign banks and a growth of corporate deposits in Russia,” said Herbert Moos, deputy president at VTB.

The bank has seen corporate deposits swell by 20% over the last year, helping fuel an increase in its corporate lending – in the third quarter alone, loans to the sector increased 13%. “It’s enormous growth,” Moos said of the deposit inflows. “Virtually all of it is euros or dollars. It’s basically cash coming from European or American banks back to us.”

According to the Central Bank of Russia, despite a deep, oil price-induced recession, corporate lending in the country is up 7.1% this year. The increase has been a lifeline for companies locked out of capital markets, proving predictions of mass defaults wrong.

Markets closed

Although the vast majority of Russian companies are free to tap global capital markets, sanctions and a precipitous drop in oil and gas prices – Russia’s main exports – have effectively closed the market to many. Russian companies raised US$40bn through 60 Eurobond deals in 2012. This year there have been just five deals, raising under US$5bn (for details on the latest, from Alfa-Bank, see page 8).

Annual issuance, US$ (billions)

Still, companies say access to finance remains unproblematic and cheap, raising questions about the efficacy of sanctions introduced last year to punish Russia for its role in the Ukraine conflict. The sanctions were initially directed at individuals close to the heart of Russian government but later widened to ban some companies from accessing international financial markets.

“There is a queue of Russian and foreign banks willing to lend to us – we are taking constant calls,” said Vsevolog Rozanov, chief financial officer at unsanctioned Russian conglomerate Sistema. “The best companies now have easier access to credit – and at lower spreads over central bank rates – than they did before the sanctions.”

Two elements have been key in enabling the Russian financial system to adapt to the partial closure of international capital markets: assertive moves from the CBR to guarantee funding for the country’s banks following a collapse in the rouble last year, and the repatriation of tens of billions of corporate deposits.

The CBR’s operations have flooded the banking system with liquidity, helping offset lost international funding and deposit outflows at smaller banks. At its height last December, the central bank lent Rbs9.3trn (US$142bn) to the country’s banks – equivalent to 15% of their balance sheets – through various operations.

“The Eurobond market is traditionally important for Russian banks as a source of funding, but it is not the decisive source,” said Alexey Simanovsky, deputy chairman at the central bank. “It is better to have access, but if there is no access then banks find alternative sources. The economy needs financing and will be financed.”

Excess liquidity

At the same time, banks have seen their deposit levels grow 14% this year, according to the CBR. Larger banks have been particular beneficiaries as Russians take their money out of smaller banks perceived to be less safe. But mass conversion into dollars and corporates repatriating overseas deposits has also led to large inflows of dollars.

Such has been the influx of dollars that banks have begun to wean themselves off the US$50bn dollar repo facility set up by the CBR last year to guarantee access to hard currency.

“We have more than enough liquidity, especially in terms of foreign currencies,” said Ilya Polyakov, deputy chairman at unsanctioned lender Rosbank.

Rosbank has used its excess liquidity from a large inflow of deposits to help corporate clients locked out of international markets. It was a mandated lead arranger on a US$750m loan for Russian fertiliser company EuroChem, for instance, and a US$350m loan for mining firm Polymetal. Neither company is under financial sanctions.

The bank has grown its corporate loan book 7.5% so far this year. Loan origination in the third quarter is double what it was a year ago.

“We have been looking to increase our corporate loan book for some time now, and the current situation has been a good opportunity to do that – and to support new and existing clients during these difficult times for the Russian economy,” said Polyakov. “Like state banks, we are actively trying to support many of these companies.”

Banks based in Russia have not been the only ones extending loans. Gazprom filings show the oil company, which is not under financial sanctions but which was shut out of global bond markets for a year until last month, received a €350m one-year loan from Italian lender Intesa Sanpaolo in January and a €300m four-year loan from UniCredit in June.

JP Morgan led a US$500m three-year loan from a consortium of international banks in April. Deutsche Bank led two such deals amounting to a combined €360m earlier in the year. Banca IMI – the investment banking arm of Intesa Sanpaolo – UniCredit and JP Morgan were chosen to lead Gazprom’s Eurobond when it returned in October.

“Russian companies haven’t been sitting around waiting for bond markets to reopen,” said Polyakov. “They’ve turned to their back-up plans and have been out looking for alternatives sources of financing such as bilateral loans and club deals: and in many cases they have found them.”

Lucrative clients

Increased liquidity in the Russian banking system and competition from international banks to be seen to be aiding lucrative clients during their time of need has meant that many large companies are able to borrow at lower rates – as measured by the spread over central bank rates – than before the sanctions regime kicked in.

Even sanctioned entities are benefiting from the situation. Lukoil, which is subject to restrictions around its Arctic and deepwater businesses and which hasn’t issued a Eurobond since sanctions started, more than trebled its short-term foreign currency borrowings in the first half to US$1.1bn. During that time its weighted-average annual interest rate dropped to 2.77% from 4.44%.*

Although international banks are unable to lend sanctioned entities money for more than 30 days, Russian banks are free to do so.

“It is our role to provide financing to the companies that need it and that is what we have been doing over previous months,” said Alexander Morozov, CFO at the country’s largest lender, Sberbank, which is on the sanctions list. “We see the current situation as an opportunity to expand our loan portfolio in certain parts of the economy, such as exporters. We have an excess of dollar liquidity at very low cost and we intend to use it.”

Untenable

But some warn that the current situation is untenable and that corporate financing requirements have decreased markedly because of the ongoing oil-induced recession in Russia, leading many companies to cut capital expenditure. When growth returns, they argue, the banking system may prove insufficient to meet corporate borrowing needs.

“Fixed assets are already stretched to capacity and, if the Russian economy is to grow and increase its productive capacity, then a huge amount of investment is needed,” said Irackly Mtibelishvily, chairman of banking for Citigroup in Russia. “Local funding can only stretch so far; it is absolutely clear that the country needs international capital markets. There has to be some return to normality.”

He thinks sanctions have not dented long-term appetite for Russian corporate Eurobonds, and pointed to the two big deals in October – one from Norilsk Nickel and the other from Gazprom, both of which were heavily oversubscribed – as proof that many investors are still lurking on the sidelines for when other corporates return.

“A market of this size cannot just disappear,” said Mtibelishvily. “As the biggest economy in the region and the biggest issuer of bonds – at least in past years – Russia is and always will be extremely important to international investors.”

Falling reliance

Much will depend, however, on how quickly sanctions are lifted. Russia’s external debt peaked at US$732bn last June. With capital markets largely closed and the Russian financial system adapting to the new reality, reliance on external capital is falling. By September, external debt had fallen to US$521bn.

Amount by sector, US$ (billions)

“We would hope that sanctions will be lifted soon since they provide no effect anyway,” said Morozov. “But we can make no assumptions and so can’t be reliant on the possibility of international capital markets reopening. We have to have alternative financing.”

Some companies say that even if they were able to do a deal right now, such is the low cost of funding within Russia – even under sanctions – that it would make little sense.

“When you factor in the price of swaps and hedges, issuing in the Eurobond market doesn’t make any sense right now,” said Sistema CFO Rozanov. “The terms are much less appealing that those on bilateral loan deals being pushed by many Russian and foreign banks.”

(*Updates to add detail around Lukoil sanctions.)

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