Syndicated Loans 2005 - Russia joins the premier league
With the country’s borrowers on course to raise more than US$30bn this year, the Russian loan market has come of age. Unsecured lending has overtaken secured lending for the first time, and with new investors entering the market, lender competition has caused margins to fall sharply. The outlook for borrowers is bright and volumes are expected to climb further. David Cox writes.
According to data from Thomson Financial, Russian companies have raised over US$20bn in the syndicated loan market so far this year, easily overtaking 2004's full-year figure of US$13.8bn. And assuming that loans like Gazprom's US$12bn jumbo for its expected takeover of Sibneft proceed, the Russian loan market is set to break not just volume records but be on track to be one of the largest in Europe.
The glut of cheap money sloshing around the European and the wider emerging markets is one reason for this but it is also a realisation of Russia's improving credit story, which Moody's and Standard & Poor's have recognised by upgrading the company to investment-grade.
"Much of the increased lending into Russia is a factor of the of wall cheap money travelling through the emerging markets," said Peter Kennedy, managing director, global distribution & specialised finance at Standard Bank Plc. "But also Russia is not the emerging market it was five years ago. Helped by a high oil price, the macroeconomic picture has improved considerably and compared with other markets such as Turkey, the returns on offer are still good."
After the country's disastrous default in 1998, Russia was generally off limits to most banks, and the country's natural resource based corporates were forced to structure their loans to mitigate country risk rather than credit risk. As such on a relative basis, returns in Russia were very good, and as the country risk profile risk improved, though pricing fell it remained - on a rating basis - still attractive.
This year's explosion in volume has seen unsecured lending outstrip secured lending for the first time with around US$15bn raised on an unsecured basis against US$5bn on a secured basis. And with the market so liquid, pricing has fallen as well.
"With Russia's upgrade to investment grade a lot of new players entered the market and pricing has fallen," said one European banker, "This reflects that Russian borrowers have in some respects been playing pricing catch-up as there has been an element of overpaying for past mistakes. Much of the recent pricing fall, though sharp, is bringing the Russian market in-line with similarly rated markets."
Sberbank is the latest borrower to benefit from rapidly falling loan pricing. Following on from Vnesheconombank, which completed a hugely successful benchmark loan at 90bp over Libor, Sberbank was able to smash through this level and mandate ABN AMRO and HSBC for a US$500m three-year loan at 55bp. Given that both borrowers are effectively state owned, the fall is undoubtedly steep. But when seen in the context of global falling returns, for a Baa3/BBB- rated bank that dominates commercial banking in Russia the loan is good value.
Elena Ivanova, a director at ING, said: "Over the past year loan returns in Russia have fallen sharply driven by global liquidity and intense competition. But still from a lender perspective returns are still good. And on a risk - reward basis if you compare pricing in other countries, Russia compares well."
This was borne out in the market reaction to Sberbank’s loan, which attracted over US$1bn in commitments in the senior phase alone.
With Russia's improving credit story, the need for structured financing is diminishing. Once Gazprom re-opened the unsecured sector with its US$215m loan in 2003, it was expected that secured volumes would plummet. However, with last year’s nervousness around Yukos, demand for the secured structure remained strong and borrowers continued to access secured and unsecured markets.
But with demand for Russian assets now at a high, the need for structures for the blue chip natural resource companies has almost disappeared. And although the secured loans that have emerged from the blue chips this year have all proved popular, the trend is clearly for the more flexible unsecured product.
Moreover, with borrowers like Gazprom increasingly looking to diversify their funding sources through the bond markets, the benefits of not tying up receivables and creating a large creditor base ahead of unsecured lenders and bond holders are manifest.
However, secured lending is almost certain not to disappear, with lenders comfortable with Russian country risk, structured commodity finance will be used to mitigate borrower risks rather than just country risk and allow lower-rated companies to access the market. Already this year, Russneft, a second tier oil firm, has completed a US$300m loan debut and Eurochem signed a US$150m facility.
The development of the unsecured market opens up the loan market to range of industries outside of the natural resource sector. For example, VimpelCom and MTS, two mobile telephone carriers, have completed successful unsecured loans. Supermarket group Perekryostok is preparing its second loan, with a €125m facility. But despite this progress, Russia's economy remains primarily commodity based and it is the natural resource sector that will provide the bulk of supply.
The availability of large unsecured loans brings the market closer to the European norm, giving Russian borrowers the same flexibility as their counterparts in the more mature western markets. This means borrowers can now use the market to fund big ticket acquisitions as well as put in place undrawn back-up lines. Emerging market lenders generally do not like undrawn revolvers because of their lower yield but large back-up lines form part of the core funding strategy of virtually every western and central European corporate of size.
But it is the opening up of acquisition market that has really shown the new depth in the Russian loan market. In a loan that is large for Western Europe let alone a supposedly emerging market like Russia, Rosneftegaz broke all size records when it mandated ABN AMRO, Barclays, Dresdner KW, JP Morgan and Morgan Stanley to arrange a US$7.5bn loan to support its acquisition of a stake in Gazprom. All indications suggest that syndication will blow out.
Despite this achievement, Rosneftegaz is unlikely to enjoy its status as the largest Russian loan for long, as Gazprom is tipped imminently to mandate a group for a US$12bn loan to back its expected purchase of Sibneft. Before any other loans are included, these two loans alone mean that almost US$20bn of unsecured supply will be absorbed into the market within three months, a feat almost unimaginably when IFR published its last survey of the Russian market a year ago.
So far the state-linked sector has dominated acquisition activity, but this is expected to change as Russian corporates become more confident and seek to expand abroad. For example, Norilsk Nickel used the loan markets to support its acquisition of a stake in Goldfields, a South African gold miner, while RUSAL has acquired smelting assets in the Ukraine and across the former Yugoslavia. Gazprom is regularly cited as a potential buyer of companies as diverse as Centrica in the UK and Mol in Hungary.
Not just loans
As the market matures, a similar process is happening in other capital markets. And the bond markets are benefiting from the same liquid conditions as the credit markets. For borrowers, while a bond offers longer tenors, a loan is usually cheaper and more flexible. But with so many investors looking to get into Russia, in some cases the difference is now marginal.
Guy Brooks, managing director at Deutsche Bank, said: “The spread differential between the bond and loan markets has contracted greatly over the past 12 to 18 months. And with low volatility, in some cases – usually in higher-yielding industries – the spreads on offer in the two markets are very similar.”
This increase in liquidity and corresponding fall in pricing has meant that institutional investors are increasingly on the hunt for yield. And these investors are now buyers of loans, although usually in the form of a credit-linked note. While not interested in buying lower-yielding blue-chip paper, these investors are more adventurous than some bank lenders and willing to lend to industrial sectors not frequently seen in the market. Investing in research resources, institutional investors are less interested in banking relationships rather than price.
“The arrival of institutional investors is a result of the fall in returns in the blue-chip names and increase in liquidity in the second and third tier ones,” said Brooks. “Most blue-chip names no longer offer the type of return that emerging market focused institutional clients are looking for. As a result they are looking to sectors not typically focused on by the traditional bank lenders. And as these sectors have less liquidity and therefore less price transparency, returns are considerably higher.”
As such, the outlook for Russian borrowers has never been brighter, although some risks remains. The private banking sector is hopelessly fragmented and in desperate need for reform, and investors looking for consolidation in that sector over the next 12 months. And although investors are happy with the political situation, questions remain about the next presidential elections in 2008, when President Putin is, at present, constitutionally barred from running for a third term.