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Saturday, 18 November 2017

To Russia with love

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After more than five years of falling pricing, Russia has moved from a yield-driven market to one where relationship is paramount. For borrowers, this means despite an increase in deal size, syndicates are smaller and inverted – with more banks at the top. For lenders left out in the cold as the market matures, there are more sectors opening up providing other higher-yielding opportunities. David Cox reports.

For a country that has sometimes awkwardly sat between Europe and Asia, the Russian loan market now looks firmly European. After the calamitous default of 1998 the market has moved from a backwater that a handful of lenders dominated and where only secured credit was on offer to a deep and liquid market where relationships are vital to the success of large, cheap credits.

"Whereas sometime ago Russia was seen as largely a yield play, relationships are now key," said Charles Griffiths, head of European origination for the syndicate group at Bank of Toko-Mitsubishi UFJ. "Many syndicates have moved away from the traditional pyramid model and are now inverted with relationship lenders now providing the bulk of liquidity. However, with core lenders willing to step up for large amounts deal sizes have grown significantly."

With a few, albeit notable, the focus on relationships has moved the market away from the secured structured commodity market. With banks now comfortable with country and credit risk, only a handful of top corporates have borrowed on a secured basis this year. From the top tier, corporates including Gazprom, TNK-BP and Gazpromneft/Sibneft have replaced their secured loans with unsecured one. In doing this, these companies have gained a rating benefit for their bond market activities by removing a class of secured lenders that sit ahead of bondholders. And they have been able to do this cost effectively given the price differential between the secured and unsecured market is now minimal.

For example, TNK-BP refinanced the remainder of its secured loans this year through a US$1.8bn four-year facility. This facility paid 65bp over Libor, a margin that TNK would only be able to reduce by around 10bp if it offered security. Compare this with TNK's 2003 loan, which paid what was then considered to be a highly aggressive initial margin of 260bp over Libor. Even with the hopeful assumption that unsecured funds could be found at this size in 2003, to clear the market the margin would have needed to be double at least.

But as in the rest of Europe, unsecured lending at tighter margins means a new dynamic comes in to play. Previously, given the yield they offered, borrowers like TNK-BP or Gazprom had no need to get involved in syndication and were simply able to sit back and watch the commitments roll in. However, just as lenders would rather decline tightly priced loans in the rest of Europe - especially if they believe it will not impact their relationship and subsequent ancillary business flow - borrowers now have to ensure that their lenders are aware of the importance of committing in the bank market.

"In terms of thinking about their relationships, top borrowers are learning fast," said Rizwan Shaikh, debt market director at Citigroup. "They are now becoming more careful about allocating ancillary business to those banks who commit capital".

This shift in thinking means that where syndicates used to be large as retail lenders uninterested or unable to win ancillary business used to sign up, they now resemble syndicates elsewhere in Europe. "Even though loans have grown considerably in size, syndicates have now taken on the typical European inverted pyramid form with a small number of lenders providing the bulk of liquidity," said Shaikh.

Still good value

On a comparative European basis, Russia's top corporates still provide a relatively decent yield and the lack of interest from retail lenders probably reflects lingering concerns over Russia's past sins. For example, Gazprom paid 55bp over Libor for its most recent refinancing. But as well as being Europe's largest company by market capitalisation, with a split Baa1/BB+ rating, on a comparative basis a German corporate would probably expect to pay 30bp-40bp over Libor at an absolute maximum. While in Hungary, the BBB– rated oil and gas group MOL recently paid just 18bp for a hugely successful €825m loan (increased from €700m).

Even as relationship lending takes hold, the secured market is still an effective way of raising funds for some. In a hugely successful loan, aluminium group Rusal signed a US$2bn secured facility this year, which included a seven-year tranche at 110bp over Libor - a feat that is impressive for a company with an implied BB rating in any jurisdiction. Moreover, long-term funding is available in the capital market at competitive rates, meaning blue chips are increasingly attracted to the capital market

"The bond markets diversify funding sources for borrowers and therefore reduce pressure on the loan market," said Citigroup's Shaikh. "If the top tier were funded entirely through the bank market then lending limits would soon come under threat and pricing would rise."

As with the corporate market, in the financial institution market pricing has fallen deeply, while deal sizes have grown. "Relationship lending in Russia first developed in the FI market then later spread to the corporate sector," said Ahmet Bekce, a managing director at Citigroup. "Pricing in the corporate market still offers value, but the FI market now looks tight, although, it still offers a premium over similar borrowers in central Europe."

This growth in the FI market has culminated with Sberbank, easily Russia's largest commercial bank, which in September launched a US$1bn three-year loan with a benchmark margin of 30bp over Libor. As the bluest of the blue chips, the loan is expected to clear the market with ease. However the FI market has recently been showing some signs of pricing fatigue.

Just before Sberbank launched, terms for VTB-24's US$300m loan, which Barclays arranged, had to be sweetened after lenders balked at the 35bp over Libor margin. With the extra fee and parent bank VTB making the necessary calls, that loan cleared the market.

Less fortunate was Alfa Bank, which had to abandon a planned full-blown syndication in favour of a smaller US$220m club when lenders stepped back. But even with Alfa's misfortune, for lenders to top tier state-linked banks like VTB, VEB and Sberbank, the margin is now of secondary consideration to the ancillary business on offer as profits made in other areas of the bank can more than make up the difference.

In the emerging markets, this situation is by no means limited to Russia. "A similar dynamic is at work in Turkey. Repeated borrowing by the major FIs has seen a progressive and aggressive reduction in pricing," said Guy Brooks, a managing director at Deutsche Bank. "But in reality these loans are often being subsidised by other areas of the lending banks. Therefore what appears to be an improvement in borrowing terms is a reflection of the depth of relationship and ancillary business of the borrower. And in Turkey as in Russia syndications are becoming thinner and increasingly top heavy as a result."

Yield opportunities

Given the size of Russia's banking sector, there are still plenty of lending opportunities for banks seeking yield. And this year has seen a slew of second and third tier banks tap the market, often achieving 50%-100% oversubscriptions.

"The smaller Russian banks are not aggressively covered by the mainstream banks and as they have relatively little side ancillary business to offer. As such their loan pricing more accurately reflects their risk - reward profile," said Deutsche Bank's Brooks.

It is not just the smaller FIs that are offering opportunities for yield. No lender has cut their Russian limits and new investors have entered the market. So while fewer banks are lending to the top tier, banks are now happier to go down the credit curve into different sectors.

This year has seen the opening up of the Russian market to various new sectors including retail, fixed-line telecoms and car dealerships. And this is a process that is expected to continue as the Russian economy expands.

And with rouble now fully convertible, the local market is developing rapidly. At present the market is largely dominated by local investors who tend to participate on a club basis in fixed rate deals, meaning the first international syndicated rouble loan still seems to be some way off. Moreover, the potential of the market is still a subject of some controversy as bankers point out that convertibility of the Turkish lira has mainly impacted the bond market, where eurolira deals are popular, while the loan market has seen few transactions.

"Convertibility is likely to make only limited difference to the rouble loan market and will have far bigger impact on the bond market where investors are drawn to the higher yield. Although, the accumulation of capital locally means there is a lot of capital looking for a home so the market will be of interest to local banks and international banks with a rouble balance sheet," said Citigroup's Bekce.

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