The Russia loan market has moved seamlessly from a secured to an unsecured basis, and despite growing ticket sizes, pricing has fallen dramatically. But with the market showing some signs pushback this year, borrowers are learning to play the relationship card. David Cox reports.
Last year was a landmark year for the Russian loan market. Borrowers were able to access the market at a quantum and a price unimaginable just a year before. This trend culminated at the end of 2005 when Rosneftegaz completed a US$7.5bn loan to fund its acquisition of a stake in Gazprom. This was then followed by Gazprom itself, which signed a US$13.1bn loan to fund its acquisition of Sibneft, Russia's fifth largest oil firm.
This access to big-ticket event-linked finance has been accompanied across the board by a fall in pricing: "The Russian market has been racing ahead so quickly that finance directors have been able to price their latest deal by simply taking the margin of their last one and halving it," said one senior Russian banker.
Even when funding its Sibneft acquisition with such a large loan, Gazprom still reduced its costs of funds: the group paid 90bp over Libor on the five-year tranche against 125bp it had paid earlier in the year. And by April this year, Gazprom had reduced its cost of funds further when it took out two secured lines and replaced them with a US$1.53bn four year five month unsecured loan priced at 55bp over Libor.
The fall in pricing and stretching of unsecured tenors now means the traditional structured commodity trade finance used by Russia's commodity firms is becoming endangered. These structures were used after the debt crisis of 1998 mainly as way of mitigating country rather than credit risk But because Russia is a strong investment-grade country, its need is minimal and Rosneft was the last corporate to access the market in any volume.
As ever in Russia, the reason for the move is price: the margin differential between unsecured and secured loans is at its lowest. For example, Gazprom is paying 55bp unsecured for what is close to five-year money against probably 45bp that it would have to pay if it offered security. Compare this to two years ago when against a margin of 200bp secured, around 450bp would be required on unsecured.
The pricing reduction has led to a structural change in the market. Until recently, the price that top-tier Russian companies paid meant that they did not need to get involved in the syndication process. Even as the market moved from secured to unsecured, accompanied by a rapid pricing fall, returns were still strong and demand was high. But pricing has now reached the level where pure asset gatherers are taking a step back.
"Borrowers have become accustomed to a market where pricing has always dropped considerably for each new deal as well as security/covenants weakening," said Penny Smith, executive director at WestLB. "However, there is a bottom level for pricing, and maybe we're getting there. Many lenders are now looking for more ancillary business or higher yields, and there seems to have been some push-back on the tightest pricings, further evidenced by a widening on secondary spreads. This is perhaps something that many Russian borrowers have not experienced before given the bullish market cycle we've experienced since the Russian loan markets reopened for business a few years ago."
Rosneft is emblematic of how the Russian market has matured over the past few years. After completing its record-breaking fundraising in 2005, the state controlled oil giant returned to the market this year with a five-year secured loan at a benchmark price of 65bp. The price was initially hard to swallow for lenders as the group's last secured loan – a US$2bn five-year secured line signed in October last year – was priced at 180bp over Libor.
But despite some protests, the facility eventually had a strong response in senior syndication and launched into general syndication in April fully subscribed. Rosneft has since used this success to reprice its two most recent secured loans at a similar margin.
But to ensure success, the borrower was forced to take an active role in this syndication to the point where four extra bookrunners were appointed during the senior phase. This suggests that, just as in the rest of Europe, if top Russian borrowers want to ensure syndication success with tightly priced relationship deals their involvement is now required.
Success at these pricing levels brings home that borrowers like Rosneft and Gazprom are major global companies which provide significant ancillary business to their banks meaning they can name their price. "The syndicated loan is the loss leader into other profitable parts of the bank," said one banker.
Given the rapid contraction in pricing combined with the fact that many lenders are still full from last year's record borrowing splurge, many feel that margins are unlikely to come under any major downward pressure in the coming months. In response, optimists argue that the top tier of Russian corporates should be seen in a global context:
"The pricing fall in Russia looks severe when it is compared to the country a year or more ago. But set against other comparables in the wider Central and Eastern European region, the country still offers good value and I see no reason why pricing in Russia should not continue to fall," said Michael Emery, director, loan syndicate, sales and trading EEMEA at ABN AMRO.
With analysts predicting that Russia could be in the Single A rating bracket within the next 12 months or so, others also argue that there is no reason why pricing should not continue to fall and converge with the wider CEE region.
Indeed it is arguable that Russia is paying for past indiscretions and lenders are demanding a premium for legal and regulatory risk: "If there is a continuous improvement in rating and credit quality then there is likely to be a continued pricing compression. Although it is difficult to see the same level of pricing improvement that we've seen over the last year," said Guy Brooks, a managing director at Deutsche Bank.
Once Rosneft completes its up-to-US$20bn IPO later this year and repays the US$7.9bn bridge loan signed last year, the rating disparity which sees S&P rate the group at B+, some five notches below Moody's Baa2 will certainly be closed. At this rating, Rosneft will be on par with regional borrowers such as MOL and PGNiG, which can command unsecured margins in the mid 20s over Libor.
A more relationship-driven market means syndication strategies will have to change. As in Western Europe, tight pricing in Russia will mean pure asset gathers will have little interest, suggesting the traditional pyramid syndicate will invert.
"As spreads decline and the markets mature, you are seeing a situation where borrowers need to focus on relationship, meaning bank groups will become more defined," said Deutsche Bank's Guy Brooks. "As in Western Europe you will increasingly have top heavy syndicates where around 80% of the loan will be taken up by just 20% of the syndicate."
This trend is already becoming apparent, with VTB avoiding syndication of its tightly priced US$600m three-year loan in favour of a one-ticket club style exercise.
Commodity boom
With commodity prices at or near record highs, there appear to be few clouds on the horizon for the Russian economy. Even after the dismemberment of Yukos at the end of 2005, investors have ignored regulatory or legal concerns. In the lending market, bankers admit that as the market is very bullish compliance problems are often brushed aside.
And even in the banking sector – which on the whole remains in desperate need of reform – international banks are rushing to lend. Although the commodity boom has brought an unprecedented improvement in Russia's economic fundamentals, for many investors this strong growth is masking the fact that regulatory and political reform remains sluggish.
"If commodity prices tank, not only will lenders focus on credit quality, political issues are likely to return to the fore," said one senior banker. "In a bearish market, investors look for any reason to sell, just as they are happy to paper over the cracks in a bullish one."
But with commodity prices high and the Russian economy booming, falling prices look here to stay. And though lenders may squeal as returns get squeezed, the change is good news for the market as a whole. Falling yields mean banks are increasing looking outside of the oil, gas and state sectors to the next tier of corporates for new supply. Sectors as diverse as supermarkets, utilities and car dealers have all been seen this year.
While in the financial sector, though the top banks may not enjoy the same level of oversubscription that they have been used to in the recent past, this year has seen a slew of private and regional higher yielding financial institutions clear the market with large oversubscriptions.