A long overdue OECD upgrade has provided Russian banks with another growth opportunity, writes Christopher Moore.
On January 26, 2007 the Organization for Economic Cooperation and Development (OECD) upgraded Russia’s country risk classification from Category 3 to Category 4. This measures a country’s credit risk, ie, a country’s likelihood that it will service its external debt. This was the first upgrade of Russia’s risk classification by the OECD since October 31, 2003, and is expected to significantly boost the ability of Russia’s banks to increase the export credit agency (ECA)-financed segment of their trade finance loan portfolios because the rating improvement lowers the minimum premium rates charged by ECAs.
Anton Zur, head of trade finance at UralSib Bank, expects the ratings improvement to result in an 80% increase in the ECA-covered financed segment of UralSib’s trade finance portfolio, raising the portfolio from US$120mn to US$215mn by the end of 2007.
Zur explains, “In fact, the previous upgrade of Russia took place in the fall of 2003, which means that the ECAs’s insurance premiums remained at the same level for over three-and-a-half years, approximately in the range of 4-5% flat for a five-year loan. This premium did not reflect the market correctly, [because] market rates for Russian borrowers went down significantly year over year from 2004 to 2006.”
The total impact on pricing is significant, and the new, lower premiums are anticipated to have an immediate boost. “We expect that the upgrade will lead to a reduction of ECAs’s premiums by around 30% thus increasing competitiveness of this product and allowing us to achieve the indicated growth plans,” says Zur.
The methodology used by the OECD to rate a country’s risk has two basic components. First, a country risk assessment model (CRAM) is used to calculate a quantitative assessment of country credit risk based on three groups of risk indicators that include the payment experience of the participants (ECAs), the financial situation and the economic situation.
Second, a qualitative assessment of the CRAM model result is completed, which is considered country-by-country to integrate political risk and other risk factors not fully accounted by the CRAM model.
Political undertones
Using the results of the country risk model, the ECAs’s country risk experts must reach a consensus on each country’s credit risk. Given that the ECAs are by and large slaves to political masters, one could perhaps interpret Russia’s favourable results and the recent upgrade as a political vote of confidence for Vladimir Putin’s management of the Russian economy during his presidency.
It is more likely, however, that Russia’s US$22.3bn final tranche repayment of its Paris Club debt completed in August 2006 needed to be both acknowledged and recognised as a significant financial feat and one that carries a lot of weight when it comes to scoring a country’s ability and willingness to repay its debts.
According to the Paris Club, on May 13, 2005, Russia concluded a first prepayment agreement, which led to the prepayment of US$15bn of debt during the summer of 2005. By prepaying the entire debt, Russia is likely to save itself between US$7bn-US$8bn in interest payments as these amounts were to be repaid between August 2006 and August 2020.
Furthermore, the OECD itself notes a host of positive factors in its latest assessment of Russia’s economic situation completed last November including: the stability of the country, the robustness of economic growth in the last eight years, the high level of gold and foreign currency reserves and the accumulation of the windfall tax revenues from oil and gas into a stabilisation fund, the sound management of foreign debt, the recent further liberalisation of capital account transactions, the reduction of the number of people living under the official poverty line, the expansion of a nascent middle class that fuels domestic consumption and retail industry development, and the rising level of foreign investment, undeterred so far by assertive moves to return certain strategic assets to state control beyond the oil and gas sector.
Russia’s economic fundamentals, namely, the positive balance of trade figures mainly the result of high commodity prices would have figured strongly in the calculus used to determine the upgrade. In OECD language it was explained as “the high level of the gold and foreign currency reserves and the accumulation of the windfall tax revenues from oil and gas into a stabilisation fund” combined with “the sound management of foreign debt”.
Unfortunately, the ‘details’s of the CRAM are kept confidential. There are, however, plenty of reliable statistics and sources for macroeconomic analysis available about Russia for the trade finance community. Eurostat, the EU’s official statistical agency, for example, provided compelling data on why there is heightened exuberance about the prospects for Russian economic and trade growth.
Last May on the occasion of the EU-Russia Summit, Eurostat announced that Russia’s trade surplus with the EU surpassed €50.3bn. Russia’s trade surplus with the EU has more than tripled in size since 1999 when it amount to €17.6bn only.
And, yes, it is no surprise that this growing surplus is ballooning, largely as the result of high commodity prices, particularly oil and gas, even as some EU exports categories also register impressive growth like EU exports of machinery and vehicles, and other manufactured goods. Energy exports from Russia to the EU rose from €17.6bn to €70.6bn from 1999 to 2005.
Commodity high flyer
High commodity prices held throughout 2006 and the trade figures are likely to show the same 2005 trends, strong growth and a strengthening of the current account due to continued high commodity prices. The 2006 annual average price of West Texas Intermediate (WTI), the primary proxy for the world price of crude oil that is widely traded on Nymex, was US$66.05 by far the highest levels in 20 years according to the US Department of Energy.
The annual average oil price of WTI has increased by 18.5%, 33%, 37% and 16.9% year over year from 2002 though 2006. The dramatic increase in the oil price began in 2000 when the WTI annual price jumped from US$19.34 to US$30.38, and between 1999 and 2006 the annual price of the WTI has increased by a massive 340% from US$19.34 to US$66.05.
Global oil prices are anticipated to trade in a range of US$60 to US$65 a barrel in 2007, and from now until 2015 the price is expected to soften, rising again between 2015 and 2030. Rating agencies and economists focused on Russia generally report that the Russian economy can withstand a drop in the oil price below US$40 without great risk to growth or adversely affecting macroeconomic stability.
Also, as Russia is a major exporter of gold and other mineral resources like nickel the balance of payments can also be supported across other commodities. Last year the gold price peaked above US$700 an ounce, and while the price has declined over the last 10 months it currently trades at about US$650, levels not reached since the late 1970s.
The result of all the stellar economic news emanating from Russia is that trade financiers have never seen better days. They are benefiting both by taking on Russian risk directly and through an increase in their own client’s trade activities in Russia. For example, total EU-Russian trade (combined imports and exports) volumes increased from €50.9bn to €163.1bn, a more than threefold increase, from 1999 to 2005.
Bank borrowing windfall
With Russia’s President Putin declaring that 2006 was the year of the Russian IPO at his recent annual televised press conference, official recognition of Russia’s access to international capital markets and the bank’s aggressive borrowing affords prestige and tacit approval of what is essentially more international integration in to the global economy.
After all, WTO entry is also within the long awaited grasps of the Russian government, and the heady external borrowing and capital market access is another economic achievement that Putin will be able to claim changed dramatically under his watch.
Indeed, Putin may also take credit for the tremendous asset growth that has occurred in the Russian banking sector too. The asset growth rate was an astounding 46%, 35%, and 32% in 2003, 2004 and 2005, respectively. According to equity research conducted by Sovlink, a brokerage firm, the banking assets will increase by 38% in 2006, so fast, that the banks’s capital base, growing at an expected 29%, will not keep pace.
This mismatch between assets and capital base growth will restrict the bank sector’s growth because of regulatory restrictions, domestic and international, related to minimum levels of capital adequacy.
Even the record levels of Eurobond issuance by the banks could not meet the rapid loan growth. The total value of Eurobond issued jumped from US$18bn to US$25bn year over year according to investment bank and research house Troika Dialog, and the total number of Eurobond issued increased by 65% in 2006 with over 110 issues being successfully brought to market. The banking sector was by far the most active in the foreign debt market easily accounting for more than 50% of the issuance.
Select Russian banks have been active in the Eurobond and syndicated loan market for the past three or four years. There are, however, a growing number of debutants that are eager to increase their balance sheets, and Eurobonds provide one of the quickest ways to grow their assets. Most of this borrowing, Eurobond and syndicated loans, are either directly trade related or inherently linked to trade portfolios.
State-owned Sberbank, Russian’s largest bank, occupies a category of its own among banks due to its sheer size and scale. In 2006 it raised US$3bn, and last October the bank completed its most successful single transaction setting a record in terms of pricing when the bank raised US$1.5bn in a syndicated loan at Libor + 0.3% per year, the lowest margin for any unsecured three-year syndicated loan for a Russian borrower to date. The deal is also the largest unsecured syndicated loan ever for a financial institution out of Russia.
Three of Russia’s largest banks – state-owned Russian Agricultural Bank, Alfa Bank and UralSib Bank – were among the most successful fund raisers in 2006 and look set to repeat their efforts in 2007. Together the three banks raised nearly US$3bn.
Russian Agricultural Bank raised US$800mn in the foreign bond markets by September 2006. Alfa and UralSib each set new fund raising records in 2006. Both Alfa Bank and UralSib Bank raised a total of US$1bn each.
Other noteworthy issuers included Vneshtorgbank and Bank of Moscow.
UralSib Bank’s Zur provides the following overview: “On the wholesale fundraising side UralSib has raised over US$1.4bn in eight syndications between 2004 and 2006. In 2006 alone three transactions accounted for an aggregate sum of US$833mn. There were also two SME financing loans provided by the EBRD and the IFC, each loan amounting to US$30mn. Also, a number of banks provided bilateral loans totalling US$270mn.”
He continues: “UralSib raised US$1.74bn between 2004 and 2006 of which US$1.08bn or nearly two-thirds of this funding was raised last year.”
The trade finance activities of the banks provide the collateral and security for most of this borrowing. The banks with scale – the likes of Alfa and UralSib – often use their counterparty relationships to secure the cheapest form of financing available to them, this is funding that is even cheaper than the funding available through the international market.
“First and foremost, and very generally, the business of trade finance is very important to Alfa Bank,” says Maxim Topper, managing director and head of international banking, at Alfa, “if for no other reason, than to maintain a competitive edge domestically. Trade finance and its lesser components, like no other area in the bank, allows us to maintain a competitive edge in the pricing of our credit facilities for our domestic clients. Essentially we use trade finance as a way to fund ourselves long term.”
Russian banks are able to finance their clients’s capital goods imports using trade finance facilities and credits built on the documentation and relationships established with the western counterparties’s banks.
Topper explains: “We initially use the LC as the first stage to long-term financing of the import and the client by way of a western inter-bank credit. It is called post-financing and it is the most widely used instrument in Russia to finance the import of that product, as well as any post-financing off the product that the client requires. If the client wants to buy a machine, he issues an LC and the LC is paid for by the confirming bank, our working counterparty, and after six months we will get an inter-bank credit for an additional six or 12 months, which allows us to take that money and convert it in to a corporate loan for our client.”
The end result is that the client does have to pay for the import, for example, machinery or vehicles (the EU exported over €26bn from this sector in 2005) immediately at sight, but can have the purchase refinanced for one or more years.
“This is done on the basis of the credit that has been extended by the western bank, and this facility is priced in such a way that it provides the most competitive funding source that we have access to, period. Nothing that we can do internationally with respect to syndicated credit, Eurobonds, commercial paper, securitisation, sub-debt, no matter what other instrument you name, nothing is as cheap for us as the funding off the LC,” says Topper.
According to Topper, this medium-term trade financing is one of the reasons why for the last three years Alfa Bank’s trade finance business has doubled every single year, and the bank has a portfolio that approaches US$1bn.
Small debuts
It is not only the first tier banks that have tapped the international markets, but also several second and third tier banks have made their international lending debut.
A few select 2006 and 2007 deals, but by no means a complete list, are highlighted below:
- Bank Center-invest raised US$80mn in a syndicated term loan facility that was 200% oversubscribed when it closed on February 28 this year. The loan will be used to finance certain trade contracts of the bank’s strategic clients. The facility was launched at US$40mn and raised over US$120mn in commitments. Center-invest elected to accept US$80mn as the final facility amount with 38 banks joining the syndicate. Center-invest also completed an international syndicated loan in July 2006 for a US$45mn A/B loan arranged by the EBRD with 15 participants.
- Soyuz Bank raised US$125mn in February when it completed its first non-ABS Eurobond. In 2005 the bank made its debut in the Eurobond market when it placed a US$43mn asset-backed security linked to auto loans.
- Bank Vozrozhdenie mandated UniCredit Group and Landesbank Berlin to arrange a US$50mn trade-related syndicated term loan facility on its behalf in January 2007. The proceeds from this will be used to refinance export-import related transactions of Vozrozhdenie’s customers.
- Locko-Bank became the smallest Russian bank to access the Eurobond market placing its debut US$100mn three-year loan participation notes on February 20, 2007. UBS Investment Bank was sole bookrunner for the deal that was priced at 10%. The bonds that mature on March 1, 2010 are issued by Locko Finance, Ireland and listed on the London Stock Exchange. Locko-Bank is Russia’s 93rd largest bank by total assets (as of January 2007). IFC and East Capital, through their shareholding of 15% and 11% respectively, are active in the bank’s management.
- Nomos-Bank in the first nine months of 2006 participated as a borrower in various trade-related lending arrangements with more than 70 foreign financial institutions in an aggregate amount exceeding US$200mn. The total volume of outstanding inter-bank trade related transactions as at September 30, 2005 exceeded US$400mn. Nomos was founded in 1992 and has evolved into one of Russia’s leading private financial institutions.
- Sibacadembank signed a US$102mn syndicated trade-related term loan facility agreement with Commerzbank and Standard Bank, the mandated lead arrangers and bookrunners, in August 2006. Also during 2006, Sibacadembank was reorganised with Uralvneshtorgbank under the name of Ursa Bank.
- MDM Bank signed a US$300mn syndicated trade-related term loan facility in May 2006. The proceeds will be applied to trade-related financing or other trade-related projects of MDM Bank’s customers.
- Bank Zenit borrowed a syndicated loan of US$135mn from 27 foreign banks representing over 10 countries in June 2006. The loan was taken at Libor + 1.3 % per year, matures within a year, and may be extended for another year. It has tapped the Eurobond market for the second time after repaying its initial bond in 2006.
Single biggest country exposure
This increased Russian borrowing has created significant opportunities for the major country risk and export-related insurers. Russian risk has become increasingly attractive over the past three years, a trend that began at least as far back as October 2003 when Moody’s was the first of the major rating agencies to upgrade Russia to Baa3 from Ba2 and in the process making it an investment-grade credit.
Growth in the insurers’s portfolios is also fuelled by their client’s strong demand for credits and business with a growing number of second and third tier bank credits. These riskier credits provide attractive yields for institutional investors in a market where spreads have narrowed substantially across many emerging markets.
“Taking a look back two years to 2005, the bank market has pushed tenors out much longer. If you look back to 2005 probably the banks were at 12 months very little was done beyond that, and today you get up to five years with the international banks,” explains Stephen Capon, head of country and credit risk management, Ace Global Markets, regarding the substantial increase in Ace’s Russian book in 2006. “In 2005, only the top names, like a Lukoil, could obtain a five-year cover. Because of the liquidity and competition, banks are going further down the relative ‘food chain’s and a number of insurers tend to follow them to a certain extent; now where banks can go out seven to 10 years, the insurers cannot do this.”
“Russia is not an easy country to deal with, but it is our largest single country exposure,” says Capon. “We are very choosy about what we do. For example, we do not have exposure on expropriation or nationalisation of oil and gas assets. We are very choosy. Most of our credit risk is placed with the leading banks, and to support exports of oil, coal and iron through to supporting imports of capital equipment and food imports that the banks are handling.”
Increasingly more banks are taking on and managing more of their Russian risks themselves. There are also opportunities for banks to share some of these risks through the secondary swap market when an appropriate benchmark can be established for the risk.
The insurers, as is the nature of the industry, are more prudent. “A lot of what we have is direct exposure on the banks, but we tend to keep this exposure relatively short term,” adds Capon. “It is rare that we go beyond three years with the banks. The banking system is still a bit weak; there exists some vulnerability to sudden withdrawal of deposits, and there is some liquidity risk.”
