Trading Pulse CIS 23 March 2007 • Dmitry Shishkin CFA* +44-20-7815-3181 [email protected]Kazakhstan: Relative value trade (Page 2) While we are as concerned as investors are over the expanding external borrowing by Ka- zakhstan banks, we believe that the bonds of Alliance Bank have suffered unduly during the recent sell-off in the country’s banking sector. Our analysis shows that given the good performance of Alliance Bank and, particularly, the strong potential for further growth in the capital base, it should meet the new regulatory requirements on the foreign debt to capital multiple. In this respect, the spread gap between the medium bonds of Alliance Bank and ATF Bank looks attractive. We believe that the main reason for the widening of the gap is the large supply of Alliance Bank Eurobonds during February. However, on a forward- looking basis, supply of ATF Banks bonds is likely to accelerate. Best/worst performers, one week total returns in currencies of issue (%) Quant Corner Index Note: Prices as of March 22 2007 Page Open/closed trades 4 Russia: Local debt 5 Russia: External debt 11 Ukraine: External debt 15 Kazakhstan: External debt 17 Expected issues and cash flows 19 Analytics: External rouble market 10 Russia: Rouble bonds Russia: US dollar bonds Ukraine: US dollar bonds Kazakhstan: US dollar bonds Sources: Bloomberg, Standard Bank Group (1.0) (0.5) 0.0 0.5 1.0 1.5 RFLB 10%10-SEP-2008 6001 URSABANK 10%12-DEC- 2008 2 RFLB 6.95%06-FEB-2036 6020 SPTLRU 7.5%03-OCT-2007 2 RURAIL 7.35%10-NOV-2010 6 RURAIL 8.33%02-DEC-2009 3 (1.0) (0.5) 0.0 0.5 1.0 RUSSIA 12.75%24-JUN-2028 REGS RUSSIA 5%31-MAR-2030 REGS IIBRU 9.5%12-FEB-2010 RUSSIA M INFIN 8 NOM OSBNK 8.25%12-M AY- 2009 PROM BNK 8.5%4-OCT-2010 (0.5) 0.0 0.5 1.0 UKRCHEM 7.875%19-AUG- 2008 UKRSIBBANK 7.75%21-DEC- 2011 NAFTO 8.125%30-SEP-2009 EXIM UKRAINE 6.8%4-OCT- 2012 ALFAUKR 9.75%22-DEC- 2009 EMTN KYIVSTAR 17.75%27-APR- 2012 REGS (1.0) 0.0 1.0 2.0 3.0 ATF BANK 10% PERPETUAL BTAS 8.25% PERPETUAL BTAS 8.5%10- FEB-2015 REGS DBKAZ 6.5%3- JUL-2020 MTN DBKAZ 6%23- MAR-2026 EM TN PETROKAZAKH 9.625%12-FEB- 2010 REGS
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Kazakhstan: Relative value trade (Page 2) While we are as concerned as investors are over the expanding external borrowing by Ka-zakhstan banks, we believe that the bonds of Alliance Bank have suffered unduly during the recent sell-off in the country’s banking sector. Our analysis shows that given the good performance of Alliance Bank and, particularly, the strong potential for further growth in the capital base, it should meet the new regulatory requirements on the foreign debt to capital multiple. In this respect, the spread gap between the medium bonds of Alliance Bank and ATF Bank looks attractive. We believe that the main reason for the widening of the gap is the large supply of Alliance Bank Eurobonds during February. However, on a forward-looking basis, supply of ATF Banks bonds is likely to accelerate.
Best/worst performers, one week total returns in currencies of issue (%)
Quant Corner Index
Note: Prices as of March 22 2007
Page
Open/closed trades 4
Russia: Local debt 5
Russia: External debt 11
Ukraine: External debt 15
Kazakhstan: External debt 17
Expected issues and cash flows 19
Analytics: External rouble market 10
Russia: Rouble bonds Russia: US dollar bonds
Ukraine: US dollar bonds Kazakhstan: US dollar bonds
Sources: Bloomberg, Standard Bank Group
(1.0) (0.5) 0.0 0.5 1.0 1.5
RFLB 10% 10-SEP-2008 6001
URSABANK 10% 12-DEC-2008 2
RFLB 6.95% 06-FEB-20366020
SPTLRU 7.5% 03-OCT-2007 2
RURAIL 7.35% 10-NOV-2010 6
RURAIL 8.33% 02-DEC-20093
(1.0) (0.5) 0.0 0.5 1.0
RUSSIA 12.75% 24-JUN-2028REGS
RUSSIA 5% 31-M AR-2030REGS
IIBRU 9.5% 12-FEB-2010
RUSSIA M INFIN 8
NOM OSBNK 8.25% 12-M AY-2009
PROM BNK 8.5% 4-OCT-2010
(0.5) 0.0 0.5 1.0
UKRCHEM 7.875% 19-AUG-2008
UKRSIBBANK 7.75% 21-DEC-2011
NAFTO 8.125% 30-SEP-2009
EXIM UKRAINE 6.8% 4-OCT-2012
ALFAUKR 9.75% 22-DEC-2009 EM TN
KYIVSTAR 17.75% 27-APR-2012 REGS
(1.0) 0.0 1.0 2.0 3.0
ATF BANK 10%PERPETUAL
BTAS 8.25%PERPETUAL
BTAS 8.5% 10-FEB-2015
REGS
DBKAZ 6.5% 3-JUL-2020 M TN
DBKAZ 6% 23-M AR-2026
EM TNPETROKAZAKH9.625% 12-FEB-
2010 REGS
2
The continuous external borrowing of large sums by Ka-zakhstan banks has long been seen as a potential prob-lem for the banking sector. According to data of the Na-tional Bank of Kazakhstan (NBK) for the end of Septem-ber 2006, the total country’s external debt is $59.6bn, of which the banks’ share is $23.6bn — a rather sizeable amount for a $78bn economy. While the debt issued by the non-banking sector is still bigger than that of the banks (although the gap is rapidly closing), a large chunk of it is inter-company indebtedness and, therefore, is less risky. It is especially worrying that funds raised by Ka-zakhstan banks in international markets are lent in the local currency to the retail and SME sectors at much higher rates. In competing for this lucrative business, it is very likely that the quality of the loan portfolios suffer and can result in negative consequences for the banks at a later stage.
The NBK and supervision authorities are aware of this threat and its implications for the country’s economy. The high quality of Kazakhstan’s banking sector, compared to those of neighbouring countries, has been one of the main attractions for foreign capital. The new measures include limiting foreign liabilities of banks to three to five times of book value, designed for slowing down banks’ foreign borrowing. We doubt that Kazakhstan banks will stop external borrowing. For one thing, they are faced with maturing obligations on existing debt, for another the local debt market is too small for raising necessary funds to maintain their share in the local loan market. Further-more, despite the regulations coming into force from March this year, Kazakhstan banks are given up to one year to fully comply.
The market recognises that the current trend of borrow-ing is likely to continue and is understandably concerned about the growing supply of Kazakhstan bank paper. Not surprisingly, the spreads of the Kazakhstan bank Euro-bonds have widened. What is less intuitive is why the spreads between bonds of banks, which are similar as far as structure of their assets and liabilities are concerned, display a wide yield gap. Consider, for example, the spread curves of Alliance Bank and ATF Bank bonds (Figure 1).
Figure 1: Kazakhstan bank spread curves over US Treasury
Sources: Bloomberg, Standard Bank Group
Alliance Bank and ATF Bank are respectively the fifth- and fourth-largest banks in Kazakhstan by assets. Alli-ance Bank is rated ‘Ba2’ and ‘BB-’ by Moody’s and Fitch respectively, whereas ATF Bank is rated one notch higher by Moody’s and the same by Fitch. For compari-son, in Figure 1 we also show the spread curve of Halyk Bank bonds, which has much tighter spreads since Halyk has the most cautious policy of external borrowing among the big Kazakhstan banks.
The spread gap between the three-year bonds of Alli-ance Bank and ATF Bank is currently 113 bps. This is too wide a spread to be explained by the credit rating difference between the two bonds. Historically this spread was mostly around 25 bps and started to widen sharply in the last six weeks (Figure 2). We believe that this was primarily due to the heavy borrowing by Alliance Bank, which issued two Eurobonds in US dollars and British pounds totalling more than $1.2bn in February 2007. During the same month ATF Bank borrowed ‘only’ US$450m on the Eurobond market. Clearly the supply of the Alliance Bank paper was so large that even a deci-sion of the ATF Bank’s board of directors taken over that period to increase the bank’s foreign borrowing limit for 2007 by $2bn to $4.7bn did not have a damping effect on the spread widening.
Kazakhstan: Relative value trade While we are as concerned as investors are over the expanding external borrowing by Kazakhstan banks, we believe that the bonds of Alliance Bank have suffered unduly during the recent sell-off in the country’s banking sector. Our analysis shows that given the good performance of Alliance Bank and, particularly, the strong potential for further growth in the capital base, it should meet the new regulatory requirements on the foreign debt to capital multiple. In this respect, the spread gap between the medium bonds of Alliance Bank and ATF Bank looks attractive. We believe that the main reason for the widening of the gap is the large supply of Alliance Bank Eurobonds during February. However, on a forward-looking basis, supply of ATF Banks bonds is likely to accelerate.
'10
'10
100
225
350
475
600
0 2 4 6 8 10Modif ied Duration
Bps
Alliance Bank ATF Bank Halyk
3
Figure 2: Spread differential between Alliance ’10 and ATF ’10
Sources: Bloomberg, Standard Bank Group
It is also possible that the market has become concerned about Alliance Bank’s violation of the new debt-to-equity ratio regulation as the time draws closer to its implementa-tion. Some of the research in the market suggests that the foreign debt to equity for Alliance Bank can be as high as 6x instead of the 3x set up by the Kazakhstan’s Financial Supervision Agency (FSA).
We disagree with this assessment as it is possible that it was based on outdated numbers released by Alliance Bank in its interim report for June 2006. According to the latest figures published on the FSA’s web-site, the bank’s capital on February 1st 2007 reached KZT85bn (around $670m). Firstly, the latest figure for capital is double that shown for H1 2006. Secondly, this allows Alliance Bank to increase its foreign debt to equity multiple to 3.5x, which is set for banks with capital ranging from KZT50bn – KZT100bn. Thirdly, the growth of the capital base is very rapid and, if it continues, would soon take Alliance Bank to the next level of the multiple - 4.0x, applicable for banks with capital over KZT100bn. Figure 3 shows the growth in the capital of Alliance Bank and ATF Banks over the last year, with the former outpacing the latter.
We are confident that Alliance Bank and ATF Bank will increase their equity base to comply with the new regula-tions. This can be done either by inviting a strategic part-ner or by raising capital through IPO on the London Stock Exchange, which we believe will be the most likely case. Earlier this year, the chairman of Alliance Bank’s board, Mr. Kereibayev, mentioned that the bank could float up to 25% of its shares.
We, therefore, are confident that Alliance Bank will meet the new regulation requirements on external debt.
Figure 3: Growth in bank capital
Sources: FSA, Standard Bank Group
Conclusion
Our analysis shows that the risk currently charged by the market on Alliance Bank bonds is too high when com-pared to the bonds of ATF Bank. Given the steep shape of Alliance Bank’s bond spread curve in the area of up to three years, we recommend switching from the ATF ’10 to the Alliance Bank ’10 Eurobond. We expect that the current spread of 113 bps between the two bonds will tighten by 50 bps in the next two months.
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