Fixed Income Analysis /

Sovcombank: AT1 issue on the way

    Tolu Alamutu
    Tolu Alamutu

    Credit Research Analyst, Banks

    Tellimer Research
    30 January 2020
    Published byTellimer Research

    A rapid riser

    Sovcombank (SOVCOM) plans to issue an Additional Tier 1 security. The initial price talk (IPT) is 8.25% area for a Reg S/144A US$300mn PerpNC5.25 security. This equates to 5Y US$ MS+ 675-700bps (approx. only). The AT1 is expected to be rated mid single-B at Fitch. This new bond comes just a few months after Sovcombank placed a US$300mn Tier 2 security – its debut eurobond issue. The SOVCOM 8% Tier 2 is quoted at 107.4 and yields c6.3% to the April 2025 call date. The IPT for the new AT1 implies a spread multiple of 1.37x to 1.42x versus the SOVCOM Tier 2 bond (approx. only). As a table later in this report shows, this is not too far off indicative spread multiples at Alfa Bank.

    Sovcombank is the third largest privately-owned bank in Russia. At end-September 2019, the bank had total assets of RUB1tn and served 6 million clients. Pre-tax profit generation is almost evenly split across retail, corporate and treasury businesses. The bank sees its installment platform and public procurement platforms as key competitive advantages. SovCo Capital Partners, a vehicle backed by management (49%) and financial investors (51%), owns 87% of the bank. Other shareholders include Qatar’s QIA, Saudi Arabia’s Public Investment Fund and Russia’s RDIF. Sovcombank aims to maintain a CET1/N1.1 ratio of at least 9.0% and a CAR/N1.0 ratio of at least 12%. The lender aims to pay 25-50% of net income out as dividends, if these capital ratios are above the stated levels. The lender is not currently classed as a domestic systemically important bank in Russia. 

    There may be questions about the bank’s treasury portfolio, which was a key driver of performance in the past. The share of the bond portfolio has declined from 52% at end-2017 to 36% at end-September 2019, and the bank is seeking to grow its corporate and secured retail portfolios. If Sovcombank succeeds in doing this, it will mean that income from the Treasury business becomes less important.

    In October 2019, shortly after the debut Tier 2 issue, one of the bank’s founders suggested that an IPO may be considered early this year. The bank could look to raise US$300mn-500mn in the equity market. If this IPO is completed, it could be a positive for SOVCOM bonds.

    RUB1tn balance sheet, decent asset quality and capital metrics, solid profitability

    9M 19 net income of cRUB22bn was about 40% higher than in the previous year, generating an annualised ROE of 23%. Net interest income and net fee and commission income both increased, and Sovcombank reversed a 9M 18 trading loss, to report a positive trading result. Total operating revenue was 24% higher than in the previous year. Operating costs increased to RUB30bn, 15% higher than in the previous year, as both personnel and other operating expenses increased. However, solid revenue growth meant that the efficiency ratio improved to 47.8% from 51.6%. Provisions fell yoy, even though non-performing loans increased. This contributed to the improved bottom line. Sovcombank’s NPL ratio was 2.4% on our calculations, and coverage was over 1.6x. The bank’s Basel III Tier 1 and total capital ratios were both 15.5%. 

    Table 1 below shows key figures for Sovcombank, and for Credit Bank of Moscow (CRBKMO), Tinkoff Bank (AKBHC) and Home Credit & Finance Bank (HCFBRU). CRBKMO, AKBHC and HCFBRU all have USD-denominated perpetual securities outstanding.

    Table 1: 9M 2019 – key figures

    Net interest income42,522 32,12963,58729,578
    Total other income21,242 3,00823,6386,029
    Revenues63,764 35,13787,22535,607
    Total operating expenses30,450 17,71335,45516,725
    Pre-provision profit33,314 17,42451,77018,882
    Loan loss provisions5,913 2,97819,6032,099
    Pre-tax income27,401 14,44632,16716,783
    Tax expense/credit5,467 2,5647,0453,387
    Net income21,934 11,88225,12213,396
    Minority Interest252 030
    Net profit post-minorities21,682 11,88225,11913,396
    Total assets1,002,950 2,184,199507,631332,214
    Total loans (net)513,914 735,468319,884255,434
    Customer deposits718,044 1,269,029346,665222,533
    Total equity133,268 199,07183,39071,776
    Loan loss reserves20,933 37,14449,07415,329
    Non-performing loans12,826 28,49529,17713,124
    Return on equity23.4% 8.1%53.3%26.5%
    Return on assets2.9% 0.7%7.6%5.4%
    Cost/income ratio47.8% 50.4%40.6%47.0%
    Provisions/gross loans1.6% 0.5%8.7%1.1%
    Loans/deposits71.6% 58.0%92.3%114.8%
    Loans/assets51.2% 33.7%63.0%76.9%
    Deposits/liabilities82.6% 63.9%81.7%85.4%
    Equity/assets ratio13.3% 9.1%16.4%21.6%
    N1.1 ratio9.1% 8.4%8.4%n/a
    Tier 1 ratio15.5% 13.3%20.1%23.4%
    Total capital ratio15.5% 20.2%20.1%23.4%
    Reserves/gross loans3.9% 4.8%13.3%5.7%
    Pre-provision profit/loans8.8% 3.1%22.9%9.5%
    NPL ratio2.4% 3.7%7.9%4.8%
    Reserves/NPLs163.2% 130.4%168.2%116.8%
    Source: Tellimer Research, based on company statements

    AT1 will have writedown language and payments will be fully discretionary

    As is commonplace with perpetual securities, interest payments are fully discretionary and non-cumulative. If interest payments are cancelled or not paid in full, the borrower will recommend that the supervisory board not proceed with any dividend distributions or share repurchases (or similar transactions). However, the supervisory board will not be bound by this recommendation. Further, like other Russian bank AT1s, the SOVCOM perp will absorb losses if the CET1/N1.1 ratio falls below 5.125% for at least six days within a 30-operational day period. The AT1 will also be written down if the Central Bank of Russia (CBR) approves bankruptcy prevention measures which ‘contemplate the provision of financial assistance by the CBR or the Deposit Insurance Agency’. 

    Sovcombank is issuing the new bond to boost capital above the D-SIB requirement and to develop a public market track record. The issuer estimates that a US$300mn security would add c1.9ppt to its total capital ratio (under RAS), which was 14% at the start of December 2019. The issuer also estimates that at that time, there was a RUB50bn buffer over the 5.125% CET1 ratio trigger.

    Ratings upgraded by all three major agencies in 2019

    Sovcombank is rated Ba2 at Moody’s, BB at S&P and BB+ at Fitch. This makes the bank one of the highest-rated private lenders in Russia. All three ratings carry stable outlooks, and Sovcombank was upgraded by Moody’s, S&P and Fitch during the course of 2019. 

    Relative value considerations: Other perps, ratings, spread differences and spread multiples

    USD-denominated Russian bank perpetual securities in our sample set total almost US$5.5bn. These securities range in size from VTB’s US$2.25bn bond to the US$200mn security issued by Home Credit & Finance Bank in 2019. The tables that follow show (a) valuations of single-B rated instruments in the Bloomberg Barclays USD EM index (b) Perp versus Tier 2 spread differences and multiples for select bank issuers, and (c) key information for Russian banks’ perpetual securities.

    Table 2: Bloomberg Barclays EM USD index – Single-B issuers 
    RatingDurationMid YTWOAS
    High single-B5.594.89%328bps
    Mid single-B5.016.46%487bps
    Low single-B4.527.43%590bps
    Source: Bloomberg

    Table 3: Spread differences and multiples

    Perp and Tier 2 pairSpread difference (bps)Spread multiple (x)
    ALFARU 6.95% Perp vs. ALFARU 5.95% T21591.42
    CRBKMO 8.875% Perp vs. CRBKMO 7.5% T22901.51
    VTB 9.5% Perp vs. VTB 6.95% T21331.65
    Source: Bloomberg. Based on indicative mid z-spreads used. No adjustment for any duration differences.

    Table 4: Russian banks – perpetual securities

    Bond nameCurrencyAmountYTCYTPMid z-spreadMid price
    AKBHC 9.25% PerpUSD3006.528.50509106.51
    ALFARU 8% PerpUSD7005.607.52413104.52
    ALFARU 6.95% PerpUSD5006.756.12535100.56
    CRBKMO 8.875% PerpUSD54010.038.6986197.24
    GPBRU 9.835% PerpUSD1000n.m.8.59n.m.102.72
    HCFBRU 8.8% PerpUSD2008.058.52665103.09
    VTB 9.5% PerpUSD22504.788.57336112.40
    Source: Bloomberg. Indicative levels only.