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THE BOND BOOM IN THE FORMER SOVIET BLOC

Across the region, nations are issuing debt like mad--and the market is still growing

Just four years ago, debt financing in central and eastern Europe was a rarity. Sovereign debt largely consisted of Brady bonds, the rescheduled borrowings of communist-era mismanagement. Corporate bonds didn't exist. When Bank of America executive and Czech emigre Gabriel Eichler returned to Prague in 1993 to advise utility giant CEZ, he had to teach local bankers how to build a capital markets team and bid on bond deals before they could handle CEZ's first issue, $62.3 million in corporate debt.

But bankers and their clients learned fast. Across the former Soviet bloc, countries, cities, utilities, banks, and other corporations are issuing debt like mad. Over the past 18 months alone, Russian and eastern European borrowers have issued $3.32 billion in new debt, says IFR Securities Data: London. Total debt from the region, including private placements, may reach $15 billion to $20 billion by yearend, compared with $5 billion in 1996, according to Credit Suisse First Boston (Europe).

''THE FUTURE.'' Although the flood of issues emanating from eastern Europe is still a small portion of the red-hot developing-country debt market, financial pros believe the trend will continue as the region's appetite for capital expands. ''We see credit as the future there,'' says Simon Treacher, director of emerging markets fixed income at Morgan Grenfell Asset Management Ltd. in London. In the last two years, Treacher, who manages $300 million in offshore and U.S.-based emerging market debt funds and an additional $800 million in private accounts, has doubled his exposure to eastern Europe to 40% of his portfolio.

Treacher and other investors are enthusiastic over the region for some simple reasons. They argue that eastern Europe and Russia boast outstanding value and some of the best yields worldwide. Claude Chaubet-Bride, associate director of business development in Eastern Europe for Standard & Poor's Corp., notes that investors can earn much greater yields for the same level of risk found in other emerging markets.

Take, for example, a $250 million, three-year Eurobond issued in July by Russian bank SBS-Agro. Rated B+ by S&P, it yields 420 basis points more than U.S. Treasuries. That is at least 200 basis points over comparably rated Eurobonds issued by the Brazilian banks Itau and Bradesco. ''If you think the rating agencies are right, buying these bonds is a no-brainer,'' says David Mars, chief economist for emerging markets at SBC Warburg in London.

To be sure, there is still credit risk. Many of the 49 ratings given by S&P to Eastern European sovereign, municipal, financial and corporate offerings are in the speculative grade category. But bond bulls maintain that at current prices, investors are more than compensated for the risks they're taking. They seem especially confident about Russia, which is swiftly becoming such an enticing draw that Merrill Lynch & Co. estimates it has accounted for 7% of total emerging market debt issued this year alone.

The Russian debt boom got off the ground with a $1 billion government Eurobond issue in November, 1996. The cities of Moscow and St. Petersburg have also issued Eurobonds, and a number of others are following suit.

TRACK RECORD. All told, Russian issues have hit nearly $6 billion since last November. The Russian government estimates that it will sell an additional $3.4 billion in Eurobonds by 1998, and there may be $1 billion more in regional Eurobond sales, plus $3 billion in bonds convertible into shares in newly privatized companies. One example: a $500 million convertible bond issue planned for this fall by the giant electric utility Unified Energy System. ''For Russia, this is the year of fixed income,'' declares an executive at J.P. Morgan & Co., which is opening a trading office in Moscow to cash in on the boom.

Spreads between the yield on Russian debt and those of Western government issues are narrowing as the country's economic and political situation stabilizes and Moscow establishes a debt repayment track record. As a result, investors are gaining ''confidence in buying new issues out of the region,'' says London-based Wolfgang Kerck, head of capital markets for CS First Boston (Europe).

Indeed, other regional issuers are also seeing their borrowing costs fall as investors head east. Romania sold a five-year, 600 million German mark ($335 million) bond in June yielding 7.75%, 300 basis points over comparable German government debt. It is now yielding 7.39%, only 260 basis points over German bonds.

As they grow more comfortable with the area, investors are ranging further afield into more speculative credits. Simon Romijn, Boston-based head of high-yield fixed-income management for Baring Asset Management, oversees $650 million in emerging market money. Romijn considers Poland, Hungary, and the Czech Republic too tame because they are investment grade borrowers. Instead, his fund has 18% of its assets in higher yielding Russian sovereign debt, in addition to some Bulgarian Brady bonds. Currently, he is looking at Ukrainian government bonds issued to repay debt owed to the Russian oil company Gazprom.

Another frontier for yield-hunting investors is debt issued in local currencies. In Russia, for example, ruble yields on short-term government bonds reach 20% to 30%, while riskier corporate paper can yield as much as 100%. Such yields are so enticing that Morgan Grenfell hopes to raise $100 million for two local currency funds, one U.S.-based and one offshore.

For many companies and local governments, Eurobonds don't make sense. Often, the cost of getting an international credit rating, hiring lawyers and investment bankers, and putting on a road show is prohibitive for their relatively small borrowing needs. Many balk at the transparency of Western-style accounting or refuse to open their books to international ratings agencies.

Despite these drawbacks, Robert Devane, head of fixed-income sales and trading at Moscow brokerage Troika Dialog, still expects ''dozens of municipal and corporate domestic bond issues'' this year and next.

Many larger companies, however, are turning to the Euromarket. In recent months, a flurry of companies and banks already have earned ratings from credit agencies. Of the nine corporate Eurobond ratings given by S&P to former Soviet bloc companies--seven of which were this year alone--four are investment grade. S&P also has rated 21 banks this year, giving five of them investment grade status. And a slew of new deals is on the way, including issues by the Czech Republic's SPT Telecom, and Russian electric utility company Mosenergo. Morgan Grenfell's Treacher sees enough of a new supply that the firm is considering offering two funds focusing on corporate fixed income in emerging Europe. ''All our analysts are booked to the end of the year,'' says S&P's Chaubet-Bride. ''We expect debt issuance to remain extremely high.''

As the flow of money into eastern European debt instruments swells, the region is taking on a healthier glow. Kerck at CS First Boston was delighted at the enthusiastic response a recent 2 billion German mark ($1.1 billion)

Russian bond deal received. Typically prudent Swiss retail investors snapped up 40% of the issue. ''If the Swiss are comfortable with Russian bonds,'' says Kerck, ''the market is here to stay.'' The region's continued economic rebirth will depend a lot on that holding true.

By Karen Lowry Miller in Frankfurt, with Carol Matlack in Moscow



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Updated Sept. 4, 1997 by bwwebmaster
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