Dismayed by Turkey’s ever-decreasing margins, banks are looking to neighbouring countries for profits. But can the legal framework of countries such as Kazakhstan keep apace? Erika Morphy reports on the region’s new trade-finance destinations.

When Gregory Raskin, president and CEO of Winncom Technologies, set about arranging financing for a turnkey telecommunications project in Kazakhstan, which included $7m in telecom equipment export sales, he received proposals from six or so banks.

Eventually, Raskin settled upon a loan facility from Société Générale (SG), supported by a US Export-Import Bank (US Ex-Im) guarantee that totalled around $48m (see ‘Inside Arc Wireless’ Deal’). It was the most competitive offer out of the lot, he says. But besides his appreciation of SG’s and US Ex-Im’s terms, tenor and conditions, Raskin came away from the bidding impressed by the interest banks have for the region in general, and Kazakhstan in particular.

"There are a lot of trade-finance banks interested in Eastern Europe and the CIS region – that is very clear," he says; back from a recent trip to Kazakhstan.

No longer the top destination

Welcome to the rest of the Caspian region. Once dominated by Turkey, the area’s surrounding countries of Ukraine, Azerbaijan, Iran (depending on how you define the region) and to a lesser extent, Serbia and Armenia, have become just as – if not more –attractive to trade and project-finance banks. Kazakhstan, in particular, has become the destination of choice for many. By contrast, margins in Turkey have dropped considerably over the past year and a half, due in part to geopolitical woes such as the question of whether Turkey will be admitted to the European Union. That has caused banks to look at neighbouring countries with new eyes.

“Kazakhstan has come a long way in a short period of time,” says Edmondo de Picciotto, the joint general manager for Intesa Soditic Trade Finance Limited. “Certainly the international investment and banking communities have become very aware of its advantages.” These include a rapidly growing economy, and heavy borrowing by the banks, most notably in the oil and gas and construction sectors. The market has a healthy appetite for investment in the country, de Picciotto reports. And then there is the fact that the country has been investment grade for a while and many banks have been upgraded to close to investment grade.

Five years ago, de Picciotto speculates, a significant portion of these investors and financiers couldn’t locate Kazakhstan on a map. “Now they travel to the country, stay in luxury hotels and close multi-million dollar deals.”

Intesa counts itself among those beating a path to the country. Over the past six months, Kazakhstan has become the biggest market for Intesa, de Picciotto says.

But even as the banks line up to do business in the country, a few warning signs suggest they might want to curb their enthusiasm a bit. In short, some bankers and attorneys say Kazakhstan’s legal framework is not ready for primetime trade flows.

The regulations around promissory notes, for instance, can be subject to varying interpretations, according to Margrith Lutschg, president of FIMBank Malta. "It is one reason why there are so many syndicated loans," she says.

But then the rest of the region is even less regulated, which is one reason Lutschg believes Kazakhstan is so active right now. "It is the best environment in the region."

Who’s doing what

Indeed, syndicated loans do appear to comprise the bulk of trade-finance transactions in Kazakhstan. Banks, though, are stretching into other product lines in certain circumstances.

Intesa, for instance, has been doing a great number of supplier-credit transactions – providing financing for imports of machinery on letters of credit (LCs) on a medium-term basis, de Picciotto reports.

Other typical deals include standby LCs, direct loans to banks for their customers, syndicated loans and pre-export finance, with tenors that stretch from one to seven years, he says.

Attila Bogaru, CEO of Hungarian International Finance (HIF), also reports that his company is extremely active in Kazakhstan. "There is a good volume of trade-related facilities guaranteed by standby LCs from Kazakh banks to cover imports of their clients," he says. One recent transaction financed by HIF in Kazakhstan was a five-year supplier credit, which was an Italian export of a brick manufacturing plant.

Even Lutschg, who worries about the country’s less-than-transparent legal framework for some trade transactions, is participating in the market. Volume-wise, she says, Kazakhstan is a very active and interesting country.

Warning signs

Lutschg is not alone in her concerns, however.

One of the major difficulties in most of these new countries is the legal framework, states de Picciotto. “Some of the legislation in these countries can be very difficult to interpret, and people are having difficulty in that sense. You have to rely on the banks to tell you what is legal and what is not.”

Sometimes, he adds, this answer can vary from bank to bank.

For example, he says, “Some banks in Kazakhstan will tell you they cannot issue promissory notes, while others will tell you they can, but only if they are issued to exporters. Others will say they can issue them to whomever they like.”

Which interpretation does de Picciotto adhere to? “If I am comfortable with the interpretation then I will follow whatever the bank I am dealing with decides.”

Mindful of the risk, Lutschg is biding her time for when the legal framework does improve. Now, though, she is limiting FIMBank’s exposure to what she calls ordinary deals. "I would really like to see factoring products for sales on open account and other products introduced if and when regulations get better – I think the country could greatly benefit from these types of developments.”

Not all participants in the market, it must be said, feel the country’s trade regime is unduly opaque or risky. Arc Wireless, for instance, reports no concerns in this respect.

Also, other, related areas of Kazakhstan’s laws – such as its direct investment incentives regime – appear to be very straightforward, according to reports from companies investing in the area. Oriel Resources, a UK-based nickel and chrome producer, completed a feasibility study at the end of last year for $594m to develop the Shevchenko nickel field in Kazakhstan. It is now currently negotiating an agreement with authorities to have amended taxation legislation applied to the project.

“The Tax Act is very clearly written – it is not a ten volume piece of legislation,” says Nick Clarke, director of mining for Oriel Resources. According to Clarke, the tax and project-finance-related laws do not present an undue burden.

Margin by margin

For some banks and investors, though, the country’s margins are not warranted given the perceived risk that Kazakhstan’s legal regime presents.

Lutschg says the spreads have come down in Kazakhstan to such low levels that she thinks it’s getting to a point where it’s hardly worth it to be active in the region. “Also, the country doesn't have a long-standing performance history as, for example, Turkey does.”

She says its regulations and laws are sufficiently vague that the risk is relatively high when compared to the spreads offered.

Margins are decreasing now in the country, Intesa’s de Picciotto acknowledges, but Kazakhstan still offers some interesting yields. “For the top banks, yields are 2% over Libor for medium-term business – five years.”

But is this combination of legal risk and lowering margins enough to send bankers back to Turkey? For some, maybe. Certainly transactions still occur in the market. Turkey is the fourth-largest country in Italian export credit agency SACE’s portfolio – absorbing over 14% of the new commitments undertaken by the country in 2004. But other bankers are not content with what Turkey – now awash in liquidity – has to offer.

"Turkish risk has been very stable in the last year and margins have dropped considerably, so if anything this market is not as attractive as it used to be," Bogaru says. “Margins have dropped in some cases to 1% or lower, over the past year and a half,” he reports. "As a result, for HIF, turnover has reduced in Turkey."

Beyond Kazakhstan

Kazakhstan is not the only country attracting new levels of interests from banks and global corporates. Ukraine, for instance, has been an active market.

It too does not offer the legal security that many bankers would like, but as they have in Kazakhstan, many have learned to work around the risks.

"We became active in this market early last year, but not in the traditional trade finance sense,” Bogaru says. “Regulations make it difficult to negotiate supplier credits, so there are no promissory notes coming out of Ukraine as a result. So everything is structured as a loan or as an LC refinancing, which makes it somewhat difficult to do business." The margins though are much more reasonable than elsewhere in the region, he adds.

One promising sign of the country’s growing stability: some eight to ten Ukrainian banks have come onto the market and all of the deals have been oversubscribed.

Azerbaijan is another country he likes. "We have concluded a few medium-term transactions in Azerbaijan," Bogaru says, giving a US export of telecom equipment with a repayment period of two years as an example.

One noteworthy deal in Azerbaijan – one that did much to boost the country’s image in international capital and banking markets – was a €235m ($280.5m), Hermes-supported loan, plus a tied commercial loan that was arranged by BNP Paribas, Société Générale and BayernLB last year. The borrower was Azerenergy, which runs the Sumgait power plant, under the guarantee of the country’s ministry of finance.

Another interesting country in the region is Iran, says de Picciotto, which, of course, has its own problems. “But it is one of the few countries in the world where margins have been rising steadily,” he says. Less then two years ago, margins in Iran hovered around 1%. Now they have risen to between 8% and 10% over Libor for the main banks.

“There are very few investors left there,” de Picciotto goes on to note. Intesa has limited itself to sight and short-term LCs in the country, as have most banks. “We stopped working on bills of exchange in Iran some time ago,” he says.

Another country with great potential is Serbia. "It is very important to us,” Bogaru says. “The country has stabilised and many banks have been privatised. We have concluded quite a few transactions there lately." For instance, the bank financed the sale of agricultural machinery from Hungary to Serbia for a repayment period of three years.

To be sure, not all banks are as sanguine about Serbia’s prospects. Some banks view it is a market that needs to ripen for a few years to reach its potential. Others, such as HIF, say it is the strongest market in the region – even stronger than Kazakhstan, the country widely seen to have displaced Turkey as a trade-finance destination. Who knows? A few years from now, as liquidity continues to flow into Kazakhstan more banks might join HIF in its views, pushing Kazakhstan to join Turkey on the sidelines.

Inside ARC Wireless’s deal

ARC Wireless Solutions is a US distributor of telecom equipment and other technologies. It is headquartered in Wheat Ridge, Colorado, and its subsidiary, Winncom Technologies is located in Solon, Ohio.

For this transaction, the buyer, Kazakhtelecom, committed to the balance of the $55m tender to either pay directly to Winncom or through a loan from the lenders. Société Générale is lending the money to Kazkommertsbank on behalf of Kazakhtelecom. Part of the transaction includes a working capital advance to Winncom to accelerate the installaton of the fibre-optic cable – a $2.3m financing that Kazakhtelecom approved. As part of the approved work programme and prior to the closing of the financing, Winncom sold to Kazakhtelecom $6m of Lucent Technologies’ equipment and $1m of Cisco equipment. The first phase of the turnkey fibre-optic communications network should be completed by the end of the first quarter of 2006.

ECAs get busy in the Caspian region

Although it is not as active a destination as Russia or China, the Caspian region has drawn its share of support from export credit agencies (ECAs).

This past December 2005, the UK’s Export Credits Guarantee Department (ECGD), underwrote two UK-sourced contracts totalling $30m to help expand mobile phone networks in Kazakhstan (see Trade & Forfaiting Review, February 2006, page 17).

The two contracts were awarded to Motorola under a five-year framework agreement, previously announced in May 2005. They are for GSM cellular phone infrastructure equipment and associated software supplied from the UK company’s Swindon facility to KaR-Tel – Kazakhstan's second largest mobile phone operator.

ECGD guaranteed a $28m finance facility made available by Citigroup for the purchase of the equipment by KaR-Tel.

Also in December, Canada’s Export Development Canada (EDC) signed a $15m line of credit with the Export-Import Bank of Ukraine (Ukreximbank).

In Turkey, Euler Hermes recently signed a co-operation agreement with Koç Allianz, one of the major Turkish insurers, to cover the risk of outstanding payments for Turkish enterprises.

And earlier last year, the Italian ECA, SACE, underwrote an insurance cover for approximately €55m ($65.6m) in favour of Agusta, a player in the helicopter sector and part Italy’s Finmeccanica group. The deal was for the supply of five coastguard helicopters to the Turkish government. It is the third stage of a transaction that has already involved the supply of nine aircraft to Turkey.

Austria’s export credit agency, OeKB, recently made cover available again in Armenia, for transactions with repayment terms of up to 12 months and a transaction limit of up to €1m. The country category six is applied.

In Denmark, Eksport Kredit Fonden's (EKF) upgraded the country risk classification of a number of countries in Eastern Europe, the Baltics and one country of the CIS following the OECD country risk meeting in January 2006, which has resulted in lower premiums.

For four of the countries the upgrade follows in the wake of structural improvements after their ascension into the European Union, EKF said. This trend is expected to continue for the remaining new EU member states.

Armenia was upgraded from premium group seven to six; Cyprus was upgraded from premium group three to two; the former Yugoslav Republic of Macedonia was upgraded from premium group seven to six; Slovakia upgraded from premium group two to one; Slovenia from premium group two to one; and the Czech Republic from premium group two to one.