Fixed Income. TCS Group - Tinkoff Bank to Test Dollar Eurobond Market with AT1 Perps

Following a long break from the dollar debt market, on Wednesday Tinkoff Bank announced that it has mandated banks for a new dollar-denominated AT1 perpetual bond offering. The bond will be in the Reg S/144A formats, and the bank is targeting a benchmark-sized issue. We understand that the deal might be priced early next week. Given Tinkoff Bank's solid financial performance and the dearth of primary debt issuance from Russian corporates since start of the year, we believe the deal should find healthy demand. We expect the bonds to be priced in the 6.50% area in the current market. Should they be priced below the 6% mark, we would consider this to be tight compared with other tradable Russian banking instruments.> The bank last tapped the international debt market in 2017, when it placed $300 mln in AT1 perps, which remain in circulation. The bank is coming to the market to raise capital to fund its balance sheet growth. The deal will also provide it with an opportunity to reduce its blended cost of capital in this benign market environment. The timing of the deal looks reasonable to us, as the first call option on the bank's outstanding AT1 perps is approaching (scheduled for September 2022), with the coupon reset spread set at 759.2 bps, which is above what we see as fair for the instrument in the current market. > Tinkoff Bank has demonstrated a resilient performance over the past two years amid the Covid-related challenges facing all Russian borrowers (see our comment on TCS Group's 2Q21 IFRS results in the August 27 Debt Markets Today). The start of 2021 turned out to be stronger than initially anticipated by market participants, with 1H21 cost of risk coming in at a fairly low 4.5% and solid internal capital generation (43.5% ROAE) despite changes in the balance sheet structure in favor of lower risk loans. A growing share of non-credit revenues (44% in 2Q21) was positive for the resilience of the business model. That said, the business is still growing quite fast and requires capital. The risks associated with international expansion are also something to follow down the road (the group plans to launch a digital bank in the Philippines and is eyeing other markets), but this is likely to be gradual development and should not require much investment at this stage. The bank has suspended dividend distributions until the end of the year, although it has yet to make a decision on next year's disbursements.> As of August 1, the bank's local standalone CET1 (N1.1) ratio was 9.7% (10.5% adjusted for unaudited net income), its T1 (N1.2) was 11.7% and its TCAR (N1.0) was 12.5%. The management aims to keep the CET1 ratio 200 bps above the local regulatory requirement, which currently stands at 7.0% for the bank, including applicable capital buffers. Should the bank be awarded D-SIB status (it is not currently on the list of Russia's systemically important banks), it will be subject to an additional 1% capital requirement, which would be a positive development for the bank's debtholders. Should Tinkoff place $500 mln in the new AT1 perps, we estimate this would push its local standalone T1 ratio 270 bps higher. We believe it would make sense for the bank to place one more AT1 instrument next year to support its capital position and replace the outstanding $300 mln AT1 perps.> The bank's local regulatory capital ratios incorporate elevated RWs for unsecured lenders in Russia, with the RWA density for Tinkoff's total assets currently standing at 116% and the density for retail loans at 133%, above the levels seen at other banks with a corporate/retail business mix. Now that the CBR has released part of the accumulated capital buffers on retail loans as part of its countercyclical measures to soften the impact of the pandemic, the tightening on new unsecured loans with higher PTIs scheduled to take effect in October will have a moderately negative impact on the bank's capital ratio, to the tune of 50 bps over 12-18 months, according to the management. > At present, the bank's regulatory capital structure does not contain any T2 subordinated capital, which does not look optimal from a cost of capital perspective, other things being equal. Given the prevailing benign market conditions, it appears that the management has opted to raise AT1 capital over T2 capital this time. Going forward, we think the bank might also issue a T2 instrument. As far as senior funding is concerned, the bank benefits from low-cost deposit funding locally, so we do not expect it to be seeking to place senior hard-currency senior debt any time soon. In any case, we expect limited primary debt issuance from Tinkoff Bank.> The structure of the new bonds is standard for Basel 3-compliant perpetual instruments eligible for inclusion into a bank's AT1 capital in the Russian market. The bond documentation contains loss-absorption language with a mechanical write-down trigger linked to the bank's local standalone CET1 (N1.1.) ratio (the threshold is 5.125%). We estimate that the bank currently has a R51 bln ($0.7 bln) capital cushion over the trigger threshold. The coupon on the bonds is fully discretionary and the interest on the bonds is not cumulative upon cancellation, which is also in line with other AT1 perps issued in the Russian market. The bonds are callable 5.25 years from the placement date and every five years thereafter. > Given that the bank's financials have been resilient recently, we expect the deal to find decent demand from investors. However, there is likely to be an element of price discovery given the borrower's lengthy absence from the bond markets and the low liquidity of its tradable bonds. We consider the similarly structured instruments of Alfa Bank and Sovcombank to be the closest comparisons for the upcoming transaction on the Russian market. Although Sovcombank is rated one notch above Tinkoff Bank, we do not expect Tinkoff's bonds to trade at a yield premium over the former. Moreover, it seems that Sovcombank's AT1 perps (callable in May 2025) are suffering from weak momentum. Meanwhile, Tinkoff's outstanding bonds have recently been trading with virtually no premium over Alfa Bank's perps at the short end of the curve (Alfa Bank's bonds are callable in February 2022 and April 2023), and we consider them to be somewhat expensive given the two banks' different risk profiles. That said, Russian risk appears to be finding healthy demand at present based on the corporate deals currently on the market, which will likely affect the pricing of Tinkoff Bank's bonds. We would expect the new bonds to be priced around the 6.50% area; should they be priced below the 6% mark, we would consider this to be a tight valuation for the bond.