Duferco’s Donbass dowry

by Simon Pirani

Don’t miss the wedding. The blushing bride, the Industrial Union of Donbass, brings a dowry of guaranteed steel and products supplies to her suitor, the Swiss trader Duferco. And IUD’s 16.5% stake in Duferco International Trading will rise to 50% by 2006.

The banks’ and export credit agencies’ present to the happy couple is unprecedentedly lavish: a remarkable seven-year project finance package being put together for Alchevsk steel works’ upgrade. The Ukrainian market has never seen anything like it.

The Alchevsk expansion will give the works the capacity to produce 5 million tonnes of slabs a year and cost around euro150 million. Two slab casters and ladle furnaces will be supplied on a turnkey basis by Voest Alpine Industriealagenbrau (VAI) of Austria, the first scheduled for operation in August next year and the second six months later. Imported content will be 55-60% of the total.

The first caster will cost about euro70 million, and two types of financing are now being put in place: an offshore loan to finance purchases from VAI and others from a group of western banks, expected to be headed by ABN Amro, with guarantees from the Austrian ECA, OeKB, and its Polish counterpart, the Export Credit Insurance Corporation; and an onshore loan to finance Ukrainian content. The borrowers want at least some of the money as project finance with a two-year construction period and five-year pay-back.

The ECA-backed portion “will attract a great deal of interest”, a banker following the negotiations said. It was initially hoped to close the deal in March, but the structure is not yet finalised. And Johann Jonach, deputy chairman of Raiffeisen Bank Ukraine, which has been in talks with the borrowers on the onshore portion, said he expected that loan to total between 8 and 18 million euros.

The Duferco-IUD relationship, and the project financing, show how fast the Ukrainian steel producers are moving towards integration into international markets.

Tom Patrick, head of trade finance at Duferco, told MB: “Our decision to accept a Ukrainian group as a stockholder is indicative of the trend. In a sense we are a service provider for IUD. We can establish a global market presence for them in long products and billets.”

The Alchevsk deal is also trend-setting. European ECAs’ readiness to guarantee deals across the CIS has certainly helped to make it possible. Even so, until last year, structured finance deals above $10 million and for terms beyond twelve months were few and far between, and seven-year project finance remains a rarity even in the much riper Russian market. But high steel prices and strong macroeconomics now make Ukrainian producers incredibly attractive to the banks.

Take the $13 million, 42-month loan made in March by Raiffeisen Bank Ukraine to Zaporozhstal, collateralised on export proceeds and earmarked for equipment purchases from Canada. Jonach at Raiffeisen said: “It’s at a competitive rate, it’s exclusively Ukrainian risk, and it’s liberally structured. The main security is a contract between Zaporozhstal and its sister trading company.”

While bankers working with Ukrainian producers – including ABN, Raiffeisen, ING, Fortis, Hypovereinsbank, Fortis, West LB and BNP Paribas – generally prefer deals with a named, established western off-taker, the producers don’t want to play that game. And right now it’s a borrowers’ market. The producers’ enthusiasm for establishing lending relationships directly with banks is a challenge to traders who have provided finance to Ukrainian steel mills as part of relationship-building.

Christopher Bachofen, manager (structured trade finance, CIS) at Stemcor, told MB: “From the trader’s point of view there are two problems. First, liquidity is going to get tighter. The banks will look at new entrants carefully and it’s already very competitive. On the other hand, mills in Ukraine and the CIS generally are requesting longer and more flexible financing to cover working capital requirements. So we are seeing progressive changes to the traditional trade finance structures.

“Traditionally, traders enter the relevant market and provide finance to mills at their own risk. The banks will provide finance to the trader, initially with full recourse to the trader. Then after the banks have seen a succesful performance over a period of time, they may be willing to follow the trader into the market. The bank’s ultimate goal is to lend to producers directly and the mills obviously always want to cut their cost of borrowing.

“Once direct lending relationships are set up between western banks and producers, the trader may find that its position at the mill is not as strong as before. So banks and traders are competing with each other as providers of liquidity to producers.”

So the international traders’ role changes. The Ukrainian producers’ partner trading companies, usually in Switzerland, still need intermediaries with global reach to market their products. But margins come down and the producers retain bargaining power.

Where to from here? If seven-year project finance is possible, anything is possible. That was certainly the principle on which CSFB operated last year before scaling down its Ukrainian corporate lending activities. Before it did so, it left two notable benchmarks for others to aim at:

 The five-year financing of a sales contract by Poltava Mining, which exports iron ore pellets to Austria, Slovakia, Romania, Poland and Italy. Offtakers are understood to have included US Steel, VAI and Istpat, and the total amount of the financing to have been around $100 million;

 On the capital markets side, a three-year $100 million loan participation note (LPN) in the London market, rated B- by Standard & Poors, to finance a loan to Privat Bank, part of which is likely to be on-lent to metals companies within the Privat Bank group. These are held through a largely untransparent holding company, Privat Intertrading. 

A version of this article appeared in Metal Bulletin, 17 May 2004. Posted June 2004; © 2004 Simon Pirani