Promsvyazbank continues to live on the edge with regard to its regulatory capital position, often raising capital at the very last moment. As of July 1, 2012, its key N1 capital ratio stood at 10.5% (versus the regulatory minimum of 10.0%), down from 11.0% at the beginning of the year and providing almost no buffer against potential earnings volatility without risking a potential breach. It also constrains the bank's asset growth, as internal capital generation remains mediocre (ROAE in the mid-teens, while the strongest banks in the sector generate 20-25%).

While Vedomosti suggested that it would be a rights issue, with Promsvyaz Capital (ultimately controlled by the Ananiev brothers) and EBRD injecting cash, there is a certain likelihood that some new shareholders could come on board. There is also a chance that this new share placement could be an integral part of the bank's preparation for its IPO, which is expected to take place in the not so distant future (based on earlier announced plans, it could involve some combination of offering existing and new shares).

While this capital injection would allay immediate pressure on the bank's borderline N1 ratio and rescue it from the "danger zone" (we estimate that it would increase the bank's N1 to about 12% post the capital injection/subordinated bond placement, all else being equal), it would fail to address the significant concentration of risk in its loan book (the 10 largest exposures accounted for 130% of the bank's IFRS equity as of end 2011), as well as the potentially high level of restructured loans, which makes the loan book somewhat resemble a "black box".

We believe Promsvyazbank's potentially weak asset quality (in absence of other strong mitigating factors) will continue to dominate the way its bonds trade, i.e. as a high-yielding paper with a significant, priced-in probability of default.

The Promsvyazbank 17 currently commands about a 270 bps spread (based on mid-Z-spread) over the Alfa Bank 17 (the latter could be called the "best in class" privately owned Russian bank). While we think the fair spread should be closer to 200 bps, Promsvyazbank's near-term upside potential appears quite limited.

Promsvyazbank's 2018 subordinated bond (callable in 2013) could be called by the bank next year given its miniscule size ($100 mln) and steep coupon reset formula (UST 5+1,125 bps), particularly if the bank succeeds in implementing its current capital raising plans. However, since this bond is currently trading well above par, there is almost no way for investors to capitalize on this likely event.

Alexander Kudrin