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Issuers: European Investment Bank;
Tennessee Valley Authority
Amounts: $1 billion; Dm1.5 billion
Launched: Tuesday September 10
Dual lead manager: Lehman Brothers
In early September the European Investment Bank (EIB) and the Tennessee Valley Authority (TVA) pulled off an unexpected coup in the capital markets: a back-to-back swap. Each borrower cut several basis points off its borrowing costs by simultaneously launching two 10-year global bonds and swapping the proceeds with one another.
On September 10, TVA raised Dm1.5 billion in its first foreign-currency borrowing. Meanwhile, in a completely unrumoured move, the EIB launched its debut global bond, raising $1 billion; more than 50% of the bonds were sold in the US. The EIB's first global was fresh evidence of the bank's new strategic approach under its new head of borrowing, the World Bank-trained René Karsenti. Each borrower tapped new investors and thus achieved fine pricing. They swapped the funds because the EIB has more need for Deutschmarks, and TVA for dollars.
It was an ideal solution to the challenge both borrowers faced to widen their international investor base, without paying up to do so. The back-to-back swap provided the saving that made the deals acceptable. Normally, each borrower would have to pay a bid-offer spread to one or more large swaps houses to convert its liabilities. This adds considerably to the cost.
"For large cross-currency swaps in 10 years, bid-offer spreads are quite wide," points out Jonathan Hakim, a managing director at Lehman Brothers which brought the two borrowers together and acted as joint bookrunner on both transactions.
But it is difficult to pin down how much the two triple-A rated borrowers saved by swapping directly with each other. Karsenti, director general of financing at the EIB, suggests that the transaction brought "substantial savings". But David Smith, chief financial officer of TVA, says the savings "were not huge", although he jokes that they did at least cover the cost of his entourage's trip to London.
The gestation period for the transaction was nine months. Lehman first suggested it over dinner to TVA officials visiting London in January, and broached the idea with the EIB during a trip to its Luxembourg headquarters in February. Both were interested. But big legal and documentation problems arose. Foremost of these was that TVA had never undertaken any kind of swap before and had to create all the required legal paperwork. The EIB needed an SEC shelf registration, so it could sell to US investors.
Each side also had to become comfortable with the other's credit before taking 10-year exposure to the counterparty's principal and coupon payments.
One particularly thorny problem led to the original launch date the third week of July being postponed.
TVA wanted its deal to emulate a World Bank global Deutschmark issue, with firm support from core Deutschmark investors, underwriters and traders. That meant that German domestic placement was important. Therefore it sought a listing on the Deutsche Börse in Frankfurt, and wanted the bonds to be eligible for clearing through the Kassenverein, the German settlement system. Settlement proved to be the problem.
No other US agency borrower had tried this before. The World Bank, a tax-exempt supranational, found it comparatively easy: it issued one global note in the Kassenverein and a second in the DTC, the American clearing system. TVA, however, could not use this simple procedure because the global note for the Kassenverein would have to be a bearer note, which TVA is prohibited from issuing.
In the spring, the Kassenverein had suggested this could be resolved easily. But, as its officials looked closely into the details, more and more difficulties cropped up.
Some progress had been made by early summer, but it was becoming clear that completing the deal would require much more time and effort from all sides. TVA and EIB officials had talked to Lehman, but had still to meet face to face. Karsenti and Smith chose Euromoney's widely-attended borrowers' conference in mid-June for their first meeting. Lehman was nervous that the two might be spotted together, so they met over a discreet lunch in the penthouse of London's Dorchester Hotel. Both men committed to the deal, no matter what resources it would require.
Eventually, after what Hakim describes as "enormous efforts", a solution to the Deutschmark clearing question was found. A single global note would be held by the DTC and a vehicle was created for the Kassenverein to participate without the implication that the note was a bearer note. The structure for this, which is outlined in the offering circular, will probably be copied by other US agencies for future issues. The bond can clear between DTC, Kassenverein, Euroclear and Cedel.
But, by the time this solution had been found, it was mid-summer and the window to issue was closed because of the long German summer holidays.
During August, Lehman built computer models for the two issuers so they could analyze details of the deal such as the swap and cashflows. On August 28 all parties committed to go ahead. Because so many teams of lawyers, clearing officials and bankers knew about the deal, keeping it under wraps was becoming increasingly difficult. So, on Friday August 30, TVA contacted Deutsche Morgan Grenfell and asked for its assistance to prepare for a Deutschmark transaction. It did not mention the EIB or the back-to-back, merely saying the bond would be associated with a hedging transaction it could not discuss.
Meanwhile, the US treasury market was suffering several days of sell-offs in the run-up to some nervously awaited US employment numbers, due on Friday September 6.
TVA arranged investor presentations in Germany, and the EIB did the same in Boston and New York, helped by its joint bookrunner CS First Boston. Getting investors to attend these meetings was difficult because the borrowers could not say openly that they were about to issue. However, the wording of the invitations gave a strong hint that deals were coming. But, since neither borrower could afford to go ahead if the markets collapsed, both readied to give routine investor presentations should the issues have to be cancelled. The new-issue details at the back of the pre-prepared pamphlets could be ripped out if necessary. The EIB, for example, could talk just about its new SEC shelf registration, put in place on September 4.
Fortunately the employment figures proved benign, coming in the mid-range of market expectations. By now the market was buzzing with rumours of the Deutschmark deal, so both borrowers separately announced the transaction that Friday afternoon, just after the figures.
The TVA deal was marketed in a range of 16bp to 18bp over German Bunds and eventually priced at 17bp over.
American institutional investors proved eager to diversify by buying bonds from a European name and so the EIB's dollar global was marketed at 17bp to 18bp over treasuries, some 7bp to 8bp tighter than where a federal agency might price a 10-year bond. The EIB had hoped to launch flat to the World Bank's latest deal at 16bp over treasuries but, when Karsenti flew back from New York and Smith from Tokyo on the Tuesday red-eye, the bookrunners advised Karsenti that this would be too tight and to launch at 17bp over instead. Says Hakim: "The World Bank has been doing globals for seven years and this was the EIB's first. So it was an achievement to get this close to what was also an historically tight spread for the World Bank."
Karsenti says he expects that "American investors will continue to diversify by name and by currency, and this deal may encourage that". His longer-term objectives include attracting US institutions to support EIB deals denominated in euros.
Adds the ever-witty Smith: "While René's pleased he had great distribution in the US, we are equally pleased we did not." So was it worth it? "I think there's a good reason why these transactions only happen once every 23 years," laughs Smith.
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