Issuer: Fannie Mae
Amount: ¥100 billion
Maturity: 3 years 6 months
Coupon: 2%
Launched: May 14
Lead managers: Nomura, Merrill Lynch
Quite a few mouths stood agape when Federal National Mortgage Association, better known as Fannie Mae, re-opened the international Euroyen market in mid-May. Not least because international investors bought a bond that offered only a 2% coupon - the lowest ever for a global issue.
The deal was driven by technical conditions which not everyone was in a position to spot - they combined a mixture of swap arbitrage, a subtle shift in sentiment among international investors towards yen, the need for existing investors to switch out of Japanese government bonds (JGBs), and the desirability of creating a new benchmark, the last having been issued by the World Bank in November 1994.
Nomura had the idea, which partly stemmed from a long position in short-dated JGBs that it built up in February, for reasons explained below. Nomura estimates that it controls 25-30% of secondary market trading in Euroyen, and talks daily to a broad range of investors. Feedback from its salesforce at the beginning of April suggested that European investors, particularly UK-based index-funds, had started re-weighting their portfolios. They were largely underweight in yen, and were seeking to establish a neutral position. They wanted a bond which was liquid, possessed a current coupon - which means that it trades close to par and therefore reflects current market yields - and carried no credit risk. Their attitude, however, was defensive, and they were buying only short maturies. (The week prior to the issue, ¥25 billion was invested at the short end of the curve.)
Nomura began narrowing the range of issuers it could approach. It settled on a shortlist of four which included Fannie Mae and the World Bank. However, because of its new single currency lending programme, the World Bank's yen borrowings have fallen drastically, and Nomura knew the swap into dollars would not meet its target. Fannie Mae, on the other hand, was keen to promote its name and expand its investor base. The bond promised to be a high profile benchmark for the whole sector, and a debut global in yen. From the lead manager's perspective it was also an issuer which carried a solid triple-A, and the status of a surrogate government bond, backed by a US government guarantee.
This was vital, because it was expected that more than half the demand for the bond would arise from switching. Indeed, one of the key technical factors creating this issue's momentum was that it was a clever alternative to coupon-washing. This is the process in which so-called non-designated financial institutions sell their JGBs just prior to coupon dates to designated financial institutions (DFIs) - ie any Japanese institution, selected central banks, or a supranational of which Japan is a shareholder. This is to avoid paying withholding tax on the proceeds. DFIs do not pay withholding tax, and recycle the bonds back to the seller.
That is why the bond was structured like a JGB. It was priced off the JGB 125 and matures, just as it does, on December 20 1999, and likewise pays coupons on June 20 and December 20. The salesforce was able to say, why not switch straight into this surrogate government bond, which as a Euro has no withholding tax, and gives a 7 basis point (bp) pick-up over JGBs? Indeed, the deal was launched in mid-May to take advantage of the coupon-washing anticipated in June.
Aside from those switchers, it was hoped that holders of other illiquid Euroyen might decide to take profits. Virtually every other benchmark Euroyen bond was trading at a premium - in many cases because they were issued at a time of higher interest rates. For example the European Investment Bank bond that matures in 1999 pays a coupon of 5.875% and was trading the week before the Fannie launch at 112.
Nomura faxed Fannie Mae on April 26, explaining: "The driving force in this transaction, which differentiates it from all other yen issues in the past 16 months, will be institutional investors and central banks in Europe and Asia, rather than solely Japanese investors."
At the same time, almost to the day, Nomura lost the mandate to lead a Fannie Mae dollar deal, and had to settle for a position as a senior co-lead. But, this was a first step. Nomura had not been involved in a Fannie Mae transaction since the 1980s.
Fannie Mae wanted to gather other opinions on the likelihood of the deal working. It confidentially approached three of its closest relationship banks. Only one saw no demand, and of the other two Merrill Lynch mobilised its enthusiasm the quickest, and was brought in as a joint-lead and joint bookrunner - the latter denoting shared league table credit.
Nomura made it clear that the deal had to be big, if it was going to work at all - otherwise the switch demand would not kick-in. An issue size below ¥100 billion (nearly $1 billion) would not be liquid enough. To ensure liquidity the lead managers also committed to a 10 sen bid/offer trading spread for the first six months after launch (sen is the yen equivalent of cents). This is the tightest spread currently in the secondary Euroyen market.
The swap itself provided the arbitrage that made the issue acceptable to Fannie Mae's borrowing targets. The arbitrage centred on an anomaly in the five-year yen futures contract.
The new five-year futures contract was created in February, and the first rollover was due on June 1. A basket of bonds with maturities between 3.5 years and 6 years are deliverable into the contract, and initally the 'cheapest' to buy were the shorter-dated bonds, of which there was heavy buying. But this surge in demand in an area of the curve where the float was only $4 billion, in turn made them expensive relative to other JGBs. The normal swap spread from fixed into floating yen was 25-30bp, but it moved out at the 3.5 year maturity to 45bp, giving an extra 15bp of arbitrage. The Fannie Mae bond had a maturity of 3.5 years to take advantage of this.
Nomura had a natural swap position because it bought a large number of shorter dated JGBs in February in anticipation of the new futures contract's impact on the underlying. Both leads locked in the swap at 8am on Tuesday May 14, launched at 9.30am and decided to price the issue the next morning.
On the Wednesday morning (London time) there was some drama as the Japanese ministry of finance held its weekly press conference, just after Tokyo closed. A MOF official indicated interest rates would not rise in the near future, and so the market rallied - or rather the 10-year futures contract, which trades outside Tokyo time, did. The fear during pricing was that the coupon might be forced below 2%, a psychological level for international investors. A rallying market was pushing down yields.
Meanwhile a morning conference call was to take place prior to pricing. David Shasha, who jointly covers Fannie Mae for Nomura with Armando Vallini, chaired the call which comprised: two from Merrill's London syndicate, four from Nomura's London syndicate, one from Merrill swaps and one from Nomura swaps in London, one from Merrill's Tokyo syndicate (where it runs its Euroyen book), a Merrill coverage officer for Fannie Mae in New York, plus one swap dealer each from Merrill and Nomura in New York. From Fannie Mae there were Mehmood Nathani, David Levine and Don Simpson all of whom were taking the calls from their beds since it was 3am Washington-time.
Fortunately, the market stabilized, and the issue was priced with a 2% coupon.
The spread tightened by 6bp in two weeks, and less than 10% of the issue was placed in Japan. Linda Knight, Fannie Mae's treasurer, told the lead managers at the Euromoney borrowers conference, a month later, that she was delighted. It was the first time she had not received a single phone call badmouthing a deal. A rare beast. |