| Nazareth Festekjian | ||||||
To a great extent, the success of the Ecuador exchange offer was a self-fulfilling prophecy.
As news of a forthcoming offer started circulating, Ecuadorean bonds began to rise in value. When the offer was released on July 27 2000, they skyrocketed, pricing in a successful exchange. Bondholders, nearly all of whom mark to market, were given the most obvious evidence possible that the new bonds were worth substantially more than the old ones: the benchmark PDI bond rose 53% from July 17 to July 28, and 31% on the day of the offer alone.
None of that would have happened had details of the offer been known in advance: the whole thing required that the market be surprised by the generosity of the terms. “To the credit of the Ecuadoreans, it did not leak,” says Nazareth Festekjian, a managing director at Salomon Smith Barney responsible for structuring the deal. “That helped us. If the details of the deal were leaked to the market, and they’re expecting X and you deliver anything less than that, then they are unhappy. The surprise element was very important and critical for Ecuador.”
That element of surprise, of course, cannot be repeated often. If the market is expecting a unilateral exchange offer in the future, it will start to price in just such a surprise, and the initial pop in price will become smaller and smaller.
There’s also an element of sleight of hand. Countries have been able to drive down the price of their bonds so far that anything looks attractive. In situations such as exchange offers, when it is in the issuer’s best interest that the price of its old debt is as low as possible, the market may not cooperate in future quite as much as it did in the case of Ecuador.
There’s also the question of whether the lead managers acted wholly ethically on the Ecuadorean deal.
Salomon Smith Barney and JP Morgan knew full well that the greater the increase in value on the first day, the more of a success the exchange offer would be. When they went public with the offer, in the middle of the trading day, they were the only market players who really understood it. Their trading desks were making markets in Ecuadorean debt – which was soaring in price – on the basis of information they had a much better grip on than anybody else.
“I know that several participants felt that there was reason to be suspicious about the price performance and the way it was announced in the middle of the day,” says Abigail McKenna, a fund manager at Morgan Stanley Asset Management. “It takes most people a few hours to crunch through that and to model the new bonds, but certainly the investment banks involved in the underwriting had that information the minute it was announced, and were able to decide whether to continue to buy debt at certain levels or not.”
Even getting the information in the first place was a non-trivial matter. The leads called the new Ecuadorean bonds global bonds, but they were issued in the US only under Rule 144a, to qualified institutional buyers.
That’s a high hurdle: it doesn’t include a lot of dedicated fund managers, who only got the details of the deal through their bankers the following day.
And even if you were a qualified investor, the details of the exchange offer were buried in about 150 pages of non-standard bond documentation and cover sheets. That’s the sort of thing no fund manager wants to digest in the middle of a trading session. “I think that’s a valid criticism, and one that’s generally shared by most people, that there was a little bit of an uneven playing field there in the way it was disseminated,” says McKenna. “And it would have been so easy to avoid, to announce it after trading one day.”
But to do that would have been to give bondholders time to digest the terms of the offer, talk to each other about them, and settle on a fair price on their own. In fact, even after the market had priced in a successful exchange, the PDI fell by about 9% in the week following the first euphoric day of trading. It would also have created a period of time in which some sort of organized opposition to the exchange offer could have coalesced.
The way it happened, the success of the exchange offer was pretty much assured before it had even been properly digested. (Of course, it had to be a good offer, too.) And as a happy corollary to that, the trading desks at Salomon Smith Barney and JP Morgan had a very good day.
No-one is suggesting that the leads traded on the information in the exchange offer before it went public. “We took our whole sales force into a room, explained the details of the transaction, and would not let them go back to their desks until the press release was out,” says Festekjian. But even he admits that with “any bond exchange that happens, the firm that’s launching knows the deal a hell of a lot better than a guy that has to read it”.
The mutterings about the way the Ecuador deal was launched haven’t gone away, and there might yet be some form of censure for the leads. Even if there is, however, the deal will remain a landmark in capital markets history, when a small Andean nation proved that, contrary to what many had said, it was possible to successfully restructure a bond issue.
Euromoney readers with long memories might recall the December 1995 issue, when we pondered what would happen the next time a sovereign defaulted. “A disaster, a catastrophe, a mess, total confusion,” said Richard Portes of the London Business School. Happily, it didn’t work out like that.
