Some issuers seem to have a natural talent for tripping up syndicate banks. In this respect few borrowers rival Germany’s Länder, who recently issued their fifth joint Eurobond. No Länder-Jumbo has ever been a notable success, but this deal seems to have made everyone a loser.
Traders who lost money by shorting the Dm1 billion ($570 billion) issue claim flawed pricing was to blame. The bookrunners, who lost money by supporting such ambitious pricing, accuse foolhardy speculators who should have realized shorting was dangerous. The issuers probably got off lightest: they lost only a bit more of their battered reputations.
At the heart was fundamental disagreement about how the market should value debt issued by the Länder. The value is obscured by the illiquidity of domestic markets, the lack of explicit ratings for the Länder, and the fact that all are guaranteed by the triple-A federal government. But vanity also plays a role.
Five of Germany’s weakest regional economies chose a spread as low as 23bp over the benchmark 10-year Bund. “It’s not easy to do the pricing,” says Hamburg’s treasurer Johannes Berndt. “We decided to follow the swap curve.”
The five treasurers used an indicator showing a synthetic pricing for 10-year debt from all 16 federal Länder. But that indicator includes the strongest economies, such as Bavaria and Hesse, which can borrow with Schuldscheine 4bp to 6bp more cheaply than Länder with weaker economies. So the 16-Land benchmark looks optimistic for this group of five northern Länder: Bremen, Hamburg, Berlin, Schleswig-Holstein and the eastern Land of Mecklenburg-Vorpommern.
The five don’t listen to warnings like this. Moreover, some banks, including joint bookrunner ABN Amro, tend to play down the credit differential between the Länder and claim that the valuation gap is largely explained by differences in liquidity, maturity and even the payment date.
That is music to the ears of weaker Länder, which – with the exception of Saxony-Anhalt – tend to be opportunistic and refuse to pay a premium to reach new investors. “We don’t sell mispriced bonds,” protests Frank Bornholdt, treasurer of Mecklenburg-Vorpommern. “But the pricing you get depends very much on the bank you choose.”
At an early stage in planning for this issue ABN Amro’s Frankfurt syndicate desk put in a bid representing a spread of approximately 23bp over the 10-year Bund (the bank won’t say exactly what it bid). That won it the mandate, although some equally ambitious pricing came in from several other contenders. Then Commerzbank heard about the opportunity and asked to participate.
Although Commerzbank’s bond trading head, Andreas Gautsch, was unhappy about the pricing, the syndicate desk under Wally Höfer-Neder insisted that 23bp was realistic, and the German bank came in as joint bookrunner with an allocation equal to ABN Amro’s, of Dm465 million.
Just as Commerzbank was split over the wisdom of the deal, so was the entire market. In some traders’ view, the pricing killed the issue from the start, and the dearth of primary selling seemed to support that interpretation. But the massive shorting which immediately followed the launch on Thursday May 7 seems to have come as a genuine surprise to the Länder and to the syndicate desks at Commerzbank and ABN Amro.
The lead managers encountered heavy selling but maintained the price into Friday, realizing that they were the only ones left supporting the deal.
By now the success of Länder-Jumbo No5 was all about nerve, and Commerzbank had lost it. When ABN’s German syndicate head Thomas Geller rang on Friday with an unexpected offer, it seemed too good to be true. The Dutch bank said it had found a single investor in the Netherlands which was prepared to purchase the entire Dm1 billion issue. Without hesitation Commerzbank gratefully bailed out, selling its entire allocation to ABN at less than the re-offer price. Most other primary dealers – with allocations of Dm10 million apiece – did the same.
ABN Amro now refuses to talk about the mysterious white knight from Holland, or even to say whether there it was one investor or 10. “We were told it was a single investor,” says Berndt of Hamburg. “We weren’t that happy because we wanted to do a broadly-placed issue, not a private placement. But we can live with it.”
Once the issue had been cornered, ABN Amro sat tight and waited for the shorters to scream. By the morning of Monday May 11 the price had risen from its original level of 99.22 to a high of 104.20. Even the Länder began to think it excessive: “Half a percent would have been enough,” says Bornholdt.
Commerzbank urged the Länder treasurers to increase the bond. They would not only raise funds more cheaply than the federal government itself – the yield on this 10-year issue fell to an astonishing low of 4.67% on May 11 – they would also drive down the bond’s inflated price and give the shorters some relief.
But the Länder refused – evidently there was no consensus between the five. “Why should we support the banks which tried to ruin our issue?” asks Bornholdt. The treasurers’ principles had now put the shorters and ABN Amro in a worse position than ever. At their exaggerated price the bonds were hardly moving. The only buyers were those with short positions who had lost their nerve.
Despite ABN’s bravado, not all the short positions were given up. By May 20, ABN Amro said that over Dm200 million of the short positions had been closed, of an estimated total of around Dm330 million (with the price at around 102).
Commerzbank regretted its panic sale, since it was now powerless to influence the price. “We were too passive,” Gautsch admits. “We should have kept some of our allocation.” Many traders in Frankfurt suspected ABN Amro’s white knight had never existed.
No-one emerges with credit, and the primary market is further than ever from agreeing on a fair value for Länder debt. Laura Covill
