A SUPPLEMENT TO EUROMONEY – MARCH 1996After the European Investment Bank (EIB) issued what they claimed was the first ever bond denominated in euros, investment bankers knew exactly where to look for other borrowers keen to follow suit. In the two or three days after his bank jointly led the EIB’s euro 1-billion issue on January 31, Cyrus Ardalan, global head of bonds at Paribas, spoke to almost all the major issuers in Germany. Most are seriously considering an issue in euros. Germany has a flock of banks which carry some sort of state guarantee and consequently enjoy triple-A ratings or a notch below. All are regular issuers in the international capital markets. But most do their lending in Germany, so have traditionally borrowed in Deutschmarks to lend in Deutschmarks. The best known issuers, such as Kreditanstalt für Wiederaufbau, have issued in other currencies for some years. But it is only over the past year that other banks have recognized the need to tap other currencies. This is not so much because they are investing and lending more outside Germany but also because they need to become better known to investors who buy non-Deutschmark debt. Norddeutsche Landesbank, for example, has tapped the French franc, peseta and lira markets for the first time during the past six months. The proceeds are often swapped back immediately into the Deutschmarks needed by borrowers. This is a costly way of entering a new market, but German borrowers have had little alternative until now. All this may change with the advent of the euro-denominated bond market. Rather than borrowing in several currencies, issuers can now reach investors in various markets while saving the cost of a currency swap. Since the euro is not yet a real currency, the pioneering euro Eurobond represents only a slight variation on the EIB’s Ecu issues which will be converted automatically into euros at the beginning of 1999. Until that date, interest on the new seven-year bond will be paid in Ecus. But because the bond is denominated in euros now, repayment will be in euros at a rate of one Ecu to one euro regardless of what exchange rate is chosen at the end of next year. By contrast, Ecu-denominated bonds also convert into euros, but the number of euros repaid will depend on the exchange rate. The EIB has promised similar issues, not just originating in Ecus, but in other currencies too. In the event it was a German issuer, L-Bank, which took that step just four days later with a twin issue: a Dm750 million bond which will merge with a Ffr2 billion bond when the euro is launched. They share the same coupon and maturity, making them perfectly fungible. L-Bank’s move was hardly a surprise. It already borrows in a number of currencies and has a reputation as an innovator. Stephan Tribull, the bank’s head of treasury, says the issue was being planned in detail long before the EIB announced its pioneer euro Eurobond because of the complex legal arrangements for this dual-currency fungible issue. In early February the German-based Siemens industrial group chose a spectacular means of returning to the international capital market with its first publicly-sold issue in 25 years by launching a parallel bond in three currencies. Others issuers are more sceptical, although none has totally discounted the idea. Influential German borrowers say that while the EIB, as the European Commission’s in-house bank, had to be first in order to establish itself as Europe’s benchmark bank issuer after European monetary union in two years’ time (one major German borrower describes it as a political statement), they still describe these bonds as marketing ploys. Presumably, however, that makes the idea more attractive to all the other borrowers who need to market themselves outside Germany. The problem is that no one knows what the exchange rates will be at the start of Emu. The EIB bond works on the assumption that Ecus will be converted into euros on a one-to-one basis. But as Ardalan of Paribas points out, if the exchange rate is not one to one, the investor will get more or fewer euros in repayment capital for every Ecu invested in the bond. Essentially, it is the investor’s risk and not the borrower’s. German borrowers are worrying, moreover, that issuers may fall into legal traps of German making. By its very nature, a euro-denominated issue will shed all its links with other currencies as soon as the euro is formally introduced at the beginning of 1999. It is possible that the German government will not convert its old debt so soon. And with German public opinion fretting about the loss of the Deutschmark for an untried, untested new currency, angry investors might just sue an over-hasty borrower. Tribull of L-Bank fears that German banks may encounter legal problems in switching their existing liabilities into the euro. When those bonds were issued, the documentation made no provision for redenomination. Uwe Zimpelmann, a board member at Landwirtschaftliche Rentenbank, says that borrowing in euros may be more expensive; the Siemens bond indicated that. “There’s no chance of borrowing on reasonable terms at the moment,” he says. “We are going to wait at least until the spring of 1998, when we know which countries are going to participate in Emu.” Issuers that venture into the euro market may be ultimately rewarded with the liquidity that eludes them all, even Germany’s best-known issuer, KfW. Christian Murach, head of international capital markets at KfW, concedes that investors can generally trade large blocks (say of Dm50 million on a Dm1 billion issue) only for the first year or two of a bond’s maturity. In the view of most investment bankers who know the German issuers well, Murach and other borrowers could solve that problem simply by borrowing less often, in larger volumes. They argue that now the German federal states, the Länder, have started issuing jointly in order to borrow up to Dm4 billion at a time, even the well-known issuers are going to have to follow suit in issuing large, liquid issues. Siemens has taken that advice, combining the advantages of visibility in three different currencies with the liquidity in the euro from 1999 in its parallel bond, issued in February. Not all share those views. “It hasn’t been our experience that larger-volume issues achieve greater liquidity or better pricing,” says Zimpelmann. Instead, he suspects that investment banks are motivated by the wish to lessen the risk and costs for themselves as market makers by underwriting fewer, more liquid issues. And for the time being, Zimpelmann remains keen on the domestic market. Landwirtschaftliche Rentenbank borrowed Dm13 billion in 1996. Half of that total was raised on the domestic bond market, and he intends to maintain that ratio. The bank’s issues are relatively small and generally target the retail markets in various currencies. The result may be that German issuers continue to divide their borrowing between the domestic bond market for all or most of their Deutschmark issues and the international market, where the euro will increasingly win liquidity away from the various currency segments over the next two years. Indeed, some are afraid of turmoil in the Deutschmark Euromarket in the months ahead because of the uncertainty surrounding its benchmark, the Bund. Since the German government has not decided whether its existing debt will be in Deutschmarks or euros from 1999, issuers and traders have to guess where liquidity will be greatest. Tribull of L-Bank fears that if the German government does not switch into euros immediately in 1999, what was hitherto the Deutschmark market could be split in two. “In effect we’d have one instrument [the Deutschmark] with less and less liquidity, but no liquidity or yield curve in the euro,” he says. For one or two German issuers, this is an opportunity to earn a special status, stepping into the breach where the Bund may not provide liquidity in euros at the turn of the decade. And while the finance ministry continues to leave a gap at the long end of the yield curve (regular 30-year issuing has been promised, but has not materialized) some traders think that frequent issuers might plug that gap. Triple-A development bank KfW has long been the premier issuer for German debt outside the Bund, above other triple-A, state-backed names like the Landesbanks or Landwirtschaftliche Rentenbank because it borrows more and is better known in the market. Last year the finance ministry awarded KfW zero weighting, which means that banks which buy KfW paper no longer have to provide 20% against these holdings. According to Murach, zero risk weighting has already improved the liquidity of KfW paper in the difficult period after one or two years of maturity, putting the country’s leading development bank in a league of its own above other state-backed borrowers and just below the Bund itself. “We now want to establish a KfW yield curve,” says Murach. So after issuing seven- and ten-year bonds in January 1997, KfW is considering a five-year issue. L-Bank, which has a 30-year yankee bond with 27 years to run (which L-Bank’s Tribull says is still liquid for blocks of up to $50 million), says it is already establishing a curve. Bunds are still particularly liquid, therefore some investors concentrate on the government sector in order to gain narrower bid-offer spreads than on the best-quality state-backed paper like KfW. The liquidity of any bank’s paper will never be as good as the Bund’s. KfW is regarded as a major liquid issuer, but its entire borrowing last year was just Dm27 billion, which is Dm2 billion less than the amount borrowed by the German federal government in the first week of the year with its New Year Bund. Issuing in euros could still be the best way to make a splash. |
