Borrowers: Borrowers start to play a strategic game
THE WORLD’S BEST BORROWER: EIB
The European Investment Bank (EIB) appears to be pulling off a remarkable trick. By most borrowers’ standards it comes to the markets too often. And one might think investors would be full up with its name, to the point that it has to pay higher spreads. But not so. “In many ways, the EIB defies gravity,” says Paul Avery, coverage officer at BZW. “The acid test is the positive reaction on the trading-floor to a new issue from the EIB The salespeople are excited by its name still.”
The EIB is borrowing more than ever before in international capital markets. It far outstrips any issuer in the volume of its annual fund-raising and in the number of separate transactions it executes. In public markets in 1996, it raised $23 billion from 109 issues, compared with $14.4 billion in 74 deals for the World Bank. But far from paying an ever higher price to raise such huge sums, the terms on which the EIB borrows are improving in comparison with its peers, according to capital markets consultancy firm, Mooyaart Consult. The firm examines the most liquid issues of the leading borrowers in the main currencies and establishes their pricing levels in varying maturities for each currency.
The most relevant comparison for the EIB has always been its sister supranational, the World Bank, which has long borrowed on finer terms. In the past two years that gap has been narrowing. In September 1995, the pricing level for the World Bank in 10-year dollar bonds was 5bp tighter than for the EIB. By May of this year, that had narrowed to 2.5bp. The same narrowing had occurred in 10-year Deutschmarks, with the World Bank’s yield advantage over EIB falling from 5bp to 2.5bp. In five-year dollars, the gap had narrowed from 3bp to 1.5bp; in five-year French francs from 2bp to 0.7bp; in five-year € from 1bp to 0.4bp.
Across a range of currencies and maturities the degree of change varies, but consistently the gap is closing. René Karsenti, director general of the finance directorate of EIB, is satisfied: “Certainly, in terms of performance relative to our peers, I am pleased.” But he qualifies that. “On absolute yield spread levels, we still have some room for improvement.” For a borrower on the EIB’s scale with a stock of outstanding debt of some €100 billion, issuing new debt at a rate of €22 billion a year, an improvement of a few basis points here or there is big news.
“It seems that a good performance in one market impacts a borrower’s profile in other markets,” Mooyaart says. “The whole funding approach of the EIB is different now. The major gain comes because of the quality of its funding.” He adds: “It pays to price your deals correctly.”
Capable team
That requires a well-motivated and capable funding team prepared to synthesize various data: the terms being offered by banks pitching for deals, the trading levels of a borrower’s own outstanding bonds and of the bonds of its peers. The team must not become over-reliant on one source of information. Mooyaart says: “If one was talking to the World Bank about where it should come in five-year sterling, one would say don’t look too closely at your own outstanding paper, because much of it is illiquid. But that kind of advice can stick in the throat. Some borrowers take comfort from what they have done before. They price off their existing paper and so, sometimes, mis-price.”
The EIB takes a different approach. At times it is strategic and might accept the need to price generously to maintain market access or to establish a benchmark in a new currency sector or maturity. Other times it is opportunistic, seeking to tighten the launch spread of its deals compared with previous offerings.
The EIB launched its first negotiated sterling deal in January 1996, paying 15bp over gilts on the 10-year £400 million deal. That spread was higher than it had paid on many earlier, more opportunistic sterling deals, where it sometimes came just a few basis points above gilts. But those opportunistic deals tended to be smaller and aimed at pockets of continental European or Asian demand.
This deal was designed to bed the EIB name down among mainstream UK investors, as the next best thing to the UK government. The spread quickly narrowed after launch to 13bp. By leaving enough on the table for some spread tightening, EIB was able to re-open the deal for another £200 million last September at a spread of 7bp over gilts and again last November for another £100 million at 2bp over gilts. “EIB deals are never a gift, but when they come with a strategic issue, they are concerned that it works well. They are careful to come at the right time, they understand the markets and they concentrate on their investor base,” says Avery at BZW.
Another example is the $500 million 10-year Eurobond it launched earlier this year through Goldman Sachs and SBC Warburg. For years the EIB has concentrated more on European currencies than on dollars or yen and it was proud last year to launch its first global dollar bond. This April, recalls Bracebridge Young, managing director at Goldman Sachs, “they were interested whether a Eurobond could come through their global bond and we believed that, given the retail appeal of the name, they could price through their global. They did so and the new issue even out-performed in the after-market”. The deal was priced at 18bp over treasuries, when its global bond traded at nearer 20bp over. The market accepted the new pricing, bringing the EIB a new, more competitive benchmark within a whisker of where the World Bank trades.
The EIB used to rely more on another single source of market intelligence: the bids it was offered by banks competing to lead its deals. It would take the lowest offered credible bid and not worry if bonds widened after launch from their initial spread. There is much to justify the approach. It is a simple way for a short-staffed treasury department answerable to an unsophisticated board of directors to show that it is borrowing on the best terms. But over time it hurts a borrower and after several years the EIB was coming some way behind the World Bank, even though it might reasonably argue that it was a stronger credit with a better quality loan portfolio. It had fewer loans to emerging market borrowers, and the support of top-rated European sovereigns as its shareholders and, in many cases, the guarantors of its borrowers.
Bankers pitching for EIB mandates deal mostly with Jean Claude Bresson, deputy director and head of the funding division within the finance directorate of the EIB, and sometimes with Ulrich Damm, deputy director general in charge of capital markets. But it is their boss, Karsenti, whom bankers widely credit with the improving performance of the EIB over the past two years. Karsenti arrived at the EIB in May 1995, following stints at the treasury departments of the World Bank, IFC and the EBRD.
He realized the institution would soon face several daunting challenges: the enlargement of the European community and the need to disburse ever greater sums to support infrastructure projects across Europe when member states’ budgets were constrained; the need to double annual borrowing; the approach of the single currency; and adapting to new staff – more than one third of employees have joined the bank within the past five years. “When I came in, the bank was at a crossroads in its strategy,” says Karsenti. “Together with our board of directors, we had to sit down and set some priorities.”
There followed something of a whirlwind of new schemes introduced by Karsenti who compares his role at the EIB to that of chief financial officer of a large industrial company. Not all his initiatives were directly relevant to its borrowing programme. One of the first things Karsenti did was centralize back-office systems which process the EIB’s cashflows. Previously, three divisions handled this, one for debt service, one for the EIB’s loans to its borrowing clients, and one for treasury operations. Bringing them together achieved economies of scale in operation and IT investments, and brought the bank closer to best industry practice. He put in new accounting and financial control departments, responsible for financial statements of the bank, for risk control, producing asset and liability management reports and running management information systems.
Karsenti also sought some involvement in the lending side of the business, setting up with the EIB’s lending directorate an independent credit department to oversee the bank’s own loan portfolio and to monitor credit exposure arising from funding operations, for example measuring exposure to banks both as swap counterparties and as co-guarantors on loans to EIB clients. Karsenti also sought to use the expertise of the capital markets staff in running the bank’s huge borrowing programme, to help its lending officers structure loans for EIB borrowing clients.
Note of exasperation
Some bankers who work closely with the EIB sense an occasional note of exasperation from veterans of the financial directorate over what they see as growing bureaucracy at the EIB. But Karsenti sees each of these new programmes as essential to the objectives of the finance directorate which he codified in a 10-point memo to staff in May 1996. Chief among these is the imperative to maintain the bank as “a highly efficient AAA intermediary”.
Efficiency is key. The aim is to use the bank’s strong rating to raise funds at the cheapest possible cost and pass that low cost on to borrowers. Everything the bank tries to do flows from this. So it seeks to maximize revenues from treasury investment. It keeps a cash cushion of three to six months of up-coming loan disbursements, but invests the rest of the funds it has raised in low-risk, short-term instruments including T-bills and repos, with the aim of beating a Libor benchmark. Some external asset managers are now being hired to invest in markets where the bank’s own staff have no great expertise, for example in mortgage-backed securities.
Even more central to Karsenti’s strategy was the creation of a new asset/liability management division within the EIB. “There was a crying need to de-link even more funding and disbursement,” recalls Karsenti, “because the best timing and structure for a funding do not often co-incide with a disbursement.” The EIB has progressed beyond having to hedge each borrowing deal-by-deal to looking at its whole portfolios of assets and liabilities and, where there are gaps between the two, hedging on a portfolio basis. There are times when a particular borrowing may provide a currency or duration of liability that brings a natural hedge for the portfolio. So any such borrowings will not be hedged themselves.
Relying on software developed from JP Morgan’s RiskMetrics the bank can now regularly review its value-at-risk and analyze its basis-point value by buckets of duration within each currency: it can see how the net present value of the cash flows of the bank in each currency will be affected by a 1bp move in interest rates. It’s a powerful decision-making tool. If the bank has large bp value in, say, seven-year French francs, that might prompt it to borrow in French francs at that maturity and leave the new issue unhedged as a way to reduce its exposure.
Portfolio hedging
The bank runs two sorts of hedges. It still hedges some specific transactions, by buying government bonds. But more important is portfolio hedging and the shape of the overall book. Whenever the funding staff consider a new borrowing, they discuss it with the asset/liability management (ALM) group, listen to their advice on maturity and structure and discuss how, if at all, to hedge the new transaction. “If the bank is considering the choice between a five-year deal and a seven-year deal, ALM will have a say, especially if the funding side is indifferent,” explains Bresson. “But ALM could not force us to do a seven-year deal if the market is not there.”
From the start of this year to mid-May, the EIB had raised $13 billion in 76 different transactions, making it the largest and most active issuer in the international capital markets, way ahead of second-ranked Commerzbank ($9.9 billion from 35 deals), third-placed Dresdner Bank ($8.3 billion from 42 deals) and fifth-ranked World Bank ($6.6 billion, 44 deals). Add in truly private private placements, and it is launching two deals a week.
Its borrowings so far this year fall into three roughly equal categories: deals driven by preparations for Emu and the single currency, which tend to be large liquid benchmark issues in European currencies; opportunistic, structured transactions sold off its MTN programmes; and everything else, including deals in dollars, yen, east European and Asian currencies.
The first two categories of transaction, including so-called euro-tributary deals and structured placements are quite new. Over the past two years, the EIB has been in a hurry to sign domestic and European MTN programmes and has begun to launch deals, for example, with redemption formula linked to individual stock market indices, baskets of indices and other structures. It has been most active in Spanish pesetas, with some deals aimed at retail investors as well as tailor-made deals targeted at sophisticated institutions, and in Italian lire. These structured deals now amount to two-thirds of the number of transactions the EIB launches and provide one- third of its funding. On each deal, the ALM team analyzes the pricing of the embedded options, and the bank also weighs the associated credit exposure and collateral requirements from derivative counterparties.
That can take from one day to a week and a deal does not always result. It has turned down offers to do long-dated zero coupon deals in emerging market currencies because it was not happy it could manage the risks. “The question is how do you obtain an independent market valuation from some of these structures and how, if your counterparty collapses, can you replace them when there is no liquid market. I would like to see market mechanisms for a greater de-linking of credit risk and market risk. That would help us,” says Karsenti.
Because the deals are numerous they are time-consuming, but they bring an obvious benefit. The blended cost of all the EIB’s funding is roughly 25bp below Libor. Large benchmark deals are expensive. The funding cost of structured deals is roughly 40bp below Libor.
As well as seeking to reduce its overall cost of funding by issuing in these new markets for structured placements, the EIB has also sought to diversify by currency, issuing where it never did before, for example in New Zealand dollars and Canadian dollars. Last year it overturned the restriction to issue only in OECD currencies, so as to issue in east European currencies as part of its mission to develop capital markets in countries aspiring to EU membership. It also issued in Hong Kong dollars and the South African rand. Its latest projects are to issue in Slovak koruna and Slovenian tolar. The bank is more keen to devote management time to these markets than to those outside Europe. Still, it is looking at issues in Philippine pesos, Korean won and new Taiwan dollars.
Another first for the EIB was its dollar global bond launched late last year, using a back-to-back swap with the Tennessee Valley Authority. A conundrum for the bank has been that, while 90% of its lending is in European currencies, these together make up just over one-third of world bond markets. By borrowing mainly in European currencies, the EIB risks cutting itself off from large groups of investors.
Pave the way
The dollar global was originally designed to establish a benchmark in dollars, but also, according to Karsenti, “to make our name better known in the US, to pave the way for possible euro-tributary issues distributed in the US.” He says: “Because of the massive research commitment required to follow 16 different European currencies, American investors do not invest much in Europe today. After 1999, when the euro could represent up to 40% of world bond markets, I expect they will move more into this market as an indispensable diversification.”
Karsenti will not pay higher spreads than in Europe to sell European currency bonds in the US. That would quickly hurt its new issue pricing levels in Europe. Issuing more dollar and Asian currency debt is a way both to diversify its liabilities and to encourage greater demand from Asian and American investors for the EIB’s euro bonds. “Our modest ambition is to be the best issuer of euros in Asia and the US,” says Karsenti. “By contrast to ourselves, sovereign borrowers may continue to anchor most of their distribution in domestic markets.”
Post 1999, Karsenti suggests the EIB will be the fifth largest issuer of euro-denominated debt, after Germany, France, Italy and the UK, assuming the last two enter. It now has €53 billion of debt maturing after 1999, mostly in European currencies which may (though perhaps not easily) be converted to euros.
Add to that €24 billion to €25 billion of annual new borrowing in 1997 and 1998, mostly in deals incorporating a provision to convert into euros, and by 1999, the EIB could easily have an outstanding stock of €100 billion of euro-denominated debt. By volume of borrowing, the EIB ranks up there with the sovereigns. Karsenti says: “We have to think more in terms of the techniques of sovereigns, such as building up liquidity through regular supply and ensuring deliverability of our issues into futures contracts. We can think in time about a regular issuing calendar.”
Meanwhile, the EIB is positioning itself as a quasi-sovereign issuer. It intends to have a yield curve of euro issues in place by the time monetary union occurs. To achieve this, it is standardizing terms and conditions – aside from issue-price – on separate tributary issues in different currencies with the same maturity. These can eventually be re-denominated and merged into large, liquid euro-denominated issues, which will benefit from having initial distribution anchored in the old national markets. It has already issued 10-year tributary deals in Deutschmarks, French francs, guilders, escudos and sterling. “There will be several benchmarks in the future euro bond market, obviously France and Germany will be major ones. Our mission is to provide the best non-government benchmark, alongside the sovereigns,” says Karsenti.
Even if the single currency project were not such an obsession, the EIB would likely still have to launch large issues in the European currencies to raise the volume of funds it needs. In all these markets, including sterling, which is unlikely to join Emu in the first wave, it positions itself as the largest international issuer and the next best thing to the sovereign. Even before Emu, this programme is bearing fruit. “We are seeing an improvement and convergence of our spreads over government bonds. We are generally in single digits over governments and in some currencies, such as escudos, we are through governments,” says Karsenti. “In certain markets, such as Germany, I felt that our spread was too high.”
In May 1995, Karsenti famously launched a negotiated Dm1.5 billion five-year deal, breaking with precedent at the EIB, which always used to employ competitive bidding. Price discovery provided a launch spread of 21bp over government paper, after banks had first suggested 25bp or more for a traditional competitive bid. Now pricing has improved even further. “On the tributary deal, our spread is below 10bp, which is more in line with where I think we are headed,” says Karsenti.
The EIB’s rates may well improve further as investors focus more attention on relative value of credits. With its substantial capital and reserves, its balance sheet is just two and a half times geared. It carries liquid assets and half of its loans are government guaranteed, with the rest guaranteed by banks. It is a conservative institution. The bank is considering ways to securitize parts of its loan portfolio and sell bonds on to new investors. “We want to be a catalyst to bring in new lenders to projects. We have an excellent quality portfolio though the structure and pricing of our loans may make securitization difficult,” says Karsenti. The EIB has limited resources to throw at such projects. It is borrowing in more currencies through larger numbers of more complex transactions than ever before but with no more staff than in earlier, simpler days. Bankers who deal with the EIB agree that the 16 individuals, including secretaries, in the funding department of the finance directorate are almost over-stretched with work. They did 125 transactions last year, more than two a week, and dealt with thousands of pitches.
Some respite should come after currency union. Though EIB will continue with its opportunistic, structured trades, the number of currencies it uses will be cut, and asset/liability management should be simpler. “It’s on the tight side and we have lost staff to the market. But this is a transition phase. It’s very tough to manage, but it should become less intense post 1999,” says Karsenti. Peter Lee
BEST DEBUT BORROWER: Russia
On the road to Moscow from the city’s international airport stands a memorial: a series of criss-crossing bars representing tank traps marks the closest point that Hitler’s troops came to Moscow in World War II. Almost 130 years before, Napoleon actually got into the city, but was forced out by Russian stubbornness and a harsh winter.
A few days before the Russian Federation’s debut Eurobond last November, it looked as if the investment bankers involved in the deal would meet the same fate.
At one point, the London leg of the roadshow seemed to be regressing into a cold war, as senior Russian officials became vexed at the niceties of the SEC rules on how information about the deal could be released publicly to the US before its launch. “One official was exceptionally annoyed,” says one observer. “He was insisting that Russia would not tolerate being dictated to by America, until the lead managers arrived to explain the situation to him.”
There were also last-minute hold-ups as the Russians would not commit to a size or maturity, and there were occasional discrepancies between the launch spread the Russians wanted, and that which the lead managers thought was achievable. At the start of October Russia received its ratings: BB+, BB- and Ba2 from IBCA, Standard & Poor’s, and Moody’s respectively.
The problems were caused not by an obstructionist team at the finance ministry – bankers involved in the transaction stress the MoF adopted a professional approach to the deal – but arose because the team was looking over its shoulder constantly at the domestic political situation in Russia. The presidential elections in June, and president Boris Yeltsin’s heart problems after his re-election, had already delayed the launch, and now there were other matters to bear in mind.
Since the end of 1995, Russia’s parliament, the Duma, had been dominated by a mix of hardline communists and nationalists, all hostile to raising capital abroad, viewing it as a sign of weakness. And just over a week before the launch, the IMF announced it was withholding $660 million, or two months’ payments, because of poor tax receipts – at present only 60% of estimated tax revenue is being collected.
But after last-minute negotiations with the MoF about pricing, size and maturity, lead managers JP Morgan and SBC Warburg brought the deal to the market on November 21 -a $1 billion, five-year issue with a coupon of 9.25%. At a spread over treasuries of 345bp it was wider than similar credits such as Argentina, and finance ministry officials were happy to accept the wider spread to establish their name in the international markets.
Some were surprised at investors’ appetite for Russian paper; the lead managers reported generating demand of $2.6 billion. “I don’t quite understand why both the dollar and Deutschmark Eurobonds were so popular,” says the vice-president of one Moscow-based bank. “The economy hasn’t really changed: most producers are in deep trouble, millions aren’t receiving their salaries or pensions, and the low tax receipts are a real problem. It’s only the IMF loans and the Eurobonds which are keeping things together, and how long can that go on? That said, the federation was very professional in its approach, and the last thing they’d want is to default on the bond.”
The lead managers are well aware of such views, and are vigorous in their defence of the attractiveness of Russian debt: “Russia is in a unique asset class,” says Richard Luddington, head of emerging market debt syndicate desk at JP Morgan. “It’s a potentially large market, and after the Mexico crisis in 1995 institutional investors have realized the need for a diversified portfolio. Any wanting theirs to be balanced ought to have some exposure to Russia.”
So one of the longest processes for issuing a sovereign debut bond came to an end. “It had the gestation period of an elephant,” says one banker close to the deal. It took nearly a year from the time JP Morgan and SBC Warburg received the mandate until the bond was issued. And the MoF had been looking at the possibility of an international issue for even longer.
“We started work on plans to tap the international capital markets towards the end of 1994,” says Vladimir Dmitriev, deputy director of the department of foreign credits and external borrowing, who is regarded by investment bankers as the driving force behind the bond issue at the MoF. “But we were starting from scratch, with our knowledge being purely academic rather than practical.”
Some ministry officials had some practical experience from their role in the Deutschmark bond issues of the old Vnesheconombank of the Soviet Union in the 1980s. But they, and their counterparts at the bank, had long since left to take up more lucrative positions at commercial banks. One of these banks, the International Company for Finance and Investments (ICFI), was in the syndicate for both the dollar and Deutschmark deals, and is run by a group known as the Twelve Apostles, some of the top men from Vnesheconombank and the MoF during the Soviet era.
Dmitriev is open about the problems this caused: “In many senses we were pioneers – we didn’t even have the documentation from Vnesheconombank’s Dm2 billion debt issues in the late 1980s, they’d been lost. So we had to create our own documentation and explain every procedure to various government entities.”
That the MoF would have preferred to issue earlier in the year is evident from the amount of debt it was allowed to raise in 1996. Of the $9.6 billion allotted to being raised externally, $2 billion was earmarked for the international capital markets. The Duma also had some say, as initially it gave permission for the dollar deal to be no greater than $500 million.
But it appears the MoF’s preferred strategy for 1996 was for at least two bond issues. However, circumstances would not allow this, and Dmitriev admits the first plan had to be shelved: “Our opportunistic plans were to go to the markets before the June presidential elections, but we then realized that we were being too aggressive. The financial situation was still not that reasonable, and pushing the issue would not have sent very good signals about our approach to the investment community.”
A deal would have been possible then – in February, the same month as the deal was mandated, the IMF agreed a $10 billion facility for Russia. But there was still no settlement of former Soviet Union and Tsarist Russia debts with the London and Paris Clubs, and official sovereign ratings were not given for another eight months. These factors would have severely restrained any issue.
“At that stage, with no credit rating, all that would have been possible was a $200 million to $300 million deal for two or three years,” says Patrick O’Brien, executive director of debt capital markets at SBC Warburg. “It would have been the first-ever public sovereign deal launched before Paris and London Club agreements.”
Utmost care
Postponing the deal until the agreements had been reached, and until Yeltsin had been re-elected, allowed for a more stable environment, but the ministry had to take the utmost care. The dominant communists and nationalists in the Duma were hostile to the government, and would have pounced on any perceived slip-ups, threatening any future issuance. Many representatives, with little or no knowledge of the capital markets, were concerned the government was willing to increase its indebtedness, when lowering the domestic debt burden was a priority.
“There were many who believed that the whole process meant that we were selling out the country to foreign tycoons,” says Dmitriev. “We had to explain to them that the purpose was to involve Russia as an integral part of the international financial community, not to be exploited by it, and that it would help attract a broader base of investors to Russian credits.”
Hostility and resentment remained up to the launch of the Eurobond, but it was soon seen as a success. Dmitriev estimates that 40% of investors had not bought any Russian debt before, be it the GKOs (short-term treasury bills) or the restructured debt of Vnesheconombank (MinFin bonds). And GKO interest rates came down immediately by as much as 12bp depending on maturity as domestic debt market participants realized the government could borrow more cheaply abroad – under 10% compared with GKO rates in the high 30s. “The deal was a success for all concerned,” says one banker. “It made Livshits [finance minister at the time] look good, and it was amazing how many of the people who had been attacking the deal beforehand then turned around to claim credit for its success.”
The MoF team was pleased with the performance: “We knew that, without a track record and given the market conditions, a spread of 345 basis points over treasuries was satisfactory,” says Dmitriev. And we didn’t want to appear to be greedy; our aim was to set a benchmark and start down the path of being a major player in the markets. We don’t want to be a second-rank country on the outskirts of the international capital markets, and so had no right to take any risks.”
However, some thought the spread was too tight, if only by a few notches, and used this to explain the secondary market performance towards the end of the year: “Initial placement went very well,” says one syndicate member. “But about a month later the spread on Russia’s Eurobond widened as others stayed flat. We think that some investors found the size of their initial allotment a bit too big for them, and the leads had to swallow up some of the bonds. But it was only a temporary glitch before they started trading in again.”
By March, when the second Eurobond was launched, spreads on the dollar deal had tightened to 320bp to 300bp, despite the general widening of emerging market spreads in the preceding six weeks. But the conditions did have an effect on the new issue, a Dm2 billion, seven-year deal with Credit Suisse First Boston and Deutsche Morgan Grenfell as lead managers. It carried a coupon of 9%, 0.25% lower than on the dollar deal; the coupon, rather than spread, is more important in a Deutschmark deal. But the proposal to launch at 370bp over the Treuhand rate was disconcerting for the Russians initially, and there were reports of heated exchanges over pricing between the leads and the MoF.
But the professionalism of Dmitriev’s team showed through, and agreement was easier to reach. “The MoF did ask questions about the spread, but fundamentally we weren’t starting from a million miles apart,” says Simon Meadows, managing director and co-head of international capital markets at Credit Suisse First Boston. “They understood that the market wasn’t as favourable, and understood that we were taking risks ourselves.”
That risk was twofold: first, the Deutschmark issue was the largest from an emerging market sovereign – and one that had no track record in the currency; second, it was done on a bought deal basis, and rival bankers claim there was no order book. “You can still pick up a couple of hundred of them without changing the price, which is somewhat unusual,” says one syndicate head. Meadows acknowledges that the paper took some time to place, but stresses that this is no longer the case: “It was relatively easy to pick up the bonds in the first few weeks, but let’s not forget that it was a Dm2 billion issue.”
At the MoF Dmitriev explains the deal was never going to be straightforward: “We had to try and balance conflicting factors, and in the end the deal was a mixture of the possible and the necessary: the former in the sense that we had to bear in mind current market conditions; the necessary because we needed the money for budgetary purposes.”
Most of the proceeds from the two bond issues have been used to alleviate stress from the budget crisis, but few are worried this will prompt the federation to act more rashly now they have established a name in the markets. Last year’s limit of $2 billion which could be raised abroad has only been raised to $3 billion this year, leaving a little under $2 billion after the Deutschmark Eurobond, “although that is somewhat flexible”, says Dmitriev. And the bankers are sure Dmitriev and his team will not sully their reputation for professionalism built up over the last 18 months.
“Dmitriev and the MoF team do care about long-term borrowing,” says Vladimir Kuznetsov, who moved to become general director of Salomon Brothers’ Moscow office at the start of 1995 after overseeing the closing of Goldman Sachs’s office in 1994. “If you suggest to them that they might like to consider a yankee, a global or a samurai, they don’t look at it simply as a way of getting in some more cash to sort out their problems. For them it’s much more a question of how such issues will fit into their profile.”
The MoF has indicated what it intends to do next: at April’s EBRD conference it signaled there was to be another dollar Eurobond within a couple of months, again using JP Morgan and SBC Warburg as lead managers. Few details have emerged, but it is likely to be $1 billion with a maturity of more than five years.
According to Dmitriev, another bond issue in the autumn is planned to raise the last of the $3 billion allocated for capital market debt raising. “We do have some plans for tapping other currencies,” he says. “Naturally we’d like to be issuing in the three core currencies of dollar, Deutschmark, and yen, but we might not do a yen issue until next year – we’ve been advised that the market there is likely to be a bit choppy for the next three to six months.”
Another reason could be the territorial disputes between the two countries, a hangover from World War Two. Yet relations are looking more promising. Last year the Japanese government informed the big financial firms it was unofficially altering its policy on Russia. And defence minister Igor Rodionov visited Japan towards the end of May, the first to do so for 80 years. (Not that it helped his career: he was sacked by Yeltsin on his return for failing to implement army reforms, and for his criticism of Russia’s deal with Nato.)
Western bankers point to other instances of unresolved conflict where debt issues have still been possible: “Look at Argentina,” says one syndicate head. “The Falkland Islands dispute with Britain hasn’t been settled yet, but the government was still able to launch a successful Eurosterling deal.” Furthermore, Japanese investment houses have a large stake in the London Club debts.
Other options are also being considered: “We’ve been talking about all manner of possibilities,” says Dmitriev. “At some point we might do a global, or go for full SEC registration in the US. And we’ve also been looking at the potential for issuing in pesetas and lira.” He mentions there might be a rouble-denominated Eurobond sometime next year. “We’ve already stabilized the currency, and by next year we will have curbed inflation, so there will be no big risks for investors on those fronts. And international investors have been showing an enormous interest in domestic Russian debt. If we combine those with a certain level of security for investors to be able to repatriate their profits, then a rouble Eurobond could be a real success.”
The immediate future for Russian sovereign debt looks good. It has a core group of western banks as advisors, and a capable team at the MoF. The Duma has been placated, if not won over, and there are signs the economy is picking up after years of decline and stagnation.
But there are concerns about the slow pace of reforms and the inadequate taxation system. Some have questioned the long-term ability of the government to service its debts – “I just don’t think that they’ve got their cash-flows as well planned as most seem to think,” says one banker in Moscow. And at a recent conference in London an analyst from Renaissance Capital, the capital markets house set up by former CSFB man Boris Jordan, cast doubt on the reliability of the ratings awarded by the agencies last October, claiming they did not use the right figures, although refused to elaborate on whether the ratings should have been higher or lower. Another Moscow-based banker is openly suspicious: “I’ve been sceptical for a while now, and am sure that there is something wrong with the fundamentals. Of course, I could be wrong, and I hope that the banks involved in the deals know better than I do.”
Yet there is little doubt that Russia, like China, is a country with opportunities just waiting to be exploited. And things change fast. All the lead managers on the bond issues so far point to the steadily improving story in eastern and central Europe. “Look at Poland,” says CSFB’s Meadows. “When they first came to the markets it was at a spread of about 200bp over treasuries; now it’s down to 50bp or less. And all the countries which received a rating were upgraded within a year or two.” Antony Currie
BEST EMERGING BORROWER: Argentina
The team in charge of borrowing for the Republic of Argentina has been busy during the first half of 1997, producing a quick succession of offerings to take advantage ofthe liquidity in the emerging debt markets. It produced a $2 billion global bond, deals in lira, Deutschmarks, pesetas, yen and Austrian schillings, and domestic treasury bond issues denominated in Argentine pesos and US dollars.
This flurry of activity shows the pace at the economy ministry’s Bureau of Public Credit, which is extending maturities and diversifying international funding sources, while gradually switching issuance into the domestic treasury market.
Miguel Kiguel, under secretary of finance at the economy ministry, is in overall charge of the borrowing programme. He is an alumnus of the US’s Columbia University, who combines an academic approach to economic theory with a practical approach to debt raising. Bureau managing director Federico Molina reports directly to him and runs a 20-strong team which tracks the markets on a daily basis and deals with underwriters. Molina works alongside Hugo Secondini, director of financial research.
The three are well-known among emerging market investors, and to executives at the big international investment banks who compete for underwriting from an issuer with $10 billion worth of refinancing to do each year.
The Republic of Argentina will remain a big customer of the underwriters in the next few years – although it has begun to make the domestic market a more important source of funding than the international capital markets.
“Our intention is to reduce our heavy dependence upon the international markets, and increase the size of our domestic programme,” explains Hugo Secondini. “The overall strategy for Argentina is to keep the same nominal amount of debt, so it is supposed that as debt comes due every year we will go to the market for the same amount of money. But this year we are running a deficit, so that implies we have to increase our access to the market for the amount of the deficit.”
This year the plan is to raise $12 billion or its dollar equivalent, of which $8.5 billion will be offered internationally and $3.5 billion in the domestic treasury market. For 1998 this 30:70 split is programmed to look more like 40:60. And by 2000 it is hoped the scales will tip in favour of domestic issuance, with 60% raised locally.
Over the past 18 months the treasury markets have been overhauled and 12 market makers appointed, including foreign institutions such as Citibank, Chase Manhattan, Bank of America, First National Bank of Boston and JP Morgan.
The market has developed well in terms of new issuance and secondary market liquidity. Last year’s busy schedule produced an issuance of peso and dollar denominated Letes (treasury bills with maturities of 91, 182 and 364 days), plus treasury bonds known as bontes. And in May this year the market took an important step forward with regard to extending tenors, with an auction of $750 million of dollar-denominated five-year bontes.
“With regard to the bontes issue we did a roadshow in the United States in order to present our domestic programme to investors,” Secondini explains. He stresses that an important goal is to develop Argentina’s domestic savings rate, and notes forecasts suggest pension fund assets will reach $20 billion by 2000, and mutual fund assets another $10 billion.
However, foreign buyers are needed to ensure liquidity in the treasury market. The bullet amortization structure of bontes, and their ability to trade via Euroclear, have been designed to appeal to overseas investors. The first offering of five-year bontes was a success. According to one market maker just over $4 billion of bids were received in the Dutch auction process, though the foreign buyers bid more aggressively than the locals and gained most of the paper.
Watching for opportunities
Both domestic and international issues are co-ordinated at the bureau. The team watching for market opportunities work in a 10th-floor office at the economy ministry, across the road from president Carlos Menem’s official residence in downtown Buenos Aires, the Casa Rosada. In a city where the working day typically runs from 9.30am until 7.30pm, work begins early, with the first staff arriving at 8.00am to gather midday market information from traders in London.
Yield curves are constructed in the various currencies in which Argentina has bonds outstanding, and new issues by other emerging market credits are tracked to see how investors are receiving them. The bureau comes up with its own ideas for transactions, and assesses the many proposals being phoned in by the leading investment banks with which it keeps in close contact.
Molinas heads this operation, looks out for market opportunities, and provides a point of contact for rating agency analysts or big investors with queries about the latest economic news in Argentina.
Work is now also under way on a liability management team, to manage more actively the republic’s complex debt portfolio. “I think that this will be a more important part of our work in the future, because we are taking an increasing amount of our debt in currencies other than the US dollar,” says Molinas.
These issues are often not swapped back into US dollars, and the republic runs a number of open positions on its non-dollar foreign currency debt. The liability management unit could be in place late this year or early 1998.
On new issuance the idea is to be able to move quickly when a window opens in a given market. “The strategy is to have all the documentation in place and everything ready for opportunities in the market,” comments Secondini, who points to a flexible Euro medium-term note programme the republic has established, under which various tenors and currencies can be issued.
If the department comes up with an idea for a transaction, or likes a proposal from an investment bank, a set of options is drawn up and sent to Kiguel, who has the final say on whether to proceed. Simple, clear lines of communication between Secondini, Molinas and Kiguel mean bureaucracy is avoided, and a decision can be taken quickly.
Once approval is given for a transaction, a small number of investment banks are invited to submit bids for the mandate. The number invited depends upon the nature of the deal, whether a relatively simply Euro offering such as a retail Deutschmark issue, or a more complex global bond where the bureau might have a clear idea of which houses it would want as possible lead managers.
“The key point for us is competition, and where a lot of competition is not possible the idea is to rotate among the major firms,” Secondini explains. “What is important is the ability of the house to tell people the Argentina story – the emerging markets have special characteristics and we want to have a firm working with us that has sufficient knowledge of the market.”
The republic awards mandates to houses proposing sensible pricing, and will not risk its name in the marketplace by going with houses pricing over-aggressively to win business. “We are extremely careful in awarding mandates – we want to have a long-term relationship with investors, so we don’t think that to be very aggressive in a single transaction is the best way of raising funds for the treasury.”
Once a transaction is approved, a roadshow is usually needed, though some deals, such as the Deutschmark Eurobond sold mainly to retail accounts in January, go without. Kiguel often heads the roadshow team, and has travelled many thousands of miles over the past few years telling the Argentina story to institutional investors around the world. The bureau also has a programme of presentations at conferences and seminars around the world: once or twice a month senior government officials tell analysts and investors about the progress of the Argentine economy.
Over the past few years Secondini has noted a maturing of the investor base, and a higher level of knowledge about Argentina among fund managers. “The quality of the questions you are receiving is more focused,” he says. “Four years ago everyone was asking about the general idea of convertibility, now everybody knows the basics and they are focusing on specific topics – you are talking with an audience that knows a significant amount about Argentina.”
Busy on the road
The past 12 months has been particularly busy on the road. The biggest deal was the $2 billion global bond launched in late January, and co-led by Merrill Lynch and JP Morgan. The tenor of 20 years was the longest achieved by Argentina, and it was well received.
But there has also been plenty of non-dollar issuance, with a wide variety of lead managers. In February there was a Dm1.5 billion euro offering of seven-year paper led by Dresdner Bank and SBC Warburg.
Last November Argentina turned to Swiss francs, offering Sfr200 million of seven-year bonds in a deal led by Deutsche Morgan Grenfell and Banque Paribas.
And in October it did two deals within days of each other, a ¥50 billion offering led by Nikko, and a Dm500 million transaction led by Deutsche Morgan Grenfell. Only a few weeks earlier it had tapped the market for L500 billion, in a deal managed by SBC Warburg.
The signs are that Argentina will continue to diversify its investor base by issuing in a wide variety of currencies as well as the US dollar. And even by 2000, assuming it hits its target of 60% of new issues done in the domestic treasury market, that will still leave $5 billion-plus a year to be raised in the international debt markets. Michael Marray
