Arguments over how to price a deal will never go away, even for frequent borrowers. Most have 15 or more investment banks chasing the mandates, offering the issuer all sorts of advice and inducements. A treasurer who chooses an aggressively priced deal might save his institution a few thousand dollars over 10 years and make himself look good to his bosses, but if it’s too aggressive and investors don’t buy it, could this harm his future issues? And if the deal is too generous, why should investors bother to buy paper issued later that might be more accurately priced?
One man who thinks he might have a solution is Brian Mooyaart. A former banker on the buy side, he now runs his own company, Mooyaart Consult, which tracks large liquid benchmark issues in each of the major capital markets. It also tracks the price performance of new issues in syndicate and primary trading and from this builds issuer-specific term structures for 200 regular issuers in the major currencies. “In this way issuers can see at a glance how the daily fluctuations of the market affect their issuing strategy, and can be guided to the optimal time to issue, both as regards the spread over the benchmark and the swap rates,” says Mooyaart. “As a general rule, this model appears to show that two-thirds of deals are mispriced. Of these, one-third are overpriced, and two-thirds underpriced.” This makes sense given the intense competition between lead managers.
Mooyaart’s contention is that his system can tell, to within two basis points, whether a deal has been accurately priced. Anything 3bp or more beyond the issue price suggested by Mooyaart’s model is a potential deal breaker.
A sample of issues between May and September provided by Mooyaart appears to show that even some of the most frequent borrowers are mispricing deals. The problem is that if they do so too often, they might alienate their investor base. At present, this can be mollified by the various European currencies available, but what happens after Emu? “After Emu the major borrowers will issue most of their debt in three currencies: dollar, yen and the euro. This will make the issuer’s market profile much more transparent,” says Mooyaart. “Issuers won’t be able to hide behind a bad franc issue by going into Deutschmarks, for example, or other European currencies.”
One culprit appears to be the World Bank. By the end of September, it had done 94 deals since the start of the year, and in the five-month sample period Mooyaart has spotted four mispriced issues. No shame there – no treasury expects to get a 100% success rate. But all four deals were in major currencies, Deutschmarks, sterling or dollars, and represent one-third of the World Bank’s issues in those currencies in the same time frame. So they could, according to Mooyaart’s thesis, taint future issues: “If they are doing mispriced deals in the major currencies, then in the longer term it could make investors wary of their other deals in some of the newer currencies,” says Mooyaart.
One of the deals singled out is the World Bank’s $300 million July issue lead-managed by Commerzbank. A three-year issue, it was launched flat to treasuries, whereas Mooyaart’s figures suggest that 3.1bp wider was the optimal launch spread. “If anything, I thought it might have showed that we’d come too wide,” says Peter Horvath, senior financial officer at the World Bank. “If you look at a range of AAA issuers in the dollar markets at three to five years, a number of them launch flat. We’d rank ourselves as at least as good as they are, but can only rarely launch any tighter because it’s very difficult to launch a dollar deal through treasuries.” In fact, the World Bank launched its $250 million deal in June at 4bp through treasuries.
Yann Gindre, global head of debt capital markets at Commerzbank, puts another spin on it: “As a $300 million deal, much of it was targeted to retail investors, but one reason we did the deal is because we’d already had some demand from institutional investors for this type of deal and so called up the World Bank to see if they were interested.”
Since the launch, the deal has traded in, with bid prices through treasuries. If, as Gindre says, some institutional investors did buy in, it would be more likely that retail is driving the demand now. Certainly some members of the syndicate shared Mooyaart’s view that the deal was too tightly priced: “It is aggressively priced and will take time to place,” says one syndicate manager. “but because of the name it should sell down over time.” Another commented that its aggressive pricing offered little chance of spread performance.
This issue – which is just on the cusp of make-or-break in Mooyaart’s methodology – highlights the main problems surrounding attempts to create a system to price bonds. The data he collects can detail past performance and present market movements but, as he admits, do not take market sentiment into account. So factors such as reverse enquiry from institutional investors, retail-driven deals, over- or undersupply of paper will not figure in the analysis.
It is the old argument over whether pricing is an art or a science: “It’s just like going to buy a car from a dealer,” says one borrower. “You can get all the information from as many sources as you like on the cost of manufacture, the trade price, how much they’re being sold for in the market, but in the end it’s market demand that determines the price. If the dealer has met all his targets, he might not care about selling the car, even if he is offered a fair price. But you could offer the going rate when he’s desperate to sell and he’ll think: ‘I’d have settled for less than that.’ Pricing is as much about context as it is about data.”
That said, Mooyaart’s research does pick up on trends in borrowers’ pricing. One example is the European Investment Bank (EIB), which over the past two years since René Karsenti took over as director general of its finance directorate, has been regarded as a mature, professional borrower. “They always used to be purely opportunistic borrowers,” says a syndicate head. “And that would lead to some overly aggressive deals being launched which just wouldn’t sell. But since Karsenti came in they’ve become much more of a strategic issuer, and most of the deals fly out of the window.” Mooyaart has tracked this, too, saying the EIB’s pricing has got consistently better over the past two years: “The EIB has been narrowing the funding gap between itself and the World Bank for some time now: in September 1995 the World Bank was getting 10-year dollar paper at 5bp better than the EIB. By May this year, the gap had halved and today is practically non-existent.”
But the EIB is not immune to mispricing. Its ¥50 billion ($413 million) deal in September came at 4bp through Japanese government bonds (JGBs). Mooyaart had the optimal deal at 1.8bp over, although he admits this would be more applicable for a larger deal. “But there have been significant price fluctuations for 10-year yen for a few months now,” he says. “So the timing is crucial.” One banker in the syndicate points to other factors: “There have only been three 10-year yen issues this year, so the demand is there. And all have offered comparatively similar yields, despite the spread differentials, because they use different benchmarks.”
Mooyaart’s data only rate the first of the three, NTT’s ¥100 billion issue in July, as well priced. This launched at 4bp over JGB compared to Mooyaart’s 3.8bp. Fannie Mae’s bond of the same size in September came at 1bp through JGBs, whereas Mooyaart places this at 6bp over. Luckily for the EIB and Fannie Mae, if one accepts Mooyart’s data, these are one-off bad deals.
With so many banks competing, they are willing to undercut to be able to win a deal or give back to the issuer some or all of their fees, even if that means pricing is too aggressive. One syndicate head mentions a Deutschmark deal for the EIB earlier in the year: “The EIB insisted on 9bp over Bunds at a time when the proper market price was at 15bp or 16bp. But the bank would not budge, and some houses went away and eventually convinced themselves that maybe they could do it at 9bp.”
If banks will swallow losses by giving back fees and pitching tighter than might be prudent, how does an issuer decide when to say no? For one lead-manager, “no” rarely seems on issuers’ lips: “Issuers aren’t concerned with the long term at the moment. And why should they be when we’re almost selling our souls for them. As far as they’re concerned, when the soup’s good, you keep eating it.” Antony Currie
