FIG bond deal of the year: Rescap $4 billion debut bond issue

Talk about price discovery. When Rescap first considered its debut bond issue in June 2005, its borrowing team was presented with wildly conflicting opinions on what price the US-based mortgage finance company would have to pay.

“We joked at one point that you could drive an Escalade through the spread range that people were talking about,” says Louise Herrle, the corporate finance group head and treasurer of Rescap, who was hired from US agency Freddie Mac – one of the world’s largest borrowers – in September 2004 to set up Rescap’s issuing structure.

Rescap is the type of issuer that investors normally can’t get enough of – the seventh-largest mortgage originator in the US, with an investment-grade rating and paying a healthy spread to US treasuries.

But Rescap is a FIG issuer with a difference. It is 100%-owned by General Motors Acceptance Corp (GMAC), the financing arm of troubled auto manufacturer General Motors, whose financial woes had led to a downgrade to junk status in May 2005.

This inauspicious background threatened to wreak havoc with the best-laid plans of GMAC and Rescap executives. Discussions about sectioning the residential mortgage business away from GMAC had begun in the middle of 2003. Rescap was established in January 2005.

But when, in May, Rescap appointed lead managers for its debut bond, with Bear Stearns and Bank of America as global coordinators and Citigroup and JPMorgan joining them in a four-strong bookrunner group, there was still huge uncertainty about whether investors would accept the degree of separation that Rescap had achieved for its parent.

Even the rating agencies could not agree on how ring-fenced Rescap’s structure was. S&P and Fitch awarded Rescap a notching above its parent, but Moody’s gave the same rating as GMAC (which is one notch higher than GM).

The uncertainty about Rescap didn’t end there. Rescap was in effect a mortgage company owned by an auto manufacturer. As pre-marketing on the deal began, the issuer was therefore somewhere between two pricing points: Countrywide, a mortgage company in the US whose business profile was similar to Rescap, and whose bonds traded at around 80 basis points over five-year US treasuries; and GMAC itself whose spreads, in the aftermath of severe downgrades, had ballooned to above 400bps. There was uncertainty, yes, but also huge interest. One-on-one investor meetings were nothing of the sort. While such meetings usually have just a fund manager and an analyst present, a Rescap meeting usually had both the high-yield and investment-grade portfolio managers, the auto and FIG analysts, ABS analysts and fund managers, plus equity analysts looking to glean new information about the worsening situation at GM/GMAC. Each would have his or her own opinion of what price Rescap would have to pay for its deal.

Some $13.2 billion of inter-company debt proved a continuing concern, as did the possibility that GM’s difficulties were so bad that, despite the notching, Rescap could fall below investment grade.

To acknowledge the continued link to the parent, Rescap included a step-up coupon that would be activated if one or more of its ratings fell below investment grade following the offering.

For Herrle, the inclusion of the step-up was critical. “We decided to offer this clause to potential buyers before they had to ask for it. We wanted to focus the discussion on ResCap, not the bond structure. It showed investors we wanted a good relationship with them and appreciated the risks involved in the transaction.”

Still, a lot of advisers outside the lead manager group were telling Herrle to hold off from issuing as the bad news continued to flow from the parent in June. “One banker outside the group told me we could not get anything done, another said the maximum we could do was $500 million of five-year bonds at around 325bps,” she says.

But Herrle was confident the deal could go ahead. “There was plenty of intrigue about the issue, and the battle was to turn that intrigue into active participation. Once we had investors’ attention, we were sure we could convince them with the story.”

Herrle expected a five-year bond to be priced somewhere between 250bps and 300bps over treasuries. It was rather different from her Freddie Mac days, she admits, where half a basis point was the difference between success and disaster.

In the end, Rescap issued a total of $4 billion in three tranches, having generated $17 billion of orders, with the largest $2.5 billion five-year tranche priced at 262bps over treasuries. By the end of the year, these bonds had traded in to 140bps over and Rescap had returned to the market with a fixed/floating $1.25 billion three-year deal, establishing its niche in the market.