Ready! Fire! Aim!
Syndicating bond deals has always been more art than science. But it is even more a leap into the unknown these days, thanks to tighter rules on communication with investors and the growing illiquidity of secondary bond markets.
If there is one deal in 2013 which highlighted the long-running debate on bond pricing in primary markets, it was Verizon’s US$49bn multi-tranche trade in September. There’s no question that the transaction was a landmark (indeed, it has won IFR’s US Dollar Bond and North America Loan of the Year), but there’s also no doubt that money was left on the table (at least US$2.5bn).
There were good reasons for this – especially the fact that it was so large – but the deal’s pricing was seen by some as symptomatic of the current difficulties that debt capital market syndicate desks have when it comes to pricing new bonds.
“The real question for the market is about the qualitative aspects of pricing a corporate [bond] right now,” said Brendon Moran, global co-head of DCM corporate origination at Societe Generale. “It’s more about where similar deals are pricing, not the company’s own yield curve, given that liquidity in secondary markets remains weak. As a result we’re seeing a continued disconnect between spreads achieved in primary and those traded in secondary.”
But are the problems to do with modern syndication practice, regulation, a drying up of secondary trading – or a combination of all three?
Many syndicate officials blame their favourite culprit: regulation. That may be convenient, but the complaints often ring true. In particular, many lament their inability to properly communicate with investors, making the syndication process more complicated and less accurate.
This stems from a tightening of the rules surrounding communication after some investors demanded more transparency around how deals were put together. Questions were raised about the syndication process, especially around price and final guidance, with some claiming that preferential treatment was given to certain investors, who got to know more about pricing and demand.
The International Capital Markets Association responded to such complaints by limiting the information supplied by syndicate desks to so-called “chatter” and “pre-sounding” in July 2011. The intention was to limit communication of order book size and to eliminate unofficial price guidance altogether.
The aim was to level the playing field so that all investors felt they had the same information as others, but in the end, bankers and even some regulators say it backfired. The restrictions only made pricing more difficult as it became harder for syndicates to gauge market interest.
Those problems were only accentuated by the EU’s Market Abuse Directive, which contains grey areas around what is acceptable to communicate and the greater use of “wall crossing”, in which investors subject to pricing discussions can no longer trade the securities of a company that is about to issue.
“The real question for the market is about the qualitative aspects of pricing a corporate [bond] right now. It’s more about where similar deals are pricing, not the company’s own yield curve, given that liquidity in secondary markets remains weak”
“Investors don’t want to be crossed,” said one syndicate official. “It limits their room for manoeuvre if they are. And that means they are unwilling to have in-depth conversations about pricing – and we have less information than before.”
Anthony Peters, a strategist at SwissInvest and IFR columnist who sits on ICMA’s market practice committee, wishes some of the changes could be rolled back.
“The role of the syndicate used to be the intermediary between the buy- and sell-side,” he said. “Now the syndicate no longer works for investors. It works for issuers. The lack of dialogue means the syndicates have to find different ways of pricing. But they don’t know where to price deals anymore.”
Illiquid secondary markets – again something caused by greater regulation in the form of increased capital requirements for banks in the wake of the 2008 financial crisis – are another bugbear of syndicate officials and investors alike.
Illiquidity causes two problems when it comes to pricing new bonds. Most importantly, it reduces the ability of syndicate officials to use secondary trades of comparable paper as guidance to set a fair price for new bonds.
It also results in higher prices for primary bonds, because investors who can’t buy what they want in secondary are left with no choice but to bid for new paper. This technical factor can create distortions between primary and secondary market prices for exactly the same bond.
No quick fix
Views from syndicates on how to price in a less liquid secondary market vary substantially, but all agree there is no magic formula and there is some degree of shooting in the dark. The most common pricing factors bankers mention are credit quality, as good an understanding as possible of investor demand, technicals on a specific bond and comparisons versus recently priced transactions.
“Some trades are being done with a hefty new-issue premium, some others at negative premiums,” said Eric Cherpion, global head of DCM syndicate at Societe Generale. “What matters now is to be in the primary flows, this allows you to know which sectors, tenors, ratings spectrum and parts of the capital structure are in demand and also enable you to have a deep footprint with investors. This allows you to fine-tune pricing and especially the new-issue concession needed. It is only by assembling a syndicate on the same wavelength that you successfully price new issues.”
Bankers also complain that a growing problem in terms of pricing is that where once there were two to three lead managers, there are now as many as eight. Issuers are being pushed by a number of second and third-tier banks to include them on deals and are being sold on the idea that it spreads out their risk and adds more expertise and objectivity to the process. Issuers are also under pressure to share the wallet of fee business with their lenders, particularly in this climate where capital and liquidity are more expensive.
More experienced syndication managers say it has become a real nuisance and has reduced accountability. With so many managers, they argue, nobody really owns the deal. Perhaps this is just bankers not wanting to share the proceeds with rival firms, but there is broad agreement that the pricing process could be significantly simplified with fewer banks on deals.
While the general lack of liquidity in the market makes life more challenging, bankers say it remains a delicate balancing game of taking both investor demands and issuer expectations into consideration.
“A good deal is one that performs well, but not too well,” said Fred Zorzi, global co-head of DCM syndicate at BNP Paribas. “It’s good for the issuer who gets a good price, and for an investor who can generate a profit. If it is performing too well, then sometimes the syndicate has got it wrong. But often a deal will perform based on technicals, nothing to do with the initial launch spread. The price where US$1m trades is not the same as where you place US$5bn.”
“The most important aspect is having good knowledge of your investor base when you do an allocation. Who is active, who is long term and who is not? Most of the time the performance of a deal is dictated by the way an allocation has been done.”
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