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Thursday, 19 October 2017

Ukraine's false economy

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A deteriorating market backdrop has not prevented certain EEMEA sovereigns from squeezing the best possible terms out of banks, which are desperate to get on deals, despite obvious financial risks to both sides. Ukraine and Romania continue to mandate on a lowest fees basis, a strategy that more sophisticated issuers rejected years ago. John Weavers reports.

In May JP Morgan, Morgan Stanley and VTB Capital secured the “honour” of arranging the next Ukraine sovereign Eurobond. However, the three banks had to pay up for the privilege: Kiev has once again mandated bookrunners on a lowest fee basis, a policy that proved a false economy before, and may do so again.

Prime Minister Mykola Azarov declared that the government had “selected the most beneficial proposal for us with optimal parameters”. But Kiev clearly based its decision on the lowest fees offered. This is despite Ukraine’s own experience in May 2008. On that occasion its Finance Ministry boasted that it had hired BNP Paribas, JP Morgan and Standard Bank to arrange a US dollar benchmark for zero fees – a deal that was subsequently pulled when market conditions deteriorated.

This year, the ministry established two qualifying criteria to win its mandate: fee size and US dollar EM sovereign track records in 2009–10. In reality, only the first criterion that mattered. Three leading EM houses – Citigroup, Credit Suisse and Deutsche Bank – formed a consortium that had together issued more than US$30bn of sovereign Eurobonds since January 2009, or 35.2% of total supply. This was more than double the amount the three successful bidders’ consortium had managed (US$12.2bn, or 14.4%). But they offered to arrange the transaction for three cents. JP Morgan, Morgan Stanley and VTB Capital offered a zero fee option, and so won the mandate.

At least on this occasion – unlike in 2008 – Ukraine has agreed to meet bookrunners’ expenses, including travel costs that could exceed US$250k.

Origination managers away from the deal insist that lowest fee mandates represent a false economy. It gives arranging banks little incentive to achieve the best possible pricing, or support the deal in the secondary market.

“Whatever is saved on fees would be more than lost by not securing tighter pricing than better compensated banks would achieve,” said one origination manager.

A syndication manager added: “When you are in a market where issuers are looking more than ever for secondary support, it makes no sense to pick banks that don’t even trade in the secondary. The three mandated banks are buying market share but losing market credibility.”

There is obvious danger that, as in 2008, this year’s planned supply will not see the light of day, if the pricing levels on offer to Ukraine in a very challenging market are not deemed satisfactory to the Finance Ministry. Clearly the risk of this happening is greater if the leads lack the financial incentive to price aggressively.

Many, if not most, banks pitched zero fees for the Russian sovereign’s return to the Eurobond market on April 22, when it raised US$5.5bn from a dual-tranche transaction. The four winning banks – Barclays Capital, Citigroup, Credit Suisse and VTB Capital – received five cents for their efforts, a level of compensation was deemed acceptable, given the size and prestige of the Russian transaction.

Most banks look to earn at least as much as the 10 cents Turkey typically pays for its sovereign benchmarks that are usually executed within 24 hours. South Africa paid out 25bp for last year’s 10-year print.

But Ukraine is not the only EEMEA sovereign with a reputation for overzealousness in the fees department: Romania (Baa3/BB+/BB+) paid a measly four cents for March’s delayed  €1bn five-year bond arranged by Deutsche Bank, EFG Eurobank and HSBC.  The 5.0% 2015s rallied by more than a point on the break after the bond was “safely” priced 25bp–30bp wide of the existing curve, in part arguably because of the low fees paid to the leads.

Ukraine is also in danger of repeating another mistake: it prematurely revealed tenor and yield guidelines/demands, after Azarov said the government intended to price a 10-year bond below 8%.

In June 2007, Ukraine paid the penalty for vanity pricing when it launched a downsized deal with a shortened tenor that was priced outside initial guidance. That US$500m 6.385% five-year raised less than the US$700m expected, while the tenor was shorter than the 10-year targeted.

In the event, the Treasury boxed itself in by insisting that the new bond pay less than the November 2016 issue’s 6.58% coupon. That was something 10-year paper could not deliver, despite the Ukraine’s Treasury spread tightening by almost 40bp in the seven months since the 2016 deal was launched.

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